The forex markets require a diverging interest rate policy among the Group of Seven economies for sustainable volatility. In 2014, geopolitical risk has been regionally contained and risk-on or -off trading strategies have been orderly executed, regardless if it has been influenced by events in Russia-Ukraine, Gaza, Syria or Iraq. Various individuals will argue that the Federal Reserve’s zero interest rate policy model (followed by Japan and likely Europe soon) is creating a “moral hazard” environment; encouraging the formation of asset bubbles that will eventually burst and lead to a deeper economic mess. These symptoms are reason enough to want to fully comprehend central bank rate strategies.
This week, investors hope to gain insight into the current mindset of policymakers through various inflation reports, central bank meeting minutes, and from Fed Chair Janet Yellen’s speech at the Jackson Hole Economic Symposium on Friday. To date, the Bank of England (BoE) has been hotly tipped to be the first of the developed central banks to hike rates. Up until last week the market had been pricing in a U.K. November hike. However, BoE Governor Mark Carney poured cold water on that idea, citing excess capacity in the labor and wage department. Tomorrow’s BoE Monetary Policy Committee (MPC) meeting minutes should be able to shed some light whether any BoE hawks have split from the consensus and voted for monetary tightening. Nevertheless, it’s today’s surprising U.K. inflation data that is pressuring the pound’s current advances.
Bank of England Meeting Minutes in Focus
It was not a surprise; U.K. inflation was expected to fall in July, but not by as much as it did. It cooled more than expected (-0.3% versus a -0.2% drop) and has now eased pressure on the BoE for an early rise in interest rates. The annual rate of inflation fell to +1.6% in July from +1.9% a month earlier, taking it well below Carney’s +2% target. Subdued inflation has been a global central bank phenomenon, and despite strong U.K. economic growth, the BoE will not feel pressured to act. Dealers and investors should now feel more comfortable pricing in a U.K. hike for the first quarter, finally eliminating anything happening this year.
GBP/USD (£1.6650) has managed to fall to a fresh four-month low, basically giving back after all of Carney’s hawkish comments last weekend. Sterling’s fall from grace this morning is also managing to support the EUR indirectly on the cross (€0.8023). Technically, this morning’s sharp drop highlights the underlying bearish structure of the market, through £1.6640 with conviction gives way to another big ‘fig’ below. A plethora of resistance levels now come into play topside — the sterling bear should be expecting more GBP offers to appear around the psychological £1.6700 handle.
The market will now shift its focus to tomorrow’s MPC minutes. Will any of the nine members have jumped ship and called for a rate hike? Before last week’s quarterly Inflation Report, the market was probably looking for one dissenting member. Ever since the dovish report was released — highlighting the lack of wage growth and slashing of 2014 growth forecasts – it has probably changed investors’ mindsets. The report has lessened the chance of a split, and the consensus is for a 9-0 reading.
The (EUR) Bear Necessities
European equity markets have so far extended the gains seen in yesterday’s Wall Street session (again led by the DAX) amid a lack of significant news flow out of Russia-Ukraine. Despite the situation remaining highly delicate, an easing of tension is allowing for some risk trading. Nevertheless, the single unit’s opening maneuver this morning is a fresh test of its current €1.3330-40 range.
There has been neither new, real news to drive the EUR lower, nor a material shift in risk appetite, or a change in the Bund-Treasury spreads. All of these reasons should clearly support the EUR bear’s position. If the EUR/USD is unable to rally on risk then the long positions have a problem. Currently, the outright EUR positions are being indirectly supported by weaker cross currencies — EUR/GBP (€0.8019). EUR stop losses are beginning to pile south of the recent 2014 low (€1.3333). The EUR’s inability to climb does make these positions more vulnerable. The technicals require a sub-€1.3333 close to support the EUR bears’ current endeavor, and opens up a new handle below. In any event, with option barriers dotted about, there will be reluctance from investors to trade ahead of the Jackson Hole meeting or today’s U.S. inflation report with conviction.
Aussie Carry Trade Carries On
Investors involved in the AUD carry trade, particularly those financed in EURs, found some support from the Reserve Bank of Australia (RBA) last night. Governor Glenn Stevens indicated no change to the bank’s view that interest rates were likely to remain on hold for some time. The RBA minutes indicated that despite the uncertainty in economic outlook, “steady rates remained the most prudent course.” Dealers have been pricing in a +50% chance that the next move in interest rates will be down in the first half of 2015. Striking a similar tone to other central banks, the RBA script suggested, “greater labor market slack and the reassessment to balance of risks to the wage/inflation outlook” will underpin the RBA’s rate normalization policy. Higher unemployment and weak commodity prices may indicate that the Aussie economy has been contracting, hence the potential need for a pricing ease.