By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
If the U.S. dollar continues to dip, buy it because the decision to keep interest rates steady last month was a “close call” according to the minutes from the September Federal Reserve meeting. Even before the report was released, we knew that 3 members voted in favor of raising interest rates and their hawkish views would be made clear in the minutes. In fact “several officials saw a hike as appropriate relatively soon,” which means that George, Mester and Rosengren were not the only policymakers eager to raise interest rates. However low inflation, differing views on labor-market slack and concerns about global risks discouraged an immediate move. A “substantial majority of policymakers saw risks as roughly balanced” and therefore voted to keep rates steady. The dollar, which had traded sharply higher ahead of the FOMC minutes, failed to extend its gains. Lingering concerns about inflation and the ongoing difference in views within the central bank gave investors an excuse to take late-day profits after the breakout in USD/JPY. The probability of a hike in December is unchanged according to Fed Fund futures, but given how much the U.S. dollar rallied this week, a correction is possible during the Asian/European trading sessions. If that happens, we like buying USD/JPY just under 104 and USD/CAD near 1.32 because yield spreads still point to stronger gains for both currencies. Japan has pledged to deliver more stimulus and we think oil prices have peaked courtesy of continued disagreement among OPEC nations. No major U.S. economic reports were released and Fed Presidents Dudley and George failed to move the markets with their comments. Fed Presidents Harker and Kashkari speak on Thursday but neither policymaker is a voting member of the FOMC this year.
Wednesday's best-performing currency was the British pound. In Tuesday’s note we said sterling would continue to fall unless “Prime Minister May suggests that Brexit terms could be negotiable” and that headline broke hours later. May conceded to holding a Parliament vote on Brexit plans with the first debate held earlier Wednesday. While some may hope that this means no Brexit, in reality it will mean the difference between a hard or soft exit. If Parliament puts up a good fight, sterling will rally, but if PM May pushes back hard, GBP will fall. Either way, we still view GBP a sell but prefer buying EUR/GBP on a dip below 90 cents and selling GBP/USD between 1.23 and 1.2450. Friday’s flash crash established a new range for GBP/USD and with the PMs voting, we may have seen the bottom for the time being.
EUR/USD made a run for 1.10 Wednesday and ended the North American trading session right above that level -- its worst levels since the end of July. The Eurozone reported positive data Wednesday with industrial production rising 1.6%, slightly more than expected. German wholesale prices also increased 0.4% vs. -0.7% last month. ECB’s Coeure said that he sees serious concerns over the sustainability of Greek debt and he hopes the IMF will get on board with some sort of relief. Unfortunately, movement in the euro was not dictated by data on Wednesday, but rather influenced by the German–U.S. yield spread and broad-based demand for dollars. The 2-year yield spread has fallen to its lowest level in nearly 10 years. However the lower the euro falls the better it is for the economy. The recent trend of positive data should continue as the currency weakens, so while a drop below 1.10 seems inevitable, we don’t expect major losses beyond that level. There are no Eurozone economic reports scheduled for release on Thursday.
The Canadian dollar ended the day lower versus the greenback while the Australian and New Zealand dollars moved higher. CAD was pressured by oil, which dropped by over 1% and ended the day near $50 a barrel. Oil prices turned south as OPEC’s monthly market report showed that cartel members averaged 33.39 million barrels per day, an increase of 220,000 bpd from the previous month. This level is higher than the limit proposed in Algeria and would signal that a production cut as opposed to a freeze would be in order. Putin, however, said on Wednesday that he saw a need for the freeze and that a production cut by Russia did not seem warranted. The conflicting ideals continue to put a drag on oil prices. The Aussie and Kiwi were both able to hold onto gains post-FOMC. Gains in the AUD were courtesy of better-than-expected data. Westpac Consumer Confidence rose by 1.1% vs. 0.3% the prior period. Next up, New Zealand reports manufacturing PMI and China is slated to report trade balance numbers.