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Fed Interest Rate Damage Control and the Deflating Dollar

Posted by Joseph Trevisani on Jul 26, 2013 2:29:00 PM


ScreenHunter 1509 Jul. 26 14.29



ScreenHunter 1510 Jul. 26 14.30


Hilsenrath sticking pins in USD balloon..

The leaked story is now resulting in leaking out of any Usd strength into week’s end.  The market now will have to wait and see if these comments are shared by Big Ben or if this is speculation on Capt. Hilsenrath.  For the moment we will have to be cautious and sell usd on rallies with particular focus on Nzd usd and Gbp usd . 


ScreenHunter 1511 Jul. 26 14.30


Who benefits from too much copper?  Now we know…

Base metals finished mostly lower on demand concerns, after China ordered more than 4000 companies in 19 industries to cut overcapacity, as the country tries to restructure its economy.   Copper fell for a second day in London as a result of this decision and underscoring concern demand is set to slow in the biggest consumer of the metal.  Copper smelting, steel and electrolytic aluminum are among areas to be affected, the government said yesterday. Surplus capacity must be idled by September and eliminated by year-end, it said. Manufacturing in the nation shrank in July for the first time in 10 months.

Thoughts from our Strategy Team

The European morning has been very quiet to close the week. A French consumer confidence reading for July improved to a 3-month high continuing the recent run of better European surveys, but was ignored by markets. EUR/USD is treading water under the 1.33 level, GBP/USD has inched up over 1.54. Elsewhere very minor USD softening has been the pattern this morning, AUD/USD edging up towards the 0.93 handle, but falling just short, USD/JPY dipping down to a low of 98.49 a little while ago.

The USD softening has been an extension of the pattern from the Asian session, with the USD index down to month lows through the morning.  In our view, we think the USD has over-reacted to comments from the WSJ suggesting the Fed may change its guidance on the funds rate.  The article suggested the Fed will keep the funds rate low if inflation is projected to be below a new tolerance bound, perhaps 1.5%pa (PCE inflation is currently 1.0%pa).  Currently, the Fed’s guidance is asymmetrical, i.e. the Fed will leave the funds rate low at least as long as the US unemployment rate is above 6.5% and inflation is projected to be less than 2.5%pa.  There is no mention of a lower tolerance bound for inflation.  Making the guidance on the funds rate symmetrical would be a sensible move.  However, Fed Chairman Bernanke has already been at pains to say that an increase in the funds rate is a long way in the future, so selling the USD on the possibility of a change in the guidance framework is an over-reaction.  In addition, changing the guidance could shift market participant’s focus away from asset purchases and towards the funds rate.  We think the Fed will want market participants to be prepared for a tapering of asset purchases rather than focused on the funds rate.  In our view, we think the Fed will choose to make only minor changes to its post-meeting statement on 31 July, such as acknowledging the improving US economy rather than changing its guidance on the funds rate.

In line with the softer USD, USD/JPY has eased and AUD/USD and NZD/USD have drifted modestly higher in today’s trade.  As expected, USD/JPY showed no direct reaction to the Japanese CPI.  Japanese CPI (excluding fresh food) recorded its first annual increase since April 2012.  As we have stated previously, we do not expect the BoJ to meet its 2%pa inflation target in two years.  Movements in USD/JPY, AUD/USD and NZD/USD should remain contingent on USD movements over the remainder of the day.  A speech by RBA Governor Stevens (30 July) and the official China manufacturing PMI (1 August) are the next AUD-focal points.  At the time of writing, the topic of Governor Stevens’ discussion has not been provided.  With regards to the China manufacturing PMI we see mild downside risks to the market consensus looking for a dip to 49.8 in July.  This would be the first dip below 50 in the official China manufacturing PMI since September 2012.  A softer than expected Chinese manufacturing PMI is likely to add to concerns about the momentum in the Chinese economy and dampen the AUD. 

