Dollar Bears To Rely On Event Risk For Support

Even as Capital markets trade tired, there are many investors trying to keep some of their powder dry ahead of the next week’s highly important FOMC meet. Markets are hoping by then that they will be in a superior position to comment and trade on tapering the Bernanke way, if anything does occurs.

Bernanke in June revealed that the Fed will start tapering this year and look to end QE sometime in mid-2014. The market is betting that the tapering journey begins next week with a consensus of $10b to be shaved from their monthly bond buying total. What should be even more important to the market is if “helicopter” Ben and company uses the “opportunity to tinker with its forward guidance.” Policy makers have been successful thus far in shifting market expectations towards tapering, but “less successful in trying to divorce what it does on unconventional policy from the outlook for conventional policy.”

Bernanke has his critics and even the IMF’s Lagarde has had time to call the US out this week on tapering, and how, if incorrectly handled, could only stifle whatever progress is being made in the Euro-zone and Emerging Markets. The developing countries have always complained loudly about the Fed’s bond buying, they have seen the resulting flows into their countries as hurtful (after the fact is always easier to conclude), the upward pressure that’s been put on their currencies and loss of competitiveness. It’s the reason why next weeks post-FOMC announcement is so globally important. Many expect Bernanke’s post-FOMC statement and more importantly the economic projections will be geared towards providing relief to markets on the rate outlook. Anything to help the ECB and BoE out should be deemed as market good!

No one is envying Governor Carney’s job. Being a foreigner and not one of the “originals” does not make anything easier. During his tenure he will be defending from all side, unless of course he provides the UK with a “utopia” economy yesterday. Carney said his flagship communications policy is supporting the U.K. and not confusing the public and doubted by investors. Is the market not picking up on this message? Traders and investors it seems want to test his “lower for longer” rate policy.

UK policy makers do not intend to raise their key interest rate from +0.5% before late-2016. Nevertheless, the markets is beginning to bet otherwise and expects Carney will have no other choice but to move sooner as the UK economy shows signs of strengthening. With the pound on a tear of late (strongest currency amongst the developed nations in past six-months), Carney has few easy options at hand to defend his view that the UK unemployment rate will be slower to drop than investors think. Friday morning’s data in the UK does not make Carneys job any easier. The output numbers in the UK construction sector rose in July (+2.2%, m/m and +2%, y/y), supported by a surge in new orders in Q2 – certainly more proof that the UK recovery is strengthening.

Today’s US retail sales release is at the top of the agenda to close this week out. The market expects a solid gain in the August print following July’s disappointment – both the headline and core is to rise +0.5%. The headline PPI should post the first monthly decline in four-months because of lower food prices, while consumer sentiment is expected to be little changed this month at 82. Are there any last minute deals? The Treasury market will always react to any tapering announcement, and at worst the market should have already priced this in by now.

The dollar bears will probably end up relying on event risk mostly for support. There is always the event risk that the Fed announcement could take more of us by surprise, either on the size of tapering (a smaller initial cut following last week’s labor market data), or in the Fed’s expectations (an improved outlook for the unemployment rate). Because of the recent slowdown in non-survey data this could increases the risk of a slower-than-expected tapering announcement next Wednesday, and coupled with the news that a military strike on Syria has been delayed, or averted, could end up weighing on the mighty dollar even more over the coming days.

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Dean Popplewell, Director of Currency Analysis and Research @ OANDA MarketPulseFX

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