Fed, ECB and Scotland Make FX Interesting

The mighty dollar is basking in glory right across the boards, egged on by investors speculating that the Federal Reserve will strike a less dovish tone in its next policy statement on September 17. Also aiding the buck’s cause is the uptick to risk-aversion trading sparked by uncertainty over Scotland’s upcoming independence vote taking place on September 18. It is thought that the Fed may be about to adapt its communication ahead of an end to its quantitative easing program next month, and that has given the USD its broad-based strength. This has managed to push the EUR/USD to trade below the psychological €1.29 handle and USD/JPY above $106. Even fixed-income traders are adapting, the USD’s overnight indexed swaps upward trend of higher-highs persists.

Watch Short-Term Yields for Clues

The dollar index (DXY: 84.38) is moving toward a break of last year’s high, aiming for its 2010 total dominance level. Over the past two months, the USD has managed to remain on the front foot for a couple of reasons. First, it was the peak on Bank of England (BoE) rate hike expectations — this initially managed to turn GBP around (£1.7130+), while today, the Scottish sovereignty issue is fueling the pound’s decline (£1.6112). Second, the European Central Bank’s (ECB) actions favor lower-for-longer. Rate divergence has been the key, and a growing view that Chair Janet Yellen is about to change the Fed’s rhetoric is applying more pressure.

Investors should be looking at short-term yields to gauge whether there is to be further divergence between the Fed and ECB, as well as the Fed and BoE. The tightening and widening of spreads helps with interpreting the dollar’s direction. USD/GBP spread has aggressively narrowed in the last couple of weeks (from 74 to 22) and is likely to flatten given that Governor Mark Carney could delay a BoE rate hike until after next year’s U.K.-wide general election. Meanwhile, the market is anticipating that the Fed could use either next week’s meet or next month’s gathering to make changes to its post-meeting statement. Assuming that every other central banker remains dovish on rates, it will only promote further dollar strength in the medium term.

Traders Fear Missing the Boat

The past few weeks have seen some extraordinary moves by the major currency pairs, which has left many traders stunned on the breadth and depth of some of these price changes. The volatile situation has been magnified due to years of inactivity — dealing with well contained and tight trading ranges — which has left some investors ill prepared for this fast, emerging USD uptrend. Many, incorrectly, continue to focus on levels that have come and gone and that do not expect to be revisited any time soon. For dealers, they have had to overcome further regulatory measures — prop trading and excess risk taking has been made a “dirty” issue. Complicating and compounding matters is that many investors have not been able to identify a trending market. All of the above have added fuel to the dollar’s move higher. If nothing else, there is a genuine uptick in both volume and volatility that should give traders more opportunities, and with the lack of return out there, a fast-paced currency market becomes attractive.

Will It Be Full Fiscal Autonomy for Scotland?

It’s no surprise to see the sterling remain under pressure again this morning. Outright, it has managed to print a new 10-month low (£1.6067) as investors become a tad more nervous about next week’s Scottish sovereign vote. Ongoing polls continue to highlight that the vote could go either way — a mirror image of Canada’s 1995 Quebec sovereignty referendum. Investors should be anticipating a nervous market with erratic price action right up to the vote. Below are some facts and poll date releases that will influence GBP prices over the next week.

Scottish independence vote facts:

  • Vote will take place on September 18. Polls will be open from 0600 GMT – 2100 GMT
  • Voters will be faced with a single question: “Should Scotland be an independent country?” They will only be able to vote yes or no.
  • Anyone who lives and is registered to vote in Scotland will be allowed to vote — including those as young as 16-years-old.
  • A simple majority is needed to secure victory.
  • The result will only be officially declared when counts from all of Scotland’s 32 local authorities have been provided to the chief counting officer and she has accepted them as valid.
  • The final result is expected to be announced on the morning of September 19.
  • If Scotland votes yes: A constitutional settlement will need to be drawn up giving terms of independence. Scottish National Party Leader Alex Salmond has already stated plans to declare Independence Day in March 2016, and hold elections in May 2016.
  • If Scotland votes no: “devo-max” (additional devolution to allow Scotland control of many of its own affairs) — all political parties in London have pledged to devolve more powers to Scotland.

Scotland has never been so important.

Here is a list of the Scottish polls timetables that remain:

  • September 9: TNS / BMRB – Capi Poll
  • September 11: Survation online poll for the Daily Record
  • September 14: YouGov for the Sunday Times
  • September 17: Final YouGov poll for the Sun and a Survation online poll via Scottish media outlets

If nothing else, the market should be expecting much price volatility around the above poll releases.

Forex heatmap

This article 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 Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell