FX Volatility Picks Up, But Stories Remain the Same

After days of consolidation we have finally seen a pickup in volatility in the forex market. Sterling dropped to a 2-week low before reversing sharply to end the day with mild losses.USD/JPY jumped to a 2-month high, USD/CHF rose to a 7-month high and EUR/USD found its way back to 1.09 after dropping to a 7-month low.  The U.S. dollar held steady or traded lower against most of the major currencies as U.S. rates refused to rise. A surprisingly large decline in consumer confidence put pressure on the dollar even as S&P CaseShiller reported an uptick in house prices, the Richmond Fed reported an improvement in manufacturing conditions and the IBD/TIPP economic optimism index ticked higher.  While Treasury yields dropped slightly, Fed fund futures increased with the market now pricing in a 74% chance of a rate hike in December, up from yesterday's 70% chance.  Wednesday's trade balance, Markit PMI services and new home sales reports should have a limited impact on the dollar as investors watch yields and the reversals in euro and sterling.

The big story today was the sharp intraday reversals in European currencies.  The wildest swings were seen in GBP/USD whose range expanded to 160 pips, nearly double its average daily range the four days prior.  With no U.K. economic reports released the focus was on Bank of England Governor Mark Carney's comments. Sterling crashed in the lead up to his speech but when he said "monetary policy can't do everything," they are "not indifferent to the moves in the pound" and there are "limits to MPC willingness to look through CPI overshoot," sterling soared.  Cable traders needed an excuse to cover their short positions and they found just that in Carney's comments today. However we don't think it changes anything. Brexit is still the big story and a hard Brexit would certainly force the central bank to put growth ahead of inflation.  But right now, it seems that Prime Minister May is willing to give Parliament a say which means that Brexit will come slowly.  Sterling is still a sell but we may see more short covering that takes GBP/USD to 1.23 before sellers jump back in again.

The euro traded as low as 1.0850 today and as high as 1.0905. While this range is extremely narrow, it is encouraging that the pair ended the day well above its 7 month low. Today was also the first positive day for EUR/USD in more than a week. German business confidence improved in the month of October, which is not surprising given the uptick in manufacturing and services activity.  However it was the fall in the U.S. dollar and the comments from ECB President Draghi that took EUR/USD higher. Investors were relieved that Draghi did not press the idea of more stimulus. Instead he said monetary policy is working as expected, warned that low rates are not costless and indicated they are committed to preserving monetary stimulus. Now keeping monetary policy easy is not the same as having plans to increase bond purchases or lower interest rates.  We still think the ECB will ease but this may be enough to trigger a much relief rally in the currency especially after the recent improvements in Eurozone data.

The Australian Dollar, New Zealand Dollar and Canadian Dollars ended the day higher against the greenback. The Australian dollar was a big gainer thanks to rising gold prices.No economic reports were released from the commodity producing countries but CPI numbers are expected from Australia this evening.  Inflation numbers are always important but in the case of Australia, they will play a big role in confirming to the market whether the neutral bias of the RBA and recent gains in AUD are justified. If CPI rises, even slightly, we should see broad based gains in AUD but if they slow particularly on a year over year basis, we could see AUD/USD fall back to 76 cents.  Meanwhile USD/CAD is holding onto its recent gains despite the drop in oil prices.  In a meeting with Russian Energy Minister, Alexander Novak, Venezuela's oil minister Eulogio Del Pino proposed a production cut of 400,000-500,000 barrels per day.  At this point Russia has still made no definitive announcement regarding its oil plans. Russia appears to be willing to participate in an oil freeze but has yet to commit to a production cut. WTI crude fell below $50 per barrel on more verbal whipsawing amongst oil producers.