Sive Morten
Special Consultant to the FPA
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Fundamentals
So, the first stunning effect of Fed policy changes is passed, euphoria around this event is calming down and investors now try to find the reasonable sense and application of current background. This search leads to more volatility on the market and some signs of indecision that we clearly see this week on EUR, for instance. Meantime sentiment data shows that nothing has changed drastically and activity that we see is mostly the speculative games. Status quo could be re-established sooner rather than later.
Market overview
The dollar dipped on Monday after data showed production at U.S. factories fell by the most in seven months in September, erasing earlier gains on expectations that the Federal Reserve may be closer to raising interest rates than previously expected. U.S. manufacturing output was hurt as an ongoing global shortage of semiconductors depressed motor vehicle output, providing further evidence that supply constraints were hampering economic growth.
Supply disruptions are adding to concerns about high inflation and adding to expectations that the U.S. central bank will need to act to stamp out price increases.
Sterling briefly hit a 20-month high against the euro after Bank of England Governor Andrew Bailey sent a fresh signal that the central bank was gearing up to raise interest rates as inflation risks mount.
Analysts at Bank of America noted on Monday that commodity-linked currencies, including the Norwegian krone and the Canadian and Australian dollars, had been the best performers since the summer as energy prices rise, while the euro and the yen had been the worst. While Goldman Sachs analysts suggest that CAD and RUB might be among best performers in 2022 as they expect Crude Oil and Copper rally next year.
Over the past week though, Dollar Index has trended lower, with a tapering of Federal Reserve stimulus as early as next month already priced in, along with a first interest-rate increase next year.
Yields appeared to stabilize on Tuesday, however, which reduced demand for the greenback. The dollar’s move lower on Tuesday was also likely exaggerated by technical factors as investors unloaded long positions.
The dollar dipped on Wednesday as risk sentiment improved and as investors focused on rising commodity prices and when global central banks are likely to begin hiking interest rates to fend off persistently high inflation. Investors are pricing for even more aggressive rate increases in other countries and as commodity-linked currencies including the Canadian and Australian dollars outperform. The dollar index fell 0.24% to 93.57.
Market participants are pricing for the Fed to raise rates twice by the end of 2022.
Fed Governor Randal Quarles on Wednesday said that while it is time for the Fed to begin dialing down its bond-buying program, it would be premature to start raising interest rates in the face of high inflation that is likely to recede next year. The Fed also said in its latest Beige Book that the U.S. economy grew at a “modest to moderate” rate in September and early October, as the latest surge of COVID-19 cases crested and began to recede.
Commodity currencies stood near multi-month highs on Thursday on strong raw material prices, while the improved mood chipped away at demand for the
safe-haven U.S. dollar, which has recently been supported by expectations of Federal Reserve tapering.
Sterling was also riding high on firming perceptions the Bank of England (BoE) will raise interest rates as soon as next month to curb inflation, despite softer-than-expected UK price data on Wednesday.
Oil prices have been supported by strong demand as countries started to reopen their economies, while a global coal and gas crunch showed little sign of abating. U.S. crude and fuel inventories have tightened sharply. Brent crude futures hit its highest level since 2018, while U.S. crude futures were at their loftiest level since 2014.
Better jobs and housing data and rising U.S. Treasury yields helped the dollar rise towards the end of the U.S. session on Thursday, gains it held in Asian hours.
The U.S. dollar slipped against its rivals on Friday and is set for a second consecutive week of decline as news that heavily-indebted property firm China Evergrande Group had averted a default buoyed appetite for risky assets.
Concerns over the embattled property developer whose liabilities are equal to 2% of China’s gross domestic product had sent investors flocking to the perceived safe-haven currencies like the U.S. dollar and government debt. Worries of economic contagion have seen swathes of other heavily-indebted developers hit with credit rating downgrades.
But days before a deadline that would have plunged the embattled developer into formal default and sent shockwaves through global markets, the company had supplied funds to pay interest on a U.S. dollar bond. News that the Chinese property developer had made a bond payment to avert a default lifted the mood globally. Worries about contagion from a potential default have rattled markets recently.
The broader market narrative remained supportive of more U.S. dollar gains as rising bond yields on the back of firmer inflation expectations are expected to lend support to the greenback.
Yields on 10-year U.S. Treasury notes held near their highest levels this year at 1.7% while yield differentials between comparable U.S. and German debt held at a chunky 177 bps.
Moreover, rising expectations that the U.S. Federal Reserve will be among the leaders to tighten monetary policy before other major central banks is also prompting investors like UBS Wealth Management to keep the dollar as its most preferred currency in its portfolio.
