FX Weekly Preview: Looking For A Rise In Vol As The Fed Finally Makes Their Move - So We Can All Move On

Submitted by Rajan Dhall MSTA and Shant Movsesian from fxdailyterminal.com

In the absence of key economic data, we tend to see heightened levels of containment in the FX markets, where the heavy presence of system (algo) traders require constant direction in order to drive price action one way or the other.  We have also been in a period of stasis given the prospect of a Dec rate hike from the Fed next week, and one which we feel the market is looking to fade given there is less momentum in the US economy to generate the three (more) hikes the Fed dot plot has been suggesting.  Caught between a rock and a hard place, ranges in the key major pairings have been exceptionally tight, albeit with some notable adjustments in previous months.

Now that EUR/USD has moved up into a fresh range after breaking above the 1.1500-1.1700 area, the market has naturally tried to push as far as it can, with the positive longer term outlook on the Euro zone driving the single currency higher almost as a 'default' mode.  Having reached the 1.2000 objective for this year, the prospects for levels closer to 1.2500 next year have driven the familiar overstretch we are used to seeing in the market these days, but we clearly need to undergo a period of consolidation to see who we progress from here, and above 1.2000, the market has been fading some of this over-enthusiasm for now.  There are also interest rate differentials to consider, and from the start of the year, the US curve has lost ground to tighten spreads, though safe haven demand for German paper distorts this traditional backdrop, which in effect maintains a level of uncertainty in the efficacy of ECB policy for the region as a whole.

Price action here will largely be dictated by the US perspective, and alongside the FOMC announcement Wednesday night, we also have key inflation data as well as consumer spending to consider, with production stats thrown into the mix at the end of the week.  

We will naturally get a better picture on how the market views the USD going forward through USD/JPY and USD/CHF, and the cautious nature of the gains seen in the past week or so further signal to us that the USD upturn of late remains corrective more than anything else.  For all the focus on tax reform, we saw a mute response to the Senate vote to the Tax cut bill, which will continue to come under scrutiny as we look to agreement between House and Senate, but more so on the supposed economic pass through this will generate, which has drawn plenty of scepticism.  Key levels vs the JPY remain in the 114.00-115.00 area, and next week may well see this tested along with parity+ against the CHF.  Those fading gains will point to the limited upside in long end US yields, which have already slipped this year, as well as the ever present deficit concerns - no surprise then that the light balance sheet reduction process has swiftly faded out of general attention. 

The ECB also meet next week, but given the much awaited tapering announcement has already been made, this is largely a non event which should pass without much fuss this time around.   Expect more optimism in the economic outlook, but he plenty of this from no end of ECB speakers on a weekly basis, so we continue to watch the data series from the key member states.  Germany's ZEW survey for Dec should tame a little, as did production (including orders) and trade last week, with manufacturing PMIs for the EU (as well as Germany also due.  As above, it will take a notable period of weakness here to dislodge the embedded positive view in the market at present.

For GBP, it should be a very interesting week ahead with the Brexit saga mixed in with the BoE meeting and some key data releases.  The algos' made hay' on a constant stream of ups and downs in the lead up to the agreement in principle on the key issues which it needed to satisfy in EU negotiators to propose a move on to phase 2 talks at the EU Summit this week.  This was highlighted by the modest pullback in the Pound after we got the confirmation on Friday.  No more fun and games in this respect from hereon out however, as we have to look at what PM May and Brexit minister have actually achieved.  Based on the fact that all now hinges on how the trade talks develop - and this is the hard part - the initial agreements will count for nothing unless the UK feel they can get a favourable trade deal. 

Over the weekend, EU trade partners have made their unease over a 'special deal' known to the (EU) commission, and the 27 member union are already expected to take a hard stance.  Any ideas or hopes of a 'bespoke' agreement from the UK still look overly optimistic, and David Davis has admitted this weekend that the agreement is more a 'statement of intent'.  The agreement is not 'legally enforceable' so in effect, the 'deal' is not binding.  As we have noted throughout the GBP rise, we have achieved relatively little in terms of actual progress in the talks themselves, and in turn, we expect the Pound to give back some of these gains unless we get some significantly positive data on jobs and retail sales, while Tuesday's inflation report will also be interesting as a backdrop to the BoE announcement later in the week - another non event on the face of it, but we have seen the market move erratically to rate projections from the MPC. 

Cable topped out in the mid 1.3500's last week, but we still need to see levels below 1.300 before we can cement this on any notable time frame.  At the same time, EUR/GBP has dropped to new lows just under 0.8700, but the reversal was emphatic, though not enough to suggest the EUR side of the equation could not take it a little lower, but on balance, the momentum under the lows looks unlikely to develop based on what we have seen so far.  GBP/JPY is also pretty vulnerable given strong buying here seen in the past few months, and will have in itself been supportive to the spot JPY rate recently. 

For the JPY itself, plenty more data to give us a sense of the level of recovery from the export perspective - manufacturing PMIs, industrial production, the Tankan indices and machinery orders all offering an insight into whether this can continue to prop up growth and expansion which is currently on a positive run.  It is however the focus on consumer spending and the follow through on inflation which continues to dominate government and BoJ thinking, and JPY weakness naturally 'plays its part'.  More evidence of positioning against the JPY last week, and this will continue as part of the carry trade theme which is egged on by yet more gains seen in the major global stock indices!
The CHF is also getting pushed lower on the back of this premise, and much to the contentment of the SNB who also meet this week.  Gov Jordan and Co will continue to cite the Franc as 'highly valued' and will keep the base rate at +0.75% accordingly.

For the AUD, traders are watching this 0.7450-0.7500 area with keen interest as it could determine a break in the longer term cycle higher.  There are current reasons to keep the pressure on the mining/commodity based currency, though not on commodity prices themselves.  From the economic perspective, inflation has fallen out of the RBA's target range, and despite a low level of concern within the board, is proving a clear negative with wage growth also tame.  Add to that a drop in the trade balance and the prospect of a tech based break back to the upside remains unlikely as yet, but we have the NAB business survey next week ahead Nov employment report, which could tip the balance to some degree.  Good to see however that the GDP miss of 0.7% for Q3 to print just a tenth lower was effectively dismissed, given an annualised growth rate of 2.8% is nothing to scoff at in this environment!

Business confidence is what has knocked the NZD in the past few weeks, but forgotten all too quickly as focus on the AUD took the cross rate back under 1.1000 again to keep NZD/USD camped in the mid 0.6800's for now.  The new Labour led coalition is clearly behind this nervousness in the business community, and despite the latest budget and debt forecasts to be delivered next week, any surpluses (if) announced will should have a limited impact compared to those released in the summer given the change in government and what they do with it.

Finally in Canada, BoC gov Poloz is speaking again in the week, and this will be another prompt for CAD traders given little tier 1 data to consider.  Irrespective of whether there was any other data, this would still be the primary factor, as the BoC statement failed to live up to the hype after the employment report the week before last, as well as seeing GDP levels at an annualised 3.0%.  Even so, the market will continue to push for 1.2900+, but once again, it is all about the USD and momentum above here should be limited despite the restrained BoC speak on rates, which the market over-reacted to in the first instance after the second 25bp hike at the start of Sep.