Over the past 3 weeks, central banks around the world have made a number of comments that have affected rate hike expectations. On Jan 27th, I showed where rate hike expectations were at the time and since then a number of interesting changes have occurred.
First, the market is now pricing in a 25bp rate hike by the Fed in Dec. Last month, no rate hike was expected. Close to 70bp of tightening is now expected from the Bank of England, up from 50bp. The market went from pricing in 2 rate hikes from the Reserve Bank of New Zealand to one. The European Central Bank and the Bank of Canada are now expected to tighten by 75bp this year instead of 50bp. A lot can change in 3 weeks =)
How close is the Federal Reserve to easing monetary policy in November? Pretty close if we look at the views of different FOMC members. However the skepticism of some officials could compromise the overall size of the asset purchase program.
Read on to find out where FOMC voters stand:
Voting Members of the FOMC
Believe More QE is Necessary
1. Ben Bernanke – Said earlier this month that “additional purchases will ease financial conditions and help the economy.”
2. William Dudley – Said on Oct 1 that “more action from the Fed is warranted unless the outlook changes.”
3. Eric Rosengren – Said on Sept 29 that the Fed needs to respond “vigorously” and “creatively” to the serious economic problem” posed by high unemployment, sluggish growth and undesirably low inflation.
Oppose More QE
1. Thomas Hoenig – Has been voting for tighter monetary policy since the beginning of the year.
2. Kevin Warsh – Traditionally leans towards more hawkish policies – said on Sept 28 that the “markets are normalizing if not normal” already and the “economy is improving if not improved.”
1. Sandra Pianalto (Possibly Dovish) – Leans towards more stimulus, very worried about sluggish growth and high unemployment and said Oct 1 that she is assessing the effectiveness of the Fed’s tools to stimulate the economy.
2. Daniel Tarullo (Traditionally Dovish) – Hasn’t talked about monetary policy recently but is traditionally a dove and supported a high degree of policy accommodation back in April.
3. James Bullard (Possibly Dovish) – On Friday, he said “more easing is not obvious” but he leans towards more stimulus after having previously said that “more help from policy may be needed to push up inflation.”
4. Janet Yellen (Unclear) – Is traditionally a dove but in her first speech as Vice Chair yesterday, she expressed concern that accommodative policy may prompt risk taking while further easing could fuel leverage build up.
5. Sara Raskin (Unclear- Slightly Dovish) – Hasn’t made comments since joining the Board of Governors, but at her confirmation hearing, she said that the Fed only has a partial victory with stable prices when “many American households continue to face the perils of unemployment.”
6. Elizabeth Duke (Skeptical About More Stimulus) – Leans towards opposing additional stimulus – is skeptical about the effectiveness of large scale asset purchases and the Fed’s decision August decision to reinvest proceeds from mortgage backed securities
Saying the U.S. dollar is falling out of bed would almost be an understatement given the recent price action in the greenback. Over the past three months, the dollar lost more than 10 percent of its value against the euro, Swiss Franc and Australian dollar. Since July, every one of the G10 currencies outperformed the debilitated buck and the latest dollar dump has even driven some currencies to significant highs. The greenback is the one currency that no one wants to own right now but the currencies that are in greatest demand are the Japanese Yen, Swiss Franc, and Australian dollar. The reason why investors are buying the Swissie and Aussie in size is because of their stable economies, healthy economic outlook and correlation with gold prices. The Yen on the other hand is being bought not because their economy is performing better than the U.S., but because investors are seeking safety in low yielding currencies that are not the dollar, the Chinese are buying Japanese bonds, exporters are hedging and carry trades are continuing to unwind their long dollar, short yen positions.
Today’s sell-off in the dollar today pushed the euro above 1.40, the Yen to a fresh 15 year high against the greenback, the Swissie and Aussie to a record high. Although the weakness of the dollar can be attributed to concerns about the U.S. labor market, the primary reason why the dollar came under assault is because U.S. yields continue to fall. Of course these factors are related since weaker economic data raises the chance of the Fed following through with additional asset purchases which are bearish for yields, but what is important is that bond traders have been particularly in tune with the market’s sentiment. Two year Treasury yields fell to a fresh record low of 0.359 percent while ten year yields dropped to the lowest level since January 2009. The dollar will continue to fall as long as U.S. yields continue to decline. If there is any hope for a rebound in the greenback, we would need to see U.S. yields stabilize first. The following chart shows the strong relationship between USD/JPY and U.S. yields. Since the beginning of the year, the correlation between these instruments on a week to week basis has been approximately 90 percent!
The biggest event in the forex market this week will be tomorrow’s Federal Reserve monetary policy announcement. On FX360.com, I published an extensive article talking about what the Fed may or may not do (FOMC Preview: The Key Language Changes to Look for)
Here are the possible scenarios for the U.S. dollar:
A) Fed uses the words “balance sheet expansion” in FOMC Statement > Dollar Bearish
B) FOMC Statement contains no hints about additional stimulus > Dollar Bullish
C) Fed announces small scale asset purchases > Very Dollar Bearish
D) Fed alters “extended period” language in FOMC statement > Dollar Bearish
More details can be found in my special report (FOMC Preview: The Key Language Changes to Look for)
Trading the Fed meeting is always difficult because in addition to a decision on rates, the tone of the FOMC statement also affects how the dollar trades. Rather than immediately jumping into the market after the announcement, I have found that in 11 out of the last 14 times that the Federal Reserve has met, the move in the EUR/USD during the U.S. trading session continued into the Asian and London sessions. More specifically, the dollar’s move between 2:15pm and 4pm NY time tends to follow through from 4pm to 12pm EST (noon) the following day. The table below illustrates the reaction in the EUR/USD from 2:15 to 4pm on FOMC day and from 4pm to 12pm EST the next day. For forex traders that may not know how to interpret and trade FOMC, this suggests that it may be better to wait and see how the market reacts before jumping in because continuation is very likely.
What are the Fed’s options?
1. A dovish statement that reinforces Bernanke’s recent concerns > initially dollar bullish
2. Dovish statement with talk of more QE (ie. Balance Sheet expansion), but not actually doing it > slightly dollar bullish
3. Dovish statement, reinvest MBS proceeds > dollar bearish
4. Dovish statement, expands balance sheet (ie. additional QE) > very dollar bearish