The RBA said on Friday it had stepped in to defend its yield target for the first time in eight months, spending A$1 billion ($750 million) to dampen an aggressive bonds sell-off as traders have bet on inflation pulling forward rate hikes.
Investors continued to unload long positions that benefited from an increase in bets that the Federal Reserve will raise rates sooner than previously expected. The greenback also faced seasonal weakness that is typical in late October. Investors have taken profits since the dollar index hit a one-year high last week, when concerns that inflation will remain stubbornly high for longer led investors to bring forward expectations on when the Fed will first raise rates to mid-2022.
That repricing momentum has now faded as investors take profits and also build expectations for sooner rate increases in other currencies.
The dollar pared losses on Friday after Federal Reserve Chairman Jerome Powell said the U.S. central bank should begin reducing its asset purchases soon, but should not yet raise interest rates. Powell said employment is still too low and high inflation will likely abate next year as pressures from the COVID-19 pandemic fade, even as many market participants are concerned that rising price pressures will last longer than policymakers believe.
It's "very possible" the Fed's full employment goal could be met next year, Powell said on Friday. Still, it's not a certainty, and if inflation - already higher and lasting longer than initially expected - moves persistently upward, the Fed would "certainly" act, he said.
"The risks are clearly now to longer and more persistent bottlenecks and, thus, to higher inflation," he said. For now, the Fed needs to "look through" that high inflation, despite the pain it means for households having to pay more for gas and food, in order to give time for the economy to work out supply kinks.
Consumer prices have been rising at more than twice the Fed's target. And, Powell noted, "supply constraints and elevated inflation are likely to last longer than previously expected and well into next year, and the same is true for pressure on wages." Still, he said, the most likely case is for inflation pressures to abate and job growth to resume its pace from this past summer. For now, the Fed will watch and wait, Powell said.
Data on Friday showed that U.S. business activity increased solidly in October, suggesting economic growth picked up at the start of the fourth quarter as COVID-19 infections subsided, though labor and raw material shortages held back manufacturing.
COT Report
Recent data confirms opinion of analysts above, suggesting that as dollar as EUR performance now is a product of rebalancing positions, and mostly technical. Data shows that there is no changes in hedgers' position this week. Net long position barely increases, but open interest drops significantly and speculators have closed large positions on both sides:
This data suggests that changes are mostly technical and are not because of sentiment change. Second - they are probably short term. It means that recent upward action stands due short covering rather than new purchases. Hence, the same background we have on the dollar index, which confirms our view of just a retracement now.
Continued in the next post...
So, the first stunning effect of Fed policy changes is passed, euphoria around this event is calming down and investors now try to find the reasonable sense and application of current background. This search leads to more volatility on the market and some signs of indecision that we clearly see this week on EUR, for instance. Meantime sentiment data shows that nothing has changed drastically and activity that we see is mostly the speculative games. Status quo could be re-established sooner rather than later.
Market overview
The dollar dipped on Monday after data showed production at U.S. factories fell by the most in seven months in September, erasing earlier gains on expectations that the Federal Reserve may be closer to raising interest rates than previously expected. U.S. manufacturing output was hurt as an ongoing global shortage of semiconductors depressed motor vehicle output, providing further evidence that supply constraints were hampering economic growth.
Supply disruptions are adding to concerns about high inflation and adding to expectations that the U.S. central bank will need to act to stamp out price increases.
"Prospects for global central banks to be more aggressive to counter growing inflation fears may put the USD under some pressure, though the Fed in turn may act sooner than previously expected, supportive of the dollar," said Ronald Simpson, managing director, global currency analysis, at Action Economics.
Sterling briefly hit a 20-month high against the euro after Bank of England Governor Andrew Bailey sent a fresh signal that the central bank was gearing up to raise interest rates as inflation risks mount.
Analysts at Bank of America noted on Monday that commodity-linked currencies, including the Norwegian krone and the Canadian and Australian dollars, had been the best performers since the summer as energy prices rise, while the euro and the yen had been the worst. While Goldman Sachs analysts suggest that CAD and RUB might be among best performers in 2022 as they expect Crude Oil and Copper rally next year.
Over the past week though, Dollar Index has trended lower, with a tapering of Federal Reserve stimulus as early as next month already priced in, along with a first interest-rate increase next year.
"The sense that 'transitory' inflation will last longer than previously thought has been the main catalyst" as "the market re-calibrated rate hike expectations in most jurisdictions," Westpac strategists wrote in a research note. However, the U.S. is likely to be insulated by energy market bottleneck that is "casting an ongoing cloud over rebound prospects in Europe and China," which "should leave yield spreads at the front end continuing to drift in the USD's favour," they said, adding that pullbacks in the dollar index should be limited to 93.70.
