June 17, 2013

All Eyes on the Fed, All Ears on Policymakers

Going into this week, market participants are in agreement that the elephant in the room is the Fed.

Going into this week, market participants are in agreement that the elephant in the room is the Fed. All eyes will be on the US Central Bank as it decides whether to extend, pause or reduce its highly controversial quantitative easing (QE) programme on Wednesday at 13:00 NY Eastern Time / 18:00 GMT / 04:00 AEST.

Recent price action has been rather USD negative with EUR/USD posting 4 consecutive weeks of gains from strong support around 1.2800 up to current levels of around 1.3350. Technical analysts are already calling it a "technical" bull market given the strong gains, over a relatively short time.

The move higher has not been erratic or extreme, but rather, EUR/USD has grinded higher in methodical trend fashion. To us, this suggests that USD positioning is slowly shifting amidst mixed feelings over the health of the US economy and the broader recovery in G20 countries. European macroeconomic data and central bank commentary has been largely non-existent in terms of making a significant impact on EUR pairs. It's becoming increasingly clear to investors and policymakers that internal factors such as GDP, employment, inflation and money supply are having less of an influence on asset values (especially FX rates) compared to other factors such as speculative money flows, leveraging/deleveraging decisions and QE policy from the world's largest central banks. The highly anticipated Fed meeting will be addressing this more influential aspect but with a view on macro data (which has been gradually improving in the US recently). Fed members have repeatedly emphasised their focus on US employment and inflation when making policy decisions; but this guidance has often been misinterpreted by jittery speculators, opportunistic investors and large hedge funds attempting to second guess the Fed.

Overall, we don't see the Fed removing stimulus measures this week. Partly because such a move would probably destabilise already fragile markets and also because we feel that the Fed's take on US macro data is not optimistic enough to warrant a repeal of QE. On the surface, employment conditions may be improving in the US which would support a gradual 'normalisation' of interest rates but on closer inspection, jobs are being created in mainly the unskilled, low paid and government sectors. This suggests that the US economy is still recessionary in many respects, despite the rosy headline data. What is more likely, is that the Fed tempers market expectations and outlines a 'wait-and-see period' before deciding to remove additional liquidity. The circa $85 billion of monthly asset purchases will probably continue unchanged because this support has been crucial to keeping yields on government bonds capped. Without the Fed's blanket buying of various assets, Treasury yields would likely rise and increase US national debt in real terms via higher interest payments.

The Fed find itself embroiled in a dilemma: If it continues with QE, it risks inflation, more leveraging and an asset price bubble. On the contrary, if the Fed removes QE, it risks an unorderly unwind of long Treasury positions because a portion of investors are likely to lose faith in US government bonds. Additionally, the Fed may induce a large decline in equities and commodities worldwide because a large proportion of recent commodity/equity price inflation has been due to speculative buying as a result of cheap money. It seems that no matter what the Fed chooses to do, the only winners will be speculators.

Taking all this into consideration, we feel the Fed will try to avoid (operative word being "try") causing intense volatility and market uncertainty and thus decide to continue with its QE policy but put added emphasis on conditions it wishes to see before pulling back on QE. We could even get firm targets such as a specific rate of unemployment, or nominal GDP although this is unlikely given past Fed meetings. Either way, the Fed has a tight rope to walk and everyone will be watching. No pressure then.

With all this speculation and uncertainty abound regarding the Fed's policy meeting and consequent press conference, markets are definitely on edge. Speculators are out in force so even a small deviation from the expected, could lead to extensive moves in US dollar pairs as well as the flow sensitive commodity currencies such as AUD, NZD, CAD and ZAR.

Expect fireworks despite the lack of gunpowder this coming Wednesday as liquidity loving speculators try to make the most out of a mixed message from the Fed.

Event risk is high in Europe, the US and the UK.


The German Constitutional Court ruling on the legality of EMS and OMT could potentially surface although most market commentators see a decision only in September after the German elections.

The German ZEW survey and parallel PMI figures also pose some event risk for EUR pairs although we would have to see an extreme print for traders to take notice (29.4 exp. vs. 27.6 prev.).

British Pound

GBP traders have a big week ahead of them as we anticipate UK inflation figures, Bank of England (BoE) meeting minutes and testimony to the Parliament's Treasury Committee by the BoE governor this week on Tuesday and Wednesday.

GBP climbed to a fresh monthly high against USD (1.5740) last week and we feel GBP pairs could continue their gains subject to the theme of the week i.e. the Fed policy meeting. If inflation projections remain stable around 2.5% we could see GBP relinquish some its strong gains against USD. On the other hand, a larger than expected reading of >2.9% would probably raise expectations of monetary policy normalisation in the UK (higher interest rates and/or a pause in QE) - this would be immensely GBP positive and would help GBPUSD to push through the psychologically important 1.60 level.


From a political/policymaker perspective we could see very intriguing comments and in turn, volatile intra-day trade this week as the G8, ECOFIN and Eurogroup meetings converge. Speculating on what will be said, decided and announced is incredibly difficult but considering that we have a key Fed meeting, the G8, Eurozone and a SNB meeting to boot, there is an outside chance of a multilateral announcement that completely changes the outlook for all asset classes and currencies.

Bond Auctions

Amidst the busy macro data calendar we think the German and Spanish 10yr bond auctions (Wednesday and Thursday respectively) will be key indicators of investor sentiment in the EU. Contrasted against a backdrop of other key macro data, we think EUR pairs could be in for a wild rollercoaster this week.

The SNB meets to decide interest rates this week on Thursday 2:30 US Eastern Time/7:30 GMT/17:30 AEST. The SNB is likely to leave interest rates unchanged but accompanying commentary at the press conference could be market moving.

New Zealand will announce the latest GDP reading on Thursday at 8:45 AEST.

Gold prices remain under pressure wit the precious metal trading at levels last seen in early 2011 ($1,390 at the time of writing). Gold prices have remained subdued over recent weeks despite rising FX and equity volatility rising and safe-haven demand also ticking up. Gold continues to trade below the key $1,400 threshold with $1,355 as key support. Market participants are now focusing on key macro event risk as the next trigger for Gold prices. Considering that the macro calendar is extensive this week with government/private debt, QE and inflation as the key themes, Gold prices may just find a footing to re-join the predominant long-term trend.

We believe volatility will be elevated for most asset classes this week but commodities and precious metals such as WTI and Silver will be the standout rollercoasters.

Written by George Tchetvertakov