GBP/USD has consolidated its NY session gains in today’s trade.  While UK economic growth accelerated in Q2, we do not think it will preclude the BoE from delivering more stimulus via the use of forward guidance on interest rates.  The Q2 outturn matched the BoE’s staff projections.  No policy change is expected by the BoE at the 1 August meeting; however, another dovish post meeting statement is likely.  We expect the BoE to announce forward guidance at its press conference when it delivers the next Inflation Report on 7 August rather than at its next policy meeting on 1 August.  Forward guidance on interest rates should cap front-end gilt yields and GBP appreciation pressures.  Added to this the UK continues to run a large current account deficit (3.9% of UK GDP) and we think the USD is on a medium-term up trend.  These factors should see GBP/USD ease lower over coming months. 

EUR/USD has tracked near yesterday’s highs in today’s session.  Looking ahead, we maintain our view that sustained gains in EUR/USD from current levels should be limited.  The next major focus for the EUR will be the 1 August ECB meeting.  While we think the ECB will acknowledge the recent improvement in the Eurozone business surveys, it should reiterate that this is in line with its base line expectations and the economic recovery will remain gradual.  Overall, we believe the ECB meeting will retain its dovish tone.  The ECB’s recently announce forward guidance on interest rates is designed to ensure the fragile Eurozone economic recovery remains on track.  As such, we think the ECB could use the meeting as an opportunity to verbally lean against the more recent relative tightening in Eurozone conditions generated by the lift in Eurozone interest rates and the EUR TWI by reiterating there is a “downward bias in interest rates for the foreseeable future”.

Thoughts from our Trading Team

Aud/usd:  trading from the long side after strong close yesterday.  Took some profit ahead of .9300 but will look to stay long and add above .9320 highs we made on Wednesday.   Support .9210-30 zone – will add here with a s/l below yesterday’s NY lows of .9162.

Usd/cad:  100 day M/A 1.0270.  Low yesterday afternoon briefly at 1.0255.  S/l’s under 1.0240.   Resistance 1.0320-25  highs from wed/thurs.

Gbp/usd:  took out all s/l’s above 1.5400 late NY yesterday.   Dipped only to 1.5375 overnight.  I am looking to buy Gpb/usd on any dip towards this low with s/l below 1.5325 today.

JPY:  99.40 trend line broke late yesterday and has held rallies several times in Asia last night.  The 100 day MA (98.45) will be initial support today.  July 11 low of 98.34 thereafter.  A break of 98.20 opens a move to 97.50 near term.  I think USD/JPY will range 98.30-90 today and will play a break outside.

EUR:  Narrow overnight session in EUR.  Good sellers seen at 1.3300 on the machines.  I like buying dips to 1.3190 for a move to 1.3400 in the near term. 

AUD & NZD Today

Aud extended its march higher with one US bank a noted buyer in Europe this morning.  Our traders are long Aud today but heavy selling interest remains 0.9300-0.9320, a break there will give Aud legs for move higher, but with little US data on the agenda we could be in for range-bound markets today. Pullbacks should be limited with the Usd still suffering post Hilsenrath, bids stacked 0.9230-0.9210 and then 0.9180. Nzd is struggling to make a clear break of 0.8100 with real money seen selling around the figure. More offers lined up towards mid June highs of 0.8137. Buyers sitting 0.8050 and 0.8035.


Upcoming Economic Calendar Highlights Important for Exchange Rates

USD – Next week is busy in the US, with the FOMC’s policy meeting and the first estimate of Q2 GDP (31 July), July ISM Manufacturing (1 August) and July Non-Farm Payrolls (2 August) the highlights.

AUD – RBA Governor Stevens speaks on 30 July, and the official China Manufacturing PMI for July is due 1 August. 

JPY – The June Industrial production (30 July) is the key Japanese data releases over coming weeks.  BoJ Governor Kuroda is set to speak on 29 July.

NZD – Q2 New Zealand labour market data is released on 6 August.  

EUR –Final readings of the Eurozone PMI data are due on 1 August (manufacturing) and 5 August (services and composite).  The ECB meets on 1 August. 

GBP –Next week’s focus will be on the Bank of England policy meeting (1 August), although the meeting may be a non-event, with the focus on the following week’s BoE Inflation Report.  The July UK manufacturing PMI (1 August) and services PMI (5 August) are the next major data points. 

CAD – May monthly GDP (31 July) is the next key data release in Canada.


Commonwealth Bank of Australia


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