"Our strong USD forecast published in early July reflected - among other things - U.S. economic outperformance, but the USD's drivers may be changing," Commonwealth Bank of Australia strategist Joseph Capurso wrote in a client note. "The spike in global inflation and interest rates may support the USD as a safe haven if short-term interest rates price in a global monetary tightening cycle that it so strong it forces equities to correct lower," with evidence of that scenario likely seen in a decline in USD/JPY and AUD/JPY, he said.
Yields appeared to stabilize on Tuesday, however, which reduced demand for the greenback. The dollar’s move lower on Tuesday was also likely exaggerated by technical factors as investors unloaded long positions.
“The movement in rates hardly explains extent of the USD drop,” analysts at Scotiabank said in a report. “Rather, it seems USD long liquidation has snowballed into a broader clear out of positioning, triggering a technical reversal in the USD generally,” they said.
The dollar dipped on Wednesday as risk sentiment improved and as investors focused on rising commodity prices and when global central banks are likely to begin hiking interest rates to fend off persistently high inflation. Investors are pricing for even more aggressive rate increases in other countries and as commodity-linked currencies including the Canadian and Australian dollars outperform. The dollar index fell 0.24% to 93.57.
“When it comes to central banks, there’s a lot of aggressive pricing out there,” said Bipan Rai, North American head of FX strategy at CIBC Capital Markets in Toronto, noting that the market is likely overstating how quickly rate hikes will come. Rai expects the dollar may outperform if investors pare back rate hike expectations in other countries, though “that’s something that’s going to take some time to correct. When push comes to shove, given the underlying fundamentals in the United States, which are still very constructive for growth, we think the Fed is probably going to be the central bank that raises rates over the course of the coming years at a bit of a more aggressive clip than the market is pricing in now,” Rai said.
Market participants are pricing for the Fed to raise rates twice by the end of 2022.
Fed Governor Randal Quarles on Wednesday said that while it is time for the Fed to begin dialing down its bond-buying program, it would be premature to start raising interest rates in the face of high inflation that is likely to recede next year. The Fed also said in its latest Beige Book that the U.S. economy grew at a “modest to moderate” rate in September and early October, as the latest surge of COVID-19 cases crested and began to recede.
ING FX strategists said in a client note that the dollar’s recent decline could be due to a combination of markets closing long-dollar positions and “a benign risk environment, where a strong U.S. earnings season has continued to offset inflation/monetary tightening concerns. At this stage, it looks like the dollar is lacking some catalysts to contain the ongoing correction, and any support to the greenback may need to come from a cool-off in the recent risk-on mood in markets,” ING said.
Commodity currencies stood near multi-month highs on Thursday on strong raw material prices, while the improved mood chipped away at demand for the
safe-haven U.S. dollar, which has recently been supported by expectations of Federal Reserve tapering.
Sterling was also riding high on firming perceptions the Bank of England (BoE) will raise interest rates as soon as next month to curb inflation, despite softer-than-expected UK price data on Wednesday.
"It looks almost certain that the BoE will raise interest rates in November, perhaps again in December, as inflation could get out of control otherwise given a severe labour shortage," said Yukio Ishizuki, senior strategist at Daiwa Securities. And globally we are likely to see rate hikes to curb inflation in many countries, which means the U.S. dollar is standing out less than before, in terms of rate hike expectations."
"It's as if the BoE is stealing the spotlight from the Fed as it looks likely to raise rates before the Fed," said Kyosuke Suzuki, president of Financial algotech company at Ryobi Systems. What could be the game changer, though, is if the Fed is also jumping on the bandwagon of global rate hikes much sooner than expected," he added.
Oil prices have been supported by strong demand as countries started to reopen their economies, while a global coal and gas crunch showed little sign of abating. U.S. crude and fuel inventories have tightened sharply. Brent crude futures hit its highest level since 2018, while U.S. crude futures were at their loftiest level since 2014.
Better jobs and housing data and rising U.S. Treasury yields helped the dollar rise towards the end of the U.S. session on Thursday, gains it held in Asian hours.
"People are wondering whether we are at an inflection point, as the dollar has been weakening and that doesn't really fit with the broader narrative that global growth is cooling and the Fed is on the path to tapering, which should be supportive for the dollar," said Paul Mackel, global head of FX research at HSBC.
The U.S. dollar slipped against its rivals on Friday and is set for a second consecutive week of decline as news that heavily-indebted property firm China Evergrande Group had averted a default buoyed appetite for risky assets.
