FxPro Forex Analysis: Dollar suffering into month end

We mentioned in the daily the risk of some more choppy trading into month-end, which is proving to be the case. Both sterling and the Aussie are fairly buoyant, with cable above the 1.71 level and also the euro up to near 1.37. It's not wise to attach too much significance to these moves, but it's notable that we are seeing dollar weakness into the end of the half year that had so much hope for dollar strength.


FxPro Forex Analysis: The dollar – struggling

The following is an extract from our quarterly outlook, published 23rd June 2014. We've included our table of forecasts at the foot of the blog. As mentioned before, we were not great buyers of the secular dollar bull trend for 2014. That view still holds and has been enhanced by subsequent events, principally the weaker economy and stronger pound. We’ve talked a lot in recent years about the change in dynamics surrounding FX markets. The “risk-on, risk-off” mantra that went by the wayside two years ago now, the shorter trends on major currencies and also the reduced impact of quantitative easing measures (see for example “From RORO to MoRO”). We still expect to see the dollar gain through the latter half of 2014, but the gains are likely to be modest. On average, we’ve seen the dollar index trade an absolute annual range of around 8% (peak to trough) in recent history. This year, the range has been less than 3%. We were looking for an increase in the dollar index of around 4% for the year as a whole (currently 0.5%) and this is now likely to be more like half of this, given our underlying forecasts. The Fed will continue with the current pace of tapering, but will keep their powder dry in relation to the tightening of policy. Another factor constraining the dollar this year has been the fall in bond yields. Asset market dynamics will continue to be a factor in the dollar’s fate. The debate as to where the greater valuation risks lie will continue, but both a fall in stocks and more so a bond market sell-off will have dollar positive implications. Source: FxPro Internal Predictions


FxPro Forex Analysis: Half time

We enter the last trading day of the quarter and also half year end. This creates some risk of greater volatility as bigger players square positions into month end and also from hedge adjustments from the benchmarked community. Fittingly, the dollar index is virtually unchanged from its closing level of last year, both reflecting the quashing of expectations for a period of dollar strength and the lack of volatility that has beset FX markets over the past few months. For a more detailed review of the year so far, see our blog “The year so far” and subsequent ones this week detailing our outlook for major currencies for the remainder of the year. There is a reasonable focus on the ECB this week, with the policy meeting on Thursday and inflation data today. The latter is seen steady at 0.5%, but the real issue is the low and also negative inflation rates being seen in the Eurozone periphery. Ironically, this is part of the cure to the rise in prices and loss of competitiveness from years of above average inflation, but for now it’s proving to be a painful one. We don’t expect to see further policy announcementsfrom the ECB this week, but the market will be keenly listening for further hints of possible asset purchases. So far, we are seeing a stronger dollar at the start of the European session, the Aussie and sterling taking more of the selling pressure. Further ahead, sterling still looks the more interesting major currency for the second half of the year, but the stronger dollar remains across this and other majors.


Weekly Look Ahead 27th June


FxPro Forex Analysis: Watching the yen

The yen has strengthened overnight to push to 5 week lows on USDJPY. Inflation data was broadly in line, with prices rising 3.7% on an annual basis. Recall that this has been boosted by the consumption tax increase which took effect earlier in the year. The 21st May low of 100.82 is now in focus, with this seen a strong area of support, together with the early Feb low of 100.76. The risk is that we see some further covering of yen shorts into month end as more short positions are forced to bail ...


FxPro Forex Analysis: The volatility conundrum

The following is another extract from my half year outlook, completed 23rd June. As we head into the half year end, the lack of volatility in markets is one of the defining factors for pretty much all asset classes. For FX, we’ve seen declines in both intra-day ranges and by design implied volatility in the options market. At the same time, bonds have rallied, both in the US (on the back of the weaker economy) and also peripheral Europe. Italian yields were on a par with UK yields mid-June. Even short-dated German government paper is at a real risk of seeing negative yields once again (as happened in 2012 and the first half of 2013). The reasons are plentiful, not least the lack of policy action from central banks, together with the reduced effectiveness of current policies that have been running (on and off) for several years now. Furthermore, forward guidance has meant that markets have placed a lot of faith in central banks and put little risk of them actually being incorrect in their ability to keep rates low for an extended period. The parallels with 2007-08 have already been made, but are pertinent. Back then, there was an over-reliance on the ability of central banks to deliver non-inflationary growth and the financial system to adequately price and diversify risk. The fact that the latter two assumptions proved to be incorrect, primarily in relation to sub-prime mortgages in the US, but also elsewhere (e.g. peripheral yields in Europe), was one of the primary catalysts of the global crisis that followed. This is not to say that we are heading for a similar scenario now, but the under-pricing of risk in general, and the stretched valuations on assets, should not be ignored. There are two potential catalysts to greater volatility. The first is that there is a rush for the exits, combined with lower liquidity, that arises from the current valuation of equities and other asset markets. The second is greater action, or potential action from central banks, together with less guidance from them on the likely future direction of policy. We are potentially seeing this shift in the UK (more on this below), which has already been felt on sterling, both in term of actual volatility and also options pricing, with premiums rising as a result. Before Carney spoke in June, suggesting that the market was under-estimating the chance of a rate hike this year, I was of the view that the Bank’s stance was becomingly increasingly flawed in trying to guide the market (see "Killing Forward Guidance" from May).


