With October being the last month of POMO, I did expect the FOMC to step back a bit and switch to a more neutral tone concerning expectations of its ST monetary policy. Despite a long series of strong NFPs (above 180K for the past seven months), an unemployment rate below 6% (back to July 2008 level) and growth revised higher to 4.6% in the second quarter, Fed officials disappointed the market yesterday evening expressing their concerns about the global outlook (slowdowns in China and EM), elevated geopolitical risks and, of course, a rising dollar. Between July 1st and October 3rd high, the USD index was up 8.8%, trading back to a 4-year high. The market was starting to price in an earlier-than-expected rate hike (Q2 2015 instead of Q3), which of course created a dollar preference.
The trend was clearly not sustainable, and there were no reasons to see another hawkish minutes yesterday. However, the stance was definitely dovish and generated some sharp moves afterwards as traders and investors were disappointed. EURUSD surged to 1.2790 overnight and is still trading above 1.2750, Cable recovered from its end-of-September losses and is back to 1.6200, up 2.5 figures compared to last week low. The Nikkei sell-off (now down 5.5% from September’s high) took USDJPY down with ‘him’; the pair broke its 107.75 support and was sold to 107.58, which clearly shows that the momentum is not over.
US yields are still compressed with the 10-year sold to 2.2980 (lowest since June 2013), sending Gold to higher levels flirting with it 2-wwek high of 1,230. I added a chart below which overlays US 10-year yield (in blue), USDJPY (in orange) and Gold (in orange) which shows how those assets have been moving for the past few days (10-min period).
I am wondering if this ‘bad’ news [for the dollar] is going to bring back faith in the British pound in the medium term. I still believe that traders overreacted on Sterling and UK figures lately, pushing back BoE rate hike to Q2 next year (vs. Q1 previously) and knocking down the market’s used-to-be favourite currency. The BoE meets today and I expect it to be a non-event.
After it bottomed at 0.7760 in the end of September, EUR/GBP recovered from its last month’s losses on the back of a ‘disappointing’ Draghi’s conference and an oversold Euro lately. However, I still think the single currency looks vulnerable against the British pound and any bounce back to higher levels is seen as a new opportunity to short the pair again.
Monetary policy divergence: despite recent market talks, we still see the BoE as the first major central bank to hike interest rate, and most likely in Q1 next year (March 2015). On the other side, the ECB is doing ‘whatever’ it takes to avoid deflation and generate some growth in the 18-nation economy. Draghi talked about a 1tr EUR increase in the ECB’s balance sheet.
My long term target stands 0.7500, which corresponds to early 2008 levels.
Growth divergence: With politicians (especially EZ ones) busy throwing sanctions to each other due to the Ukraine conflict, the third quarter in the Euro Zone looks ugly. Growth was null in Q2, and there is potential risks of a negative print in Q3, which means that the EZ could enter into a triple-dip recession (already) if we define recession as two consecutive quarters of negative or null growth.
In the UK, GDP came in slightly higher than expected in Q2 at 0.9%. Britain is expected to grow by 3.2% in 2014 and will be the fastest growing major economy in the develop world. Therefore, I think the pound will benefit from that.
In the short term, I went short at 0.7900, targeting 0.7750 at first . Resistance on the topside stands at 0.7930, followed by 0.7960 (100-day SMA).