The dollar correction is in full swing, it’s what I’ve been expecting, but I must confess to some disappointment in my timing! Even a stopped clock is right twice a day as they say. The fight against the greenback was given added impetus in the aftermath of the FOMC minutes being published last night, so I’ll focus on the minutes to begin todays blog.
It appears some members of the committee were concerned that their recent guidance is vulnerable to misinterpretation. Specifically, now that asset purchases are ending this month and their employment targets are largely achieved, the market is assuming rate rises next year… indeed the only point of discussion appears to be which quarter of 2015 will see the first rate hikes. There was a desire from some members to ensure that financial conditions are not prematurely tightened, and a part of this relates to the strength of the dollar, and also the rather dismal economic news we’re all seeing outside of the US. For my part I don’t envy the Fed members, they have acquired a massive balance sheet that will lose a tremendous amount of value when rates go up. The bottom line is that over the next few meetings the Fed will go through contortions to find the right wording to fit the current circumstances.. a situation where the US economy is doing well, but is potentially vulnerable to a slowing Europe and China, and to an appreciating dollar. They will be keen to convey an intention to tighten policy if.. and only if.. inflation becomes a problem, wage growth starts to pick up, and of course the US economy continues to grow strongly.
But, even if there’s no active intent to tighten financial conditions in the US, we know that the ECB, if anything, wants to find a way to ease conditions in the Eurozone. So in our view, this rally in EUR/USD cannot go very far. It is a correction of a bearish trend, and as I’ve said before, it is a necessary condition for trends to remain sustainable. From a technical perspective a rally up to the low 1.28s may be sufficient. At those levels I become cautious, and my expectation is that EUR/USD is likely to turn lower again, or at least it could struggle to get much higher than that. I would be similarly cautious about the recent bounce in EUR/GBP, it’s conceivable it might go as high as 0.7950 in the next few days, but there again, I see the euro as too vulnerable, and the currency pair is susceptible to fall back into its recent trend decline. These next few days should be great for sellers of euros, it might be some time before such a beneficial opportunity comes around again!
Other currency pairs have experienced similar moves – appreciation vs the dollar – over the last few days, and in general I would be cautious about how far their moves can go as well. USD/JPY might be an exception, but I will need to do a bit more research to understand the dynamics in that pair. Some of the comments from senior Japanese officials in the last week, have appeared hostile to further yen depreciation, but again.. these comments might just have been focussing on the pace.
Emerging market currencies like the South African Rand and Mexican Peso, if anything, saw even more aggressive appreciation against the dollar following the minutes, my guess is that there have been traders steadily accumulating short positions in these types of currencies in recent months. Those chaps are probably sitting at their desks this morning wondering where it all went wrong. Still I doubt this has led to outright losses for them, it’s more likely to be a significant reduction in their profits on the trade. The question needs to be asked though.. what happens to these currencies now? This is a different question to the euro. If the Fed is telling us to be more considered about when rates will need to be hiked, do we need to be as concerned about the financial stress Emerging economies are likely to experience? In my view, yes. It’s going to happen, rates will go up, maybe a bit later than the market has anticipated until recently, but as sure as taxes, they will go up. We should still have the same concerns for Emerging economies, laugh in the face of anyone who tells you that this time it will be different, it might not be an Asian crisis, or a Tequila crisis, but there will be some crisis, so some caution is warranted, we should just be a bit more discriminating this time as there are economies out there, which are still called developing that really aren’t!
We have the BoE rate decision today. Don’t expect much there. Perhaps more members will consider the possibility of hiking, but if the FOMC is any guide, the recent data out of the Eurozone might temper their positive view of the British economy’s prospects next year. Not much else to look forward to today, but really… isn’t all this enough?