Kathy Lien
BK Asset Management
The sharp sell-off in Chinese stocks overnight and the intraday swings in oil kept investors on their toes throughout the North American trading session. Oil ended the day higher after dropping to a low of $29.25 a barrel and this recovery helped take the market's mind off the meltdown in Asian equities. Most high beta currencies such as the Canadian, Australian and New Zealand dollars traded higher versus the greenback despite mixed U.S. data. However the buck still managed to rack up gains versus the euro, yen and Swiss Franc ahead of tomorrow's monetary policy announcement.
In the next 24 hours, two major central banks will be delivering monetary policy announcements. We start with the Federal Reserve meeting and follow with the Reserve Bank of New Zealand's rate decision. Both of these central banks have recently policy but their moves could not have been any more different. Last month the Fed raised interest rates for the first time in 9 years while the RBNZ cut interest rates for the fourth time last year. While monetary policy announcements are always important especially when they come from central banks who are considering more tightening/easing, this month's rate decisions could be far less exciting because no changes are expected. Of course monetary policy changes are not needed to ignite volatility in a currency - forward guidance can be sufficient but we don't expect a major shift in bias by either central bank.
Having only raised interest rates last month, the FOMC may feel that adjusting their forward guidance is premature especially since they didn't commit to a specific timetable for additional tightening. Adopting a less hawkish bias and then changing it later could cause more disruption to the financial markets than maintaining a steady stance and leaving the FOMC statement virtually unchanged. There are 2 non-farm payroll reports and 7 weeks between the January and March meeting, so there's plenty of time for the Fed to see how the market and economy performs before shifting their forward guidance and if they wait until March Janet Yellen could smooth the reaction through her press conference.
So the best way to trade the FOMC rate decision is to wait. If the Fed grows less hawkish, USD/JPY will be a sell for a move towards 117. If they maintain their stance and USD/JPY rallies to 119.50 or higher, it will be an attractive short as there is no doubt in our minds that the pace of tightening will be slowed by recent market developments. As we indicated in yesterday's note, there's enough improvement in the U.S. economy since the last meeting for policymakers to still considering tightening in March. At the same time weakness in retail sales, average hourly earnings, manufacturing and service sector activity along with GDP are all reasons for waiting. With 7 weeks and 2 non-farm payrolls reports between the January and March meetings, we believe the Fed will reserve judgment for the time being.
New Zealand has a lot more to worry about than the U.S. because of its reliance on China and the sharp decline in consumer prices. However as shown in the table below there has been nearly as much economic improvement as deterioration since the December meeting. Service and manufacturing activity expanded at a faster pace helping to boost business confidence. GDP growth also picked up in the third quarter and even though CPI was lower, the decline in food and commodity prices eased. There's no question that New Zealand's economy faces serious challenges and the RBNZ may need to lower rates again in 2016 but having just said their inflation target can be achieved with current policy, Wheeler may opt to maintain a steady stance in light of stronger economic activity. So the best way to trade the RBNZ rate decision is to sell the post RBNZ rally because at the end of the day, there's more pressure on New Zealand's economy.
Commodity currencies performed extremely well today with AUD, NZD and CAD enjoying strong gains. However Australian consumer prices are scheduled for release tonight and between the slide in Chinese stocks and the decline in commodity prices at the end of last year, the rally in AUD could run out of steam. The Canadian dollar on the other hand is enjoying strong gains on the back of rising oil prices. There's been a significant amount of daily and intraday volatility in oil - today prices closed sharply higher after falling to $29.25 a barrel. The initial decline was driven by concerns about China and the recovery was fueled by comments from Iraq's oil minister who said Saudi Arabia and Russia have become more flexible on making production cuts. While it remains to be seen whether this is really true, it is becoming increasingly clear that oil is finding support between $26 and $30 a barrel. We have been looking for USD/CAD to drop to 1.40 and if oil continues to recover, this target could be reached in days.
There's also been a lot of talk about Japan - some reports suggest that they could ease further but policymakers such as Japan's Hayashi believe the BoJ has less room to ease than others. We are not looking for the Bank of Japan to increase QE at this week's meeting but they may be increasingly willing to do so.
Sterling also traded sharply higher against the greenback today despite dovish comments from Bank of England Governor Carney. He said conditions are not yet in place for a rate increase and in order for rates to rise, above trend growth and unit costs pickup is needed. Investors have already come to terms with the idea that the BoE will probably forgo raising interest rates in 2016 and while we believe there's scope for further losses in sterling, risk appetite drove sterling higher today.
Finally euro ended the day virtually unchanged against the U.S. dollar. No economic reports were released this morning with only German consumer confidence being the only noteworthy release on tomorrow's calendar. While ECB dovishness should keep the euro under pressure, the FOMC announcement will determine how EUR/USD trades for the rest of the week.
In the next 24 hours, two major central banks will be delivering monetary policy announcements. We start with the Federal Reserve meeting and follow with the Reserve Bank of New Zealand's rate decision. Both of these central banks have recently policy but their moves could not have been any more different. Last month the Fed raised interest rates for the first time in 9 years while the RBNZ cut interest rates for the fourth time last year. While monetary policy announcements are always important especially when they come from central banks who are considering more tightening/easing, this month's rate decisions could be far less exciting because no changes are expected. Of course monetary policy changes are not needed to ignite volatility in a currency - forward guidance can be sufficient but we don't expect a major shift in bias by either central bank.
