USD: Big Year-End Squeeze in the Making?

Just when you thought it was safe to go back into the water, along comes another wave of negativity that less nimble investors are drowning in as capital markets prepare to closeout an extraordinary year.

Disappointing data from the newly crowned world’s largest economy, China, coupled with other geopolitical (Greece formally requested a bailout extension) and economically challenged hotspots (Russia, Europe, Japan and commodity-sensitive countries), is inciting another round of negative-momentum trading that is sure to ruin this month’s festivities for many investors. The market’s biggest challenge over the remaining few weeks is not the data itself, but liquidity, or rather, the acute lack of it. Expect low trading volumes, akin to this time of year, to exaggerate market moves across the varying asset classes.

Will the Greenback Feel the Squeeze?

This week’s mighty dollar moves will have heightened the risk of an even bigger year-end squeeze. The dollar’s losses have been minimal when compared to the buck’s astonishing gains in the last few months, and given the excess of speculative risk. The market still has the potential to whip up the ingredients for a much larger move. But, will the market get it? Due to the success of the long dollar strategy, many continue to buy USDs on dips. Some longs will have been pared, but the event risk indicates that the market remains very long dollars and is happy to add. This week’s fallout will have some wade to the sidelines and wait for the New Year — that could lead to fast-declining liquidity. Follow U.S. Treasury yields to gauge market risk aversion. Since last Friday’s surprisingly strong nonfarm payrolls headline and details, U.S. 10-year yields have declined -14bp. No matter what, fast, furious, and volatile should be capable of covering market expectations for the remaining few weeks.

China CPI Falls to Five-Year Low

Disappointing overnight data has again managed to keep the markets Down Under and across Asia challenged. Despite some of the regional bourses printing some of the largest intraday losses in a number of years earlier this week, the overnight activity does not come without its own headaches; nevertheless the session is notably more benign.

China’s consumer-price index has slowed to a new five-year low of +1.4%, while the producer-price index has fallen by its biggest year-over-year rate in 18 months. It’s not a surprise to see slowing consumer inflation attributed in part to the continued fall in oil prices (crude has fallen -18% this month, and Iran is predicting oil as low as US$40 per barrel if there’s OPEC discord). Also weighing on the headlines is the non-food component slowing to +1.0% from +1.2%. With the disinflation theme intact, and China’s inflation lower-than-expected, it is renewing the possibility that the People’s Bank of China (PBoC) will act by cutting rates or required reserve ratios as early as this month. The daily deluge of weak data is creating a central bank-investor FX rift. A battle is being waged in China’s currency markets over the past few days, with traders attempting to push the yuan weaker, while the PBoC attemps to strengthen the tightly controlled FX rate. Expect this story to have strong legs.

New Zealand Rate Decision Pending

China is Australia’s largest trading partner, and if the world’s largest economy happens to sneeze, the regional economies’ temperatures are taken. Data released overnight indicated that Australia’s Westpac consumer confidence has slumped to its lowest level in over three years. Analysts’ remarks indicated consumers’ concerns are over job security. Fearing a bout of job losses will always pose meaningful risk to consumer spending patterns. The commodity and interest rate sensitive country and currency will, like most other currencies, be greatly influenced by what happens in China (A$0.8327). This is what makes it exciting for traders.

The Kiwis’ Reserve Bank of New Zealand (RBNZ) will take center stage later this afternoon. As the market heads into the rate announcement, the fixed-income market is forecasting a +67% chance of a hold on rates by Governor Graeme Wheeler, up from +62% before the last decision. A more neutral RBNZ statement would likely put further pressure on the Kiwi dollar (NZD$0.7704), with market expectations previously anticipating renewed tightening in the first half of 2015. Already today, the world’s most powerful dairy co-op, New Zealand’s Fonterra (owned by +13k farmers), has cut its full-year 2014/15 payout forecast for farm-gate milk prices, citing geopolitical uncertainty, and subdued demand from China amid elevated inventory levels.

The RBNZ and the Swiss National Bank are the two central banks that the market is trying to get a handle on this week. While this is ongoing, dealers globally are still debating whether the Federal Reserve might use next week’s two-day meeting to soften its guidance language given the continued strength seen in U.S. economic data. Like a jigsaw puzzle, investors are attempting to put the pieces together. Currently, it feels like all attempts are been done in the dark, especially with what China has been able to come up with of late. Even the renewed political concerns in Greece, and associated worries over its commitment to economic reform, will continue to have a noticeable impact on the EUR’s (€1.2378) and USD’s final destinations.

Is it Easy Street for Abe?

Even the yen is not immune to the ongoing global events. Japan’s political indecisions have voters worried about their own exchange rate. The USD/JPY pair outright (¥119.33) is under some pressure, but is attempting to consolidate the sharp USD fall to the ¥118 handle (¥118.37) overnight. With general elections on Sunday, perhaps Prime Minister Shinzo Abe needs to acquire more votes. There have been suggestions that the Japanese government should include measures dealing with the adverse effects of weak yen in the economic stimulus. Nevertheless, perception is everything, and current reports indicate that Abe’s ruling LDP/Komeito coalition could actually come away with a “super majority” on election day, with more than two-thirds of seats in lower house of Japan’s Parliament.

Content is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Business Information & Services, Inc. or any of its affiliates, subsidiaries, officers or directors. If you would like to reproduce or redistribute any of the content found on MarketPulse, an award winning forex, commodities and global indices analysis and news site service produced by OANDA Business Information & Services, Inc., please access the RSS feed or contact us at info@marketpulse.com. Visit https://www.marketpulse.com/ to find out more about the beat of the global markets. © 2023 OANDA Business Information & Services Inc.