The U.S. dollar remains king. It has risen against a broad basket of currencies for nine consecutive weeks and so far has completed its longest winning streak in 17 years. Will the Federal Reserve end its winning ratio or is it to be a temporary blip before pushing on to greater heights? Many expect the greenback to continue its rally, hitting €1.20 against the EUR by the end of 2015, driven mostly by the cyclical strength in the U.S. economy as opposed to Europe.
The single unit will have to battle various structural macro-disadvantages, and most importantly, the growing divergence in central bank monetary policy. A fear of the Fed taking a more hawkish stance at its two-day Federal Open Market Committee meeting that concludes tomorrow is keeping both European and U.S. bond yields elevated. U.S. policymakers are expected to shed some light on plans to raise interest rates. Despite policymakers having a habit of disappointing, the recent uptick in the dollar’s interest is a massive boost to both volume and volatility and hence opportunity for investors.
Celtic Pride Weighs on Sterling
Despite central bank rhetoric dominating directional flows across the various asset classes, it’s nationalism that is pounding sterling. The looming Scottish referendum is dominating market price action. The pound remains under renewed pressure this morning (£1.6178), as the market suffers with last minute nerves with a too-close-to-call vote on sovereignty. There is a belief that the market is a tad too complacent in pricing the possibility of a “yes” vote – an outcome in favor of independence would probably weaken the GBP by a further -4 to -8%. Making it increasingly difficult for skittish investors is the Fed. If Chair Janet Yellen and company happen to be hawkish or less dovish tomorrow, it will certainly put the pound firmly on the back foot along with the remaining majors, as U.S. rate divergence trumps all.
Despite the ‘toing and froing’ in opinion polls, the U.K. bookies report that the “no” wagers outnumber “yes” bets by three to one — this would suggest that the danger to sterling remains to its left-hand side. So far this year, it has lost -2.5% in value to the dollar and even a close vote will bring its own repercussions. Just ask the Canadians about Quebec: it took years for the sovereignty question to go away while businesses fled la belle province, hurting the Canadian economy. Official results in the Scottish referendum will be made public on Friday.
RBA Finds New Pet Peeve
Aussie policymakers rarely mince words, and on the release of the Reserve Bank of Australia’s (RBA) policy meeting minutes overnight, they renewed their concerns over the risks of rising housing prices. The RBA has warned of speculative demand in the country’s real estate sector, triggered by record low interest rates, signaling that further monetary policy easing is unlikely in the near term — on September 2 Governor Glenn Stevens kept interest rates at +2.5% for the thirteenth straight month. Like other prudent central banks, RBA officials are worried that Aussie macroeconomic stability would be in danger, and that speculative demand (instigated by Asian interest) increases the probability of a free-fall in prices. There is a flipside: many do not see a substantial risk in the sector and that Australia should produce more housing given the demand. Even economic growth, which is expected to recover next year thanks to encouraging trends in employment of late, would be expected to absorb most new development.
The AUD made a feeble attempt to rally today (AUD$0.9050), supported by the RBA’s growing concern about housing prices, and the uptick in iron-ore prices. Nevertheless, the rally is fleeting at best, as the Aussie is currently making an assault on the psychological AUD$0.9000 handle. Despite the diminished expectations of another rate cut, the AUD faces downside risks from a plethora of outside forces — the massive unwinding of the carry trade fueled by Fed rate divergence and soft Chinese data. Currently, the AUD is expected to make another assault on Monday’s six-month low (AUD$ 0.8984). Many investors will want to wait for the Fed tomorrow to support current convictions.
Euro Steady despite Improved ZEW
The EUR has been contained, supported by carry trade unwinds, or EUR/GBP buying. Both of these trades had become crowed in recent months and currently the focus is not directly on the EUR but the Aussie dollar and sterling. Even this morning’s German ZEW has had little direct impact on the single unit despite it coming in slightly better than the 4.8 that was expected with a reading of 6.9 compared with 8.6 previously. It is the ninth consecutive month that the index is lower, but the rate of decline has slowed. The current condition index is much lower at 25.4 compared to 44.3 previously, obviously weighed down by geopolitical risk concerns and the fallout from sanctions imposed on Russia by the West. The market remains a comfortable seller of EUR on rallies with offers reported between €1.2965-75, and stop-losses just above the option reported €1.3000 level.
Many investors would be better served focusing on the CHF rather than the EUR outright this week as the single unit remains at the total mercy of other currencies. After the European Central Bank, the Swiss National Bank (SNB) could be the next up to introduce negative interest rates. Its officials meet on Thursday as the EUR/CHF cross has dropped below levels where the SNB has sought to hurt speculative positioning in the past. Swiss policymakers have the option of moving the €1.2000 floor, but why mess with something that seems to be working and replace it entirely with something that is unproven?