Having only raised interest rates last month, the FOMC may feel that adjusting their forward guidance is premature especially since they didn't commit to a specific timetable for additional tightening. Adopting a less hawkish bias and then changing it later could cause more disruption to the financial markets than maintaining a steady stance and leaving the FOMC statement virtually unchanged. There are 2 non-farm payroll reports and 7 weeks between the January and March meeting, so there's plenty of time for the Fed to see how the market and economy performs before shifting their forward guidance and if they wait until March Janet Yellen could smooth the reaction through her press conference.
So the best way to trade the FOMC rate decision is to wait. If the Fed grows less hawkish, USD/JPY will be a sell for a move towards 117. If they maintain their stance and USD/JPY rallies to 119.50 or higher, it will be an attractive short as there is no doubt in our minds that the pace of tightening will be slowed by recent market developments. As we indicated in yesterday's note, there's enough improvement in the U.S. economy since the last meeting for policymakers to still considering tightening in March. At the same time weakness in retail sales, average hourly earnings, manufacturing and service sector activity along with GDP are all reasons for waiting. With 7 weeks and 2 non-farm payrolls reports between the January and March meetings, we believe the Fed will reserve judgment for the time being.
New Zealand has a lot more to worry about than the U.S. because of its reliance on China and the sharp decline in consumer prices. However as shown in the table below there has been nearly as much economic improvement as deterioration since the December meeting. Service and manufacturing activity expanded at a faster pace helping to boost business confidence. GDP growth also picked up in the third quarter and even though CPI was lower, the decline in food and commodity prices eased. There's no question that New Zealand's economy faces serious challenges and the RBNZ may need to lower rates again in 2016 but having just said their inflation target can be achieved with current policy, Wheeler may opt to maintain a steady stance in light of stronger economic activity. So the best way to trade the RBNZ rate decision is to sell the post RBNZ rally because at the end of the day, there's more pressure on New Zealand's economy.
Commodity currencies performed extremely well today with AUD, NZD and CAD enjoying strong gains. However Australian consumer prices are scheduled for release tonight and between the slide in Chinese stocks and the decline in commodity prices at the end of last year, the rally in AUD could run out of steam. The Canadian dollar on the other hand is enjoying strong gains on the back of rising oil prices. There's been a significant amount of daily and intraday volatility in oil - today prices closed sharply higher after falling to $29.25 a barrel. The initial decline was driven by concerns about China and the recovery was fueled by comments from Iraq's oil minister who said Saudi Arabia and Russia have become more flexible on making production cuts. While it remains to be seen whether this is really true, it is becoming increasingly clear that oil is finding support between $26 and $30 a barrel. We have been looking for USD/CAD to drop to 1.40 and if oil continues to recover, this target could be reached in days.
There's also been a lot of talk about Japan - some reports suggest that they could ease further but policymakers such as Japan's Hayashi believe the BoJ has less room to ease than others. We are not looking for the Bank of Japan to increase QE at this week's meeting but they may be increasingly willing to do so.
Sterling also traded sharply higher against the greenback today despite dovish comments from Bank of England Governor Carney. He said conditions are not yet in place for a rate increase and in order for rates to rise, above trend growth and unit costs pickup is needed. Investors have already come to terms with the idea that the BoE will probably forgo raising interest rates in 2016 and while we believe there's scope for further losses in sterling, risk appetite drove sterling higher today.
Finally euro ended the day virtually unchanged against the U.S. dollar. No economic reports were released this morning with only German consumer confidence being the only noteworthy release on tomorrow's calendar. While ECB dovishness should keep the euro under pressure, the FOMC announcement will determine how EUR/USD trades for the rest of the week.
-------
Who were the best experts in 2015? Have your say and vote for FXStreet's Forex Best Awards 2016! Cast your vote now!
-------
Past performance is not indicative of future results. Trading forex carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade any such leveraged products you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading on margin, and seek advice from an independent financial advisor if you have any doubts.
Recommended Content
Editors’ Picks
EUR/USD stays below 1.0700 after US data
EUR/USD stays in a consolidation phase below 1.0700 in the early American session on Wednesday. The data from the US showed a strong increase in Durable Goods Orders, supporting the USD and making it difficult for the pair to gain traction.
USD/JPY refreshes 34-year high, attacks 155.00 as intervention risks loom
USD/JPY is renewing a multi-decade high, closing in on 155.00. Traders turn cautious on heightened risks of Japan's FX intervention. Broad US Dollar rebound aids the upside in the major. US Durable Goods data are next on tap.
Gold trades on the back foot, manages to hold above $2,300
Gold struggles to stage a rebound midweek following Monday's sharp decline but manages to hold above $2,300. The benchmark 10-year US Treasury bond yield stays in the green above 4.6% after US data, not allowing the pair to reverse its direction.
Worldcoin looks set for comeback despite Nvidia’s 22% crash Premium
Worldcoin price is in a better position than last week's and shows signs of a potential comeback. This development occurs amid the sharp decline in the valuation of the popular GPU manufacturer Nvidia.
Three fundamentals for the week: US GDP, BoJ and the Fed's favorite inflation gauge stand out Premium
While it is hard to predict when geopolitical news erupts, the level of tension is lower – allowing for key data to have its say. This week's US figures are set to shape the Federal Reserve's decision next week – and the Bank of Japan may struggle to halt the Yen's deterioration.