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Forex: Higher volatility to remain

We’ve seen an undeniable shift in sentiment over the course of the month. Markets are now a lot more focused on the risk and implications of deflation, rather than looking for more QE from the ECB to support the Eurozone and provide a further boost to sentiment and stocks. Behind this, the dynamics operating on the dollar have also shifted, not least because short-term interest rates in the US have also plummeted and bought into question the efficacy of the Fed ending its tapering program this month and also put fresh uncertainty on the ability of the Fed to increase rates next year. What we have seen is also greater volatility in FX in general, but far less one-way traffic as dominated the majors in the third quarter.

For this week, we’ve already seen a big push higher on Japanese stocks (up nearly 4%), related to further stories on the investment intentions of the main Japanese government pension fund. There has been plenty of speculation for most of this year on the impact of portfolio shifts, but for the most part this has more been speculation rather than action as the fund looks to take a less conservative approach. USDJPY has weakened overnight, but only modestly so. Elsewhere, GDP data from China will be key for risk sentiment and also the Aussie tomorrow. There is also inflation data in Australia in the middle of the week, together with the latest MPC minutes in the UK and Eurozone bank stress test results at the end of the week. Overall, greater volatility is likely to remain in place, with the downward correction of the dollar having run its course for now, but the well-worn story dollar strength on economic divergence is now looking more fragile, especially given the moves seen in market interest rates, the US 2 year bond yield having touched early March levels last week.

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