FxPro Forex Analysis: Bank of England bares teeth

Leaving aside Suarez references for now, the Bank of England has today taken the opportunity to bare its teeth in the new power given to it under the guise of the Financial Policy Committee (FPC). Previously, the Bank monitored financial stability and conditions, but did not have the power to take action. That changed post-financial crisis, with the FPC given macro-prudential tools to tackle perceived financial excesses or potential issues. The measures announced today are seen as insuring against the “risk of a marked loosening in underwriting standards and a further significant rise in the number of higher indebted households”. These include assessing affordability in the first five years of the loan were rates to rise 3% higher than that prevailing at the time of origination. Furthermore, the PRA and FCA have been tasked with ensuring that mortgage lenders limit the proportion of mortgages at load to income multiples of 4.5 and above to no more than 15% of new mortgages. So why is sterling higher? Two things; earlier this month at his Mansion House speech, the Bank of England governor stated that “macro-prudential policy is not a substitute for monetary policy” and further added that if it is used for insurance (as today’s measures have been described), then “it won’t necessarily affect the path of interest rate increases”. The Governor also stated in the press conference today that these measures don’t reverse activity and don’t slow the economy. Secondly, today is being taken as a sign of a Bank not shy of taking action and the market has become more sensitive to the possibility of an early interest rate increase. This can be seen in interest rate futures (short sterling) and also 2 year yields, both of which were pretty much unmoved by the Treasury select committee hearing earlier this week and today are pricing in an earlier rate increase than before.


FxPro Forex Analysis: The year so far

This is the first of several blogs for my half year review and look ahead. This is more looking back, but nevertheless this is always an important part of this. Looking back at what you got right (and if it was for the correct reasons) and also what you go not so right. The subtitle to our 2014 dollar outlook ‘subtly stronger’. The first half of the year stretched the definition of subtle to the limit (dollar index up just 0.3% to 23rd June) and the dollar did not wholly perform in the way we envisaged, but we were correct in saying we were not heading for a “secular dollar bull market as the Fed starts tapering”. The disappointing performance of the US economy was the key driver of the dollar early on, but underlying this was the fact that the relationship between quantitative easing dynamics (in this case the tapering of bond purchases) and the dollar was a lot weaker than was the case in the early days of the financial crisis. As such, we found the “tapering = firmer dollar” mantra as flawed in its approach. On the majors, our biggest miss was the Aussie and yen (0.85 and 107 for end Q2) . Even though we recognised that the Aussie was far less correlated with China, the domestic economy and the shift in stance from the RBA were the key drivers to the strength, together with the generalised search for yield as volatility was crushed to multi-year lows across most asset classes. As for the yen, we were added to the pile of other forecasters who have tried and failed to fully rationalise the Japanese currency. We were closest on the euro, although not quite achieving our end Q1 target of 1.41 (end Q2 1.38). Back in December, the market (Bloomberg survey of forecasts) was looking for EURUSD at 1.30 by mid-year, reflecting the view that further easing and deflation were set to weaken the single currency. The sterling strength we were envisaging for Q1 did happen and more rapidly than we anticipated. The surprise was the shift in interest expectations into the end of Q2, with Carney indicating a potential rate rise by the end of the year, a view which we took on board before his speech and continue to believe will come to fruition. The market was looking for cable at 1.60 by the end of Q2, so we were on-side (seeing 1.63) vs. the market, but some way off the reality (only 2 of 70 forecasters saw above 1.66). The other development, that did have implications for FX, was the collapse in volatility and also bond yields during the first half of 2014, especially in the eurozone periphery. The fall in volatility was caused in part by central bank policies, including forward guidance, together with the steady and assured pace of Fed tapering.


FxPro Forex Analysis: Watching sterling

Looking at the net change of the dollar index, the dollar seems to be just about holding its head above water so far this year. Yesterday’s further downward revision to US GDP for the first quarter was a further blow to the notion that differing policy cycles would provide support through most of 2014. From here, it’s a case of the durability of the recovery from the Q1 weakness, but also the extent to which the dollar is able to stand apart from the crowd. Against the euro, that’s still possible given the easing put in place by the ECB earlier this month. Against sterling it’s going to be harder, given the indication from the BoE that the first tightening move may come earlier than previously thought. On sterling, we could get a better steer on this today, with the release of the results of last week’s financial policy committee meeting. Before the financial crisis, the central bank was pretty toothless when it came to financial stability issues. Since then, new powers are designed to rein back financial excesses before they impact the economy. There are thoughts this could well happen today, with some restriction on mortgage lending or possibly capital requirements against it. If seen, these could well soften the currency, on the basis that such measures would be seen as making an interest rate increase less likely. Details are expected to be announced around 09:30 GMT. Overall, FX has been steady overnight, but cable has nudged upwards the 1.70 level again, with the Aussie also finding some support above the 0.94 area. US claims data the main focus later on, together with income and spending data, but no major changes on the dollar tone anticipated.