By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Forex: The 5 Most Important Events Next Week
This week's FOMC rate decision failed to spark fireworks in the forex market. After an initial expansion in volatility, most of the major currencies have fallen back into recent ranges. USD/JPY is still trading above 119 and EUR/USD below 1.1450. The lack of action and clarity from the Federal Reserve leaves investors with very little motivation to take big positions in the dollar. We still anticipate a decline in the dollar before a recovery post FOMC because for as long as Janet Yellen keeps the market guessing, large one way moves in currencies will be limited. The Fed did not rule out a 2015 rate hike and in fact Yellen indicated that every meeting is a live one including October. So from now until then, investors will be obsessing over U.S. data and Chinese stocks. There is no major U.S. economic data set for release next week outside of revisions to Q2 GDP, so the focus will be on Fed speak.
#1 Four members of the Federal Reserve will be speaking next week and most of them are expected to share their views on the economy. Janet Yellen introduced the notion of raising interest rates in October and investors will be listening carefully to see how serious policymakers are about beginning liftoff next month. Unfortunately only 2 of the 4 officials are voting members of the FOMC and one of them is Yellen. Voter Lockhart is typically a dove and will most likely share her cautious views. Bullard and George are hawks but they are non-voters. So we would be surprised if the dollar had a big reaction to any of these comments. We continue to look for a slow drip lower in the greenback and plan to reestablish long USD/JPY trades near 118 and short EUR/USD trades near 1.15.
#2 ECB President Mario Draghi is testifying in Brussels next week and like his counterparts at the central bank, he will most likely remind us they stand ready to increase Quantitative Easing if necessary. Just Friday morning we heard from ECB member Coeure who said they could extend QE beyond September 2016 if necessary. Clearly the European Central Bank is worried about the outlook for the economy and the persistently low level of inflation so while boosting the size of their Quantitative Easing program is ten times more complicated for the ECB than for the BoE, Fed or BoJ, the mere notion that they are considering increasing stimulus should be enough to cap the EUR/USD rally above 1.15.
#3 Beware of China's Caixin PMI Report - The main takeaway from this week's FOMC meeting is that even the Federal Reserve is worried about China. Other central banks particularly in the emerging market have been very vocal about the impact that volatility in Chinese markets and slower Chinese growth will have on their economy. But up until this week, U.S. policymakers have downplayed its significance. The Shanghai Composite Index did not extend its losses on Friday but next week the Caixin PMI manufacturing index is scheduled for release. This private-sector report hides no blemishes, so if they saw a further slowdown in manufacturing activity, it could trigger another decline in Chinese equities that would take risk currencies including USD/JPY lower. Of course if the data is strong and an improvement is seen, we would see a broad-based risk rally.
#4 Eurozone PMIs are a Litmus Test for Europe - On the same day that Mario Draghi is scheduled to speak, Eurozone PMIs will be released. The concerns of Eurozone policymakers need to be validated by economic data. Economists are looking for weaker growth in the manufacturing and service sector and if they are right, it will reinforce our view that selling EUR/USD into the post-FOMC rally is one of the smartest trades. According to the recent ZEW survey, current conditions in the Eurozone economy improved but the outlook is gloomy. In addition to Eurozone PMIs, the German IFO report is also scheduled for release, making next week an important market-moving week for the currency.
#5 For the U.S., we have Q2 GDP revisions, housing-market data and durable goods scheduled for release. Changes to the initial projections for US growth could have a brief impact on the dollar but at the end of the day, we do not expect any big moves in reaction to next week's reports. These are not the areas of the economy that the Federal Reserve is particularly concerned about right now and their weakness or strength will not have a significant impact on the central bank's plans to raise rates in October versus December.
BONUS #6 If you are trading the Canadian dollar like we are, Monday's speech from Bank of Canada Governor Poloz will be very important. USD/CAD fell sharply post FOMC, coming within 10 pips of our 1.30 target only to reverse by the end of the North American trade on Friday. Between the Fed's less-hawkish posture and the BoC's less-dovish monetary-policy stance, we have loved selling USD/CAD. We rode the move down to 1.30 and are looking for opportunities to reenter at a higher level. There were no surprises in Friday's Canadian consumer price report but the lack of an uptick in CPI was disappointing. A new leg lower in USD/CAD will require optimistic comments from Poloz and higher oil prices prices.