FX: Fears Subside, Rate Divergence Dominate

Central Banks monetary policy divergence continues to be the catalyst in the FX market. Similar to other recent terror attacks, capital markets response to the weekend events in Paris have been short lived. The brief risk-off trading has finished as investors continue to covet the dollar in anticipation for the first Fed hike in nearly a decade next month.

The U.S dollar has managed to print a new seven-month high against the Euro in overnight trading (€1.0650) and a multi-month high against the yen (¥123.40). From a outright technical perspective, the dollar is encroaching on some key Euro support levels (€1.0640/50) and today’s U.S CPI may end being the final domino for the Fed to solidify a gradual tightening of its monetary policy and reason enough for investors to further lean on the single unit. Divergence between European and U.S 2-year yields are at its eight year widest, which would suggest that the EUR has further to fall.

RBA minutes show further concern over China: The Reserve Bank of Australia (RBA) minutes regurgitated the script from a fortnight ago when Aussie policy makers engineered a balancing act between lower inflation and mortgage hikes to remain on hold at +2.00%. Last week’s Aussie stellar jobs report (+59k and +5.9% unemployment rate) would suggest that Governor Stevens and his fellow policy makers made the most prudent of decisions. The minutes expect to see the AUD (A$0.7112) to continue to adjust to commodity price declines. Policy members are anticipating spare capacity to remain for some time, and that Aussie inflation risks remain balanced to the downside. The prerequisite China disclaimer was also mentioned – the outlook for China will continue to pose further uncertainty for Australia.

RBNZ rate cut bets edge higher: In contrast, the Reserve Bank of New Zealand (RBNZ) has had more of a direct impact on its own currency in the overnight session. The RBNZ’s Governor Wheeler and company released their latest projections for inflation, GDP, and unemployment. The RBNZ reported a drop in its long-term inflation expectations. This has the market increasing their bets on an interest rate cut next month (+50% vs. +33% one week ago) and has pressured the Kiwi outright (N$0.6480). The next hurdle for the currency will be today’s global dairy auction (milk futures indicate further price pressure).

UK Oct CPI matches record low reading: CPI inflation recorded its second consecutive month of negative rates in October (-0.1%), but with inflation set to rebound at the turn of the year (once the sharp fall in oil prices is passed through the data). The details indicate that University education fees contributed to the fall. Partially offsetting the decline was clothing and other recreational goods. This left the core rate up a little at +1.1% from 1.0% in September. Today’s numbers should not worry Governor Carney and his fellow MPC members, as weak price pressures are being influenced more by lower energy prices than by domestic economic weakness. Nevertheless, there is still very little pressure on the MPC to raise interest rates any time soon. Despite the negative headline, GBP (£1.5202) has found some support as dealers focus on the core-inflation number (+0.3%m/m and +1.1% y/y).

German ZEW survey mixed but optimistic into year-end: The German ZEW investor survey shows that easing fears about the global environment led sentiment to improve this month and suggests that the Paris attacks have had little impact on sentiment so far. The rise in the headline index, from +1.9 to +10.4, was sharper than the modest expected gain of +6. The fact that the index is in positive territory suggests that the majority believe that German economic activity will improve over the coming quarters. Nearly +18% of the responses were answered after Friday’s terrorists events and it seems that “economic pessimism appears not to have increased after the terror attacks.”

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