Dollar jumps on increased Fed rate expectations

Yesterday, counting down to the Fed policy decision was still the name of the game. EUR/USD was under slight upward pressure; USD/JPY was little changed in the low 107 area. The Fed policy statement was balanced. The Fed maintained the ‘considerable period of time phrase. At the same time the interest rate projections of the individual Fed members showed an interest rate path that is well above market expectations and higher than in June. This triggered a moderate rise in US bond yields, but the reaction of the major dollar cross rates was much more pronounced. Equities even ended about unchanged. USD/JPY was already in very good shape of late and the pair easily settled above the 108 barrier. The dollar also made significant gains against the euro with EUR/USD testing the previous low in the 1.2860 area.
For an in depth analysis of the Fed policy decision see our KBC Flash report

Overnight, most Asian equities trade in positive territory after the Fed policy decision, but the gains are very moderate, too. Japan outperforms on back of the USD/JPY rally, but even there, there is no euphoria. The dollar remains well bid with USD/JPY changing hands in the 108.75 area. EUR/USD set a minor new correction low but is still testing the 1.2860 support.

Today, there are few economic data in Europe, but the ECB will hold the first auction under its no T-LTRO framework. On the basis of the outcome of the auction, markets will make up their mind whether the ECB will be able to raise its balance sheet back to the 2012 level. The rise in the balance sheet is an important driver for a further decline of the euro. However, it is not clear how the currency market will react in case of disappointing bank participation in the TLTRO. At first sight, a lack of balance sheet expansion should be a positive for the euro. However, a (big) part of the market may think the ECB will be forced to full blown QE (including government bonds). For now, the working hypothesis remains that any upside of the euro due to this issue is limited. In the US, the initial jobless claims, the housing starts & permits and the Philly Fed business outlook will be published. Yellen yesterday stressed that the Fed is very much data dependent. This could make the (currency) market quite nervous in case of deviations from consensus. We see a slight asymmetrical risk. The reaction of the dollar might be a bit more pronounced in case of strong data than in case of below-consensus data.

From a technical point of view, USD/JPY extends its rally after the break of the key 105.44 resistance. The Fed statement was balanced, but the rate projections suggest that the dollar might get additional interest rate support in the short-to-medium term. At the same time, the yen remains in the defensive as markets see a decent chance of more BOJ easing down the road. We maintain a positive bias on USD/JPY. 110.66 is the next important resistance.

The technical picture of EUR/USD deteriorated substantially after the break below the key 1.3105 level (Sept 2013 low). This level is now the new resistance that will be difficult to regain. The negative deposit rate is a structural negative for the euro. The Fed communication was not that hawkish, but the difference in policy bias and projections of higher official interest rates keep the dollar well bid. In a longer term perspective, the EUR/USD downtrend is confirmed. 1.2755/1.2662 is the next key support. A more pronounced correction (EUR/USD rebound), is an opportunity to add to EUR/USD short exposure. The recent consolidation helped the mark to digest the post-ECB decline, but the pair is still in oversold territory.

Sterling positioned for a no vote?

Yesterday, sentiment on sterling improved further as new opinion polls still indicated a marginal lead of the ‘no side’ in the Scottish referendum. This gave sterling bulls some comfort (or triggered some scaling back of sterling short positions). The UK labour market report was slightly better than expected but the tone from the BoE minutes remained rather soft, even as two members voted again in favour of a rate hike. The rally of sterling slowed a bit after the minutes; Even so, cable returned to the mid 1.63 area. EUR/GBP tested the 0.79202 area ahead of the Fed. After the Fed policy decision, the dollar rose across the board but cable clearly outperformed EUR/USD. EUR/GBP dropped to the 0.79 area. Cable returned to the mid 1.62 area.

This morning, the outperformance of cable against EUR/USD continues pushing EUR/GBP within reach of the 0.7874 support. Later today, the UK retail sales and the CBI industrial trends orders will be published. In normal circumstances, the retail sales have market moving potential. This time, the reaction is still hampered by the uncertainty on the outcome of the Scottish referendum. At this stage, it looks that sterling investors are not that worried on a no-vote anymore. So, there could be a moderate positive reaction in case of good data.

The outcome of the referendum remains a binary risk. We might see some strange swings between now and the publication of the result, probably tomorrow morning. It looks that GBP is positioned for a no vote.

Uncertainty on the referendum after the recent opinion polls made us change our ST bias on sterling last week. We removed our sell-on-upticks bias for EUR/GBP and installed stop loss protection on GBP-longs (both against USD and EUR). After a correction last week, sterling reversed all its losses against the euro and is looking for a bottom against an overall strong dollar. We stay on the side-line until the referendum is out of the way. Given recent sterling optimism, the sterling reaction will be much more pronounced in case of a yes compared to a no-vote.