Before the Federal Reserve’s highly anticipated December FOMC meeting, which came to a conclusion on Wednesday, the dollar traded cautiously against its peers but still managed to hover within one per cent of a five-year high against the yen.
Strong economic data from the US last week reignited hopes of an imminent tapering by the Fed. Robust advance retail sales data from the world’s largest economy last week was enough to fuel talk of a reduction in its record stimulus program by the Fed. Despite a weaker initial jobless claims print, that was attributed to the effects of the Thanksgiving holiday, US Treasury yields nudged higher raising the scope for a cut back in asset purchases.
The dollar rose against the yen as the yield differential between the Treasuries and Japanese bonds widened. USD/JPY soared to 103.92, its highest since October 2008. At the start of the week, the dollar eased somewhat as forex traders were reluctant to pile on long positions before the FOMC two-day meeting. Traders trimmed massive short-yen positions at the start of the week and USD/JPY slipped lower to hover around 103.
A decision (announced at 8pm CET yesterday) by the Fed to scale back from its record $85 billion a month of asset purchases may pave the way for a fresh bout of dollar buying. With the Bank of Japan also holding a policy meeting this week, and expected to stay on hold, policy divergence between the two central banks will be further evident, however, traders will more likely exercise caution given the holiday season approaching. A new peak in USD/JPY above the 104 level is not to be excluded, however, more broad strength for the buck against its peers is unlikely, especially since many forex investors and analysts have already voiced their belief that an eventual tapering in December or at latest January 2014 has already been priced in.
In fact the Dollar Index (DXY) climbed to 81.30 in November, its highest since mid-September, but has since then slipped towards 80 despite the buoyant US data.
The European single currency was higher across the board last week, especially against emerging and commodity-linked currencies. Against the greenback, the single currency held its ground despite increasing speculation of an imminent Fed tapering. By the time of writing, the common currency got another bout of support lifted by stronger ZEW sentiment reports from Germany and the euro area, and following a stronger PMI manufacturing read from Germany on Monday.
EUR/USD flirted with the 1.38 level for most part of the last trading week. With forex investors reluctant to take any significant positions in the most traded pair before the FOMC outcome, the euro reaped strength against its other peers from the fact that the European Central Bank looks to have shrugged off the need for any new easing measures.
Despite growing policy divergences even between the ECB and the Fed, as the latter appear to be commencing their tightening cycle, the euro may still be kept afloat by its already shrinking balance sheet. We expect any selling in the EUR/USD pair to be limited even if the Fed do taper, but even upside potential seems limited as long as 1.3832 is not broken. Therefore, barring any major surprises from both monetary parties, significant breakouts in either direction are unlikely in the near-term.
Emerging markets and currencies may not suffer the same fate however, as the larger world powers move away from ultra-loose policy. A scale back in its bond buying programme by the Fed will mean less cheap cash to feed their growing appetite. Commodities and commodity-linked currencies may also come under significant pressure in a scenario of less stimulus by the Fed.
The Australian dollar has been under pressure for the past few weeks. Stop-loss orders were triggered as the Aussie stumbled below 0.90 against the buck. Reserve Bank of Australia Governor Stevens has embarked in a vocal debasing of the currency but may soon have to resort to more action. AUD/USD fell to a three- and-a-half-month low on Friday last week, but investors are calling on Stevens to put his money where his mouth is if he wants the currency to fall to the desired level. The pair has fallen around 14 per cent already this year, but only a physical intervention will ensure that it falls below this year’s low of 88.48.
Upcoming FX key events:
Today: UK retail sales, US Philly Fed index & US existing home sales.
Tomorrow: UK GDP final, US GDP final & Consumer confidence index.
Technical key points:
EUR/USD is neutral. EUR/GBP is bearish, target 0.8050, key reversal point 0.8600. USD/JPY is bullish, target 105.00, key reversal point 97.50. GBP/USD is bullish, target 1.6700, key reversal point 1.5700. USD/CHF is neutral. AUD/USD is bearish, target 0.8850, key reversal point 0.9750. NZD/USD is neutral.
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Emman Xuereb is a trader at RTFX Ltd.