Concerns over the embattled property developer whose liabilities are equal to 2% of China’s gross domestic product had sent investors flocking to the perceived safe-haven currencies like the U.S. dollar and government debt. Worries of economic contagion have seen swathes of other heavily-indebted developers hit with credit rating downgrades.
But days before a deadline that would have plunged the embattled developer into formal default and sent shockwaves through global markets, the company had supplied funds to pay interest on a U.S. dollar bond. News that the Chinese property developer had made a bond payment to avert a default lifted the mood globally. Worries about contagion from a potential default have rattled markets recently.
“So while this is good news in terms of a formal imminent default being avoided over the weekend, uncertainty is set to remain high until there is further clarity on Evergrande’s position and the position of other property companies in China,” MUFG strategists said in a daily note.
The broader market narrative remained supportive of more U.S. dollar gains as rising bond yields on the back of firmer inflation expectations are expected to lend support to the greenback.
Yields on 10-year U.S. Treasury notes held near their highest levels this year at 1.7% while yield differentials between comparable U.S. and German debt held at a chunky 177 bps.
Moreover, rising expectations that the U.S. Federal Reserve will be among the leaders to tighten monetary policy before other major central banks is also prompting investors like UBS Wealth Management to keep the dollar as its most preferred currency in its portfolio.
The RBA said on Friday it had stepped in to defend its yield target for the first time in eight months, spending A$1 billion ($750 million) to dampen an aggressive bonds sell-off as traders have bet on inflation pulling forward rate hikes.
Investors continued to unload long positions that benefited from an increase in bets that the Federal Reserve will raise rates sooner than previously expected. The greenback also faced seasonal weakness that is typical in late October. Investors have taken profits since the dollar index hit a one-year high last week, when concerns that inflation will remain stubbornly high for longer led investors to bring forward expectations on when the Fed will first raise rates to mid-2022.
That repricing momentum has now faded as investors take profits and also build expectations for sooner rate increases in other currencies.
“There’s a bit of a positioning unwind taking place, we’ve obviously seen a firmer dollar since the September Fed,” said Mazen Issa, senior FX strategist at TD Securities in New York. That also dovetails with the seasonal tendency for the dollar to soften into the end of the month. Issa expects the dollar to regain traction as global central banks push back against the aggressive repricing of rate hikes, while the Fed is likely to remain relatively hawkish and move forward with a reduction in its bond purchase program. “Once we get the pushback from other central banks and the Fed’s committed to taper we should see dollar dips really being shallow,” Issa said.
The dollar pared losses on Friday after Federal Reserve Chairman Jerome Powell said the U.S. central bank should begin reducing its asset purchases soon, but should not yet raise interest rates. Powell said employment is still too low and high inflation will likely abate next year as pressures from the COVID-19 pandemic fade, even as many market participants are concerned that rising price pressures will last longer than policymakers believe.
"I do think it's time to taper; I don't think it's time to raise rates," Powell said in a virtual appearance before a conference, noting that there are still five million fewer U.S. jobs now than there were before the coronavirus pandemic. He also reiterated his view that high inflation will likely abate next year as pressures from the pandemic fade. "We think we can be patient and allow the labor market to heal," he said.
It's "very possible" the Fed's full employment goal could be met next year, Powell said on Friday. Still, it's not a certainty, and if inflation - already higher and lasting longer than initially expected - moves persistently upward, the Fed would "certainly" act, he said.
"The risks are clearly now to longer and more persistent bottlenecks and, thus, to higher inflation," he said. For now, the Fed needs to "look through" that high inflation, despite the pain it means for households having to pay more for gas and food, in order to give time for the economy to work out supply kinks.
Consumer prices have been rising at more than twice the Fed's target. And, Powell noted, "supply constraints and elevated inflation are likely to last longer than previously expected and well into next year, and the same is true for pressure on wages." Still, he said, the most likely case is for inflation pressures to abate and job growth to resume its pace from this past summer. For now, the Fed will watch and wait, Powell said.
Data on Friday showed that U.S. business activity increased solidly in October, suggesting economic growth picked up at the start of the fourth quarter as COVID-19 infections subsided, though labor and raw material shortages held back manufacturing.
COT Report
Recent data confirms opinion of analysts above, suggesting that as dollar as EUR performance now is a product of rebalancing positions, and mostly technical. Data shows that there is no changes in hedgers' position this week. Net long position barely increases, but open interest drops significantly and speculators have closed large positions on both sides:
This data suggests that changes are mostly technical and are not because of sentiment change. Second - they are probably short term. It means that recent upward action stands due short covering rather than new purchases. Hence, the same background we have on the dollar index, which confirms our view of just a retracement now.
Continued in the next post...