As December approaches two huge events could impact the largest currency pair in the world, EUR/USD. The ECB this Thursday is likely to propose further quantitative easing measures which will have the equivalent impact of an interest rate cut, while in a couple of weeks on the other side of the Atlantic, the US Federal Reserve is likely to hike interest rates. In anticipation of these events EUR/USD and GBP/USD are under pressure this morning. In the case of EUR/USD the key levels to watch are 1.0521 and 1.0463, the latter being the year to date low, and for GBP/USD the immediate concern is the 1.50 level. GBP/USD today has already come within a fraction of a pip of this level, but it looks like someone – probably banks – are defending this level at the moment. It is highly unlikely that such a defence is will prove successful for any significant period of time. This sort of scenario occurs when there is significant optionality at a key level, and one party (mainly the option seller) is likely to lose a lot of money if a path dependent option is exercised within a set period of time. It seems all but inevitable that as early as this afternoon GBP/USD will be trading with a 1.49- handle, watch this space!
Interest rate decisions are not the only things we need concern ourselves with this week. We also get the US labour market report – non-farm payrolls – and Chinese and UK PMI’s, as well as a rate decision from the Bank of Canada. It’s all bunching up, and it means that there could be some serious fluctuations amongst developed market currencies. And I haven’t even mentioned the excitement that could happen with emerging market currencies as well. We have seen over the last 18 months, the disruptions that occur when even the possibility of rate rises in the United States flashes around the market. Now, as the reality finally catches up to us, there could be difficult times ahead for these less liquid currencies.
Interestingly the IMF has published a report with a relatively cheery view on where emerging market economies go from here. I would characterise the report as suggesting that things are unlikely to get much worse in 2016 than 2015. On that basis, it’s not time to start popping champagne corks for developing economies, certainly not when you consider that emerging country private sector debt levels will become more vulnerable with tighter monetary conditions in the United States. The future will tell us if there are any systemic issues that will be spawned by these risks, but it’s something we should all be cautious of, and we should remember that the risks are still probably to the downside.
For today, and indeed the next few days, it is likely that the dollar will remain ascendant. But no one should be too surprised by large currency fluctuations.
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