No OPEC Action could trigger a fresh rally in USD against majors

NO OPEC action, a widely expected outcome of the meet today, may result into a fresh rally in the US Dollar against the majors – especially EUR, GBP and AUD

The fall in October was driven by Deflation fears

The sharp rise in the market volatility in advanced economies witnessed in October this year was mainly driven by deflation fears due to falling energy prices. Moreover, in October, Crude prices were down more than 25% from June highs.

Following the concerns of deflation in October, the Bank of Japan surprised markets with expansion of monetary stimulus, while the Bank of England turned ultra-dovish in the quarterly inflation report. Meanwhile, the European Central Bank is on the verge of announcing sovereign bond purchase program. Amid, these dovish central banks, the Federal Reserve ended its monthly QE program.

If the OPEC fails to put a floor under Crude prices

• A further fall in Crude prices to USD 60/barrel as widely expected shall renew concerns of deflation in the advanced economies.

• A further fall in inflation expectations shall mean that the major central banks ex-Fed shall have more room to delay interest rate hikes and/or implement more aggressive measures stimulus measures.

• However, the Federal Reserve would still be considered relatively hawkish, since the US CPI failed to decline from 1.7% in October despite slumping energy prices.

The 10-yr Bond yields in Germany, UK and US

• German ten-year Bund yields hit a record low of 0.709% today on the increased probability of sovereign bond purchases by the ECB

• The UK ten-year Gilt yields declined from 2.27% to 2.00% post the release of the dovish quarterly inflation report earlier this month. The BOE governor Mike Carney has stated a high possibility of inflation falling below 1% in the next six months. The dovish report pushed rate hike expectations to late 2016 or early 2017.

• Meanwhile, bond yields in the US are comparatively more steady around 2.25%-2.4%.

Bond yields may slip further if Crude declines

The current action indicates that the markets have priced-in more aggressive stimulus from the ECB and the delay in the rate hike in the UK. On similar lines, the Bank of Japan is likely to stay quiet for at least another six months after announcing a surprise stimulus expansion on Oct. 31.

However, if the OPEC does not announce an output cut today, the yields in the Eurozone, UK, and the US would again start pricing-in deflation concerns. Again, the Treasury yields are likely to be more resilient since the market expects Fed to make a first move with respect to raising interest rates.

Currencies that may see a fresh sell-off against the USD

• EUR, GBP, AUD and other currencies vulnerable to falling inflation expectations are likely to be the biggest losers against the USD

• However, the Japanese Yen is likely to gain strength since falling Crude shall reduce the trade deficit. The inflation expectations would also fall, however, the Bank of Japan is likely to remain silent for next six months.

• On similar lines, other Asian currencies will benefit from falling Crude prices.

To conclude

• Expect the USD to rally against the majors after a week’s time as markets begin pricing-in the falling inflation expectations due to further weakness in Crude

• If crude prices stabilize, US Dollar risks sharp correction against majors

• In case No OPEC action leads to sharp fall in Crude, the worst performers are likely to be Yen crosses – EUR/JPY, GBP, JPY, AUD/JPY and the best performers are likely to be Asian currencies against EUR, GBP.