As I wrote in yesterday's FX newsletter, traders should prepare for a pivotal week in the foreign exchange market with both the BoJ and the Fed holding important policy meetings.
Judging by the major banks' research reports, most analysts expect the BoJ to attempt to steepen the JGB yield curve, but the effect that would have on the JPY remains open to interpretation. It will perhaps be more crucial that the BoJ can convince the market that it is not running out of options to step up its easing measures if required, but that will be a tough task to achieve without support from Japan's Ministry of Finance. While I expect JPY strength to come to an end soon, the Japanese currency remains supported by the unwinding of carry trades and next week's central bank meetings will provide plenty of downside risk for my base scenario. Given this uncertainty, I'm afraid USDJPY might test the 100 level if neither the BoJ nor the Fed can reintroduce JPY weakness and USD strength, respectively. I hold a USDJPY long position with a S/L just below 100 and a short-term target at 105.
Speaking of the Fed, don't expect too much from Yellen & Co.! A rate hike would be a big surprise that would push EURUSD below 1.10 and USDJPY above 105, but the more likely scenario is that the Fed will (once again) not hike and merely introduce a slightly more hawkish tone to its statement instead. Although that should signal perhaps one rate hike by the end of the year, it will not be broadly USD-supportive and thus the risk of temporary EURUSD and USDJPY volatility without a sustainable breakout from recent price channels remains high, i.e. there will be a lot of risk in the market but the likelihood of an adequate compensation for that risk remains relatively low. Risk-averse traders will remain on the sidelines. Those open to more speculative positions will put on EURUSD short, GBPUSD short and USDJPY long trades.
Yesterday's FOMC statement contained mixed signals with regard to the US dollar's future path. While the Fed "dots" were rearranged in a slightly more hawkish way, the wording in the statement itself did not change drastically and still contains many dovish references, including the oft-cited phrase that the federal funds rate will stay low for a "considerable time" after asset purchases end.
We retain our EURUSD short and USDJPY long views, targeting $1.25 and Y110 respectively. However, we choose to wait for a correction in USDJPY before entering into a new long trade after having taken profits yesterday.
The USD has posted impressive gains against most currencies during the past four weeks and just bounced off some year-to-date highs in most cross rates. The USDJPY rate climbed more than 6% since mid-July and currently trades at 107.09. The YTD high is at 107.39 and was reached on 12 September.
We advise to take profits in USDJPY ahead of this week's FOMC meeting, but note that we are inclined to open new USD long positions around 105.90 and again at 105.00 in case of USD dips. If the FOMC surprises on the hawkish side, we will go long USDJPY immediately.
This week's event risk aside, our long-term expectation for the two currencies remains unchanged: USD long and JPY short.
Much to its embarrassment the Federal Reserve had to admit on Wednesday that it had released its March 19-20 FOMC minutes to about 100 lobbyists on Tuesday afternoon, one day before the official release date. As of now, it is not known whether there has been any trading based on information from the leaked document. The minutes have now been posted on the Fed's website.
From what I understand, the wording is still rather neutral without any specific hints at the future direction of the Federal Reserve's asset purchases. According to the minutes, few FOMC members think the programme's costs begin to outweigh its benefits and would hence prefer to reduce asset purchases sooner rather than later:
The staff provided presentations covering the efficacy of the Federal Reserve's asset purchases, the effects of the purchases on security market functioning, the ways in which asset purchases might amplify or reduce risks to financial stability, and the fiscal implications of purchases. In their discussion of this topic, meeting participants generally judged the macroeconomic benefits of the current purchase program to outweigh the likely costs and risks, but they agreed that an ongoing assessment of the benefits and costs was necessary. (...) However, a few participants were not convinced of the benefits of asset purchases, stating that the effects on financial markets appeared to be short lived or that they saw little evidence of a significant macroeconomic effect. (...) In light of their discussion of the benefits and costs of asset purchases, participants discussed their views on the appropriate course for the current asset purchase program. A few participants noted that they already viewed the costs as likely outweighing the benefits and so would like to bring the program to a close relatively soon. A few others saw the risks as increasing fairly quickly with the size of the Federal Reserve's balance sheet and judged that the pace of purchases would likely need to be reduced before long. Many participants, including some of those who were focused on the increasing risks, expressed the view that continued solid improvement in the outlook for the labor market could prompt the Committee to slow the pace of purchases beginning at some point over the next several meetings, while a few participants suggested that economic conditions would likely justify continuing the program at its current pace at least until late in the year.
It is always difficult to interpret the wording of central bank releases, which mostly try to be as neutral as possible in order to avoid introducing excess volatility, but at least there seems to be consensus among the majority of FOMC members that the Fed's quantitative easing programme should be reconsidered over the course of this year. Depending on the further development of macroeconomic indicators, such as an improvement in the next US payrolls data, it is quite possible that the asset purchases will slowly be reduced within the next two quarters. For the time being, currency traders need not fear a sudden end of QE, but in the medium term the Federal Reserve may begin to change course and thereby put pressure on EUR/USD while supporting the upward momentum of USD/JPY.
Stock markets are down worldwide today after yesterday's Federal Open Market Committee (FOMC) June meeting and the release of its economic projections (PDF). The Federal Reserve projects unemployment in the U.S. to be high through the year 2013, when it should be 7 to 7.5 per cent, according to the Fed's latest estimates (this is up from last month's projections of 6.8 to 7.2 per cent). The wide range of projections even suggests the unemployment rate to be between 6.5 and 8.3 per cent (see image from the FOMC report below).
I think it's unsettling that unemployment is likely to remain that high until at least seven years after the start of the recession! Investors will be thinking the same, as suggested by international stock markets today. It certainly didn't help that Federal Reserve Chairman Ben Bernanke didn't hint at potential new steps to boost economic growth. Apparently, Mr Bernanke believes the current slowdown of economic growth to be temporary. Therefore, the central bank, which is ending its $600bn bond-buying program at this inauspicious time, will remain on hold for at least two more months before deciding about further interventions. Interestingly, the Dow Jones index temporarily jumped up yesterday right after a tweet by PIMCO's Bill Gross saying that August would likely bring first hints at QE3. However, as soon as the FOMC published its downgraded economic outlook for the US, markets turned down again.
Today's losses in Europe could also be due to profit taking after mostly good stock market performances on Tuesday. Charts below the fold. Continue reading "Stock Markets Down on Fed Projections"