Dollar Attempts Comeback

  • PBoC cuts rates and reserve requirements
  • Will China’s actions stem the current equity rout?
  • China’s cut bring much needed stability
  • Dollar finds some much needed support

China’s equity markets now seem to be isolated with their equity rout continuing (down -7.63% Tuesday) as concerns about a hard economic landing remain. Currently, the world’s second largest economy seems to be decoupling, temporarily at least, as other Asian markets stabilize or bounce back in the overnight session. China this morning has lowered interest rates for the fifth time since November and lowering the amount of cash banks must set aside (RRR). The People’s Bank of China (PBoC) easing policies will take effect tomorrow. Now the market has to wait and see if Chinese authorities have managed to stifle the current equity rout.

In the mean time, China’s proactive measures seem to have brought some stability back to the forex market, which was certainly playing catch up in respect to volatility to equity markets. Nonetheless, the recent global volatility has many recalibrating the timing of both the Fed and BoE rate hikes.

September Fed Funds at 21%

Fed fund futures are pricing in a 21% chance of a U.S September rate hike in a few weeks. Before last Thursday’s FOMC minutes, fixed income traders had been pricing in a +50% probability for higher interest rates. Now that the current market turmoil and China’s troubles threaten to undermine the “unspectacular” outlook for world’s largest economy, U.S rate hikes are being pushed further out the curve. The current equity rout is fundamentally a rebalancing of overvalued assets. It’s neither 1998 nor 2008 over again for a number of reasons.

In 1998 there were many ‘fixed’ currencies, now there are much fewer. In 2008, the crash was about the ‘payments and settlements’ system.

Today, the necessary rebalancing of asset prices has more to do with growth, which has been much slower than analysts have been predicting. Technically, monetary and fiscal policies have been less effective than people have been calculating.

Banks Determination To Meet Growth Objectives

The risk of capital outflows and tighter liquidity after China devalued its currency two-weeks ago, coupled with weaker-than-forecast economic readings, and a domestic bourse plummeting -22% over the past week, supports the significance to apply fresh stimulus.

This morning’s acceleration of monetary easing by China (one year lending rate cut by -25bps to +4.6%, deposit rate to +1.75% and the banks required reserve ratio to +1.5%) emphasizes the People’s Bank of China (PBoC) determination to meet China’s 2015 growth objectives of +7%.

For the U.S, if equity drops are sustained it will only further hurt consumer sentiment and spending, making businesses even less willing to invest. It may not even be rate hikes, but rather quantitative easing that will be required by the Fed, as the unbalanced global growth outlook is creating upward pressure on the U.S. dollar and a downward force on their exports. Fundamentally, this could restrain the U.S economy and inflation even further in the coming months.

Dollar Finds Much Needed Support

The dollar is threatening to climb for the first time in five days against the yen (¥119.67) as stock markets rally following yesterday’s global equity wipeout and China rate cuts. An equity calm will again raise expectations for a September Fed hike and further support the USD, temporarily at least.

Thus far, the dollars biggest gains have come against the CHF ($0.9427), EUR (€1.1467) and yen – the paring and taking profit in some safe haven positioning.

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