By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Next Week's FX Trade In 6 Points
We all know that next week is going to be an important one for the financial markets because the Federal Reserve will decide whether the U.S. economy is strong enough to warrant the first rate hike in 9 years. However that's not the only market-moving event risk on the calendar. In fact, the calendar is so jam-packed with data that we can be assured of a pickup in volatility, which will translate into big moves in the forex market. If you're trading currencies next week, here are the 6 things you need to know:
#1 - The markets appetite for U.S. dollars is going to be very important but it won't be the only force driving the markets -- especially in the front of the week. Based on the performance of the U.S. economy alone, the Federal Reserve should raise interest rates because the unemployment rate has fallen to a level often associated with full employment. Wages are on the rise, the housing market is steady and manufacturing- and service-sector activity is expanding. The emergency conditions that warranted the zero interest-rate policy is no longer in place and in turn, it is time to raise interest rates. However the Fed does not operate in a vacuum and between the volatility in international equities, the ECB's dovishness and a dovish bias from other central banks, it will be difficult for Janet Yellen to pull the trigger. 60% of economists surveyed by Bloomberg are still looking for the Federal Reserve to raise rates next week, but Fed fund futures are pricing in only a 30% chance of a move. It will be a difficult decision for the central bank and for that reason, we expect investors to reduce their exposure to long dollar positions ahead of Thursday's decision. In other words, the dollar should weaken in the front of the week. Even if the Fed does hike, the rally will be short lived with choppy trading to follow as we expect tightening to be accompanied by lower guidance. One rate hike is all we're looking for from the U.S. central bank this week and they will go out of their way to ensure that the market understands that trajectory.
#2 - Before the FOMC rate decision, we have 2 other central-banks announcements from the Bank of Japan and the Swiss National Bank. Normally we do not pay much attention to Swiss data, but the SNB only meets quarterly and they have been consistently talking down the currency. The Bank of Japan on the other hand could either increase Quantitative Easing or talk about their willingness to do so. Over the past week, a few Japanese policymakers have talked about the need for more stimulus. In the first half of the year, Japan's economy was recovering strongly and it was widely believed that further QE was not necessary. However with the slowdown in China and the yuan's depreiation, the outlook for Japan's economy has worsened significantly. If the BoJ talks about increasing stimulus, we could see the Japanese yen spike lower in the front of the week, driving USD/JPY higher.
#3 - The week(end) kicks off with Chinese data. China has been a major source of volatility for the financial markets and over the weekend we have Chinese retail sales and industrial production numbers scheduled for release. While many Chinese officials have tried to reassure the market that 7% growth will be achieved in 2015, many seem to acknowledge that the economy is slowing. However the stabilization in equities toward the end of the week was extremely important (especially if they did intervene in their currency) and they will not want to risk causing another turn in sentiment. As such, they may opt to massage the reports to ensure the data doesn't trigger additional volatility. But if they don't, we're in for a nasty surprise.
#4 - The UK is also in the spotlight with consumer prices, employment and retail sales data scheduled for release. Last week, the Bank of England did not express any specific concerns about the recent weakness in domestic data and the problems in the global economy. This coming week will test their relaxed attitude with a number of important economic reports. The British pound is in play and we believe that risk is to the downside with the prospect of weakness in inflation, job growth and spending.
#5 - The New Zealand dollar could drop to fresh multi-year lows. One of the big stories last week was the 25bp rate cut from the Reserve Bank of New Zealand. Their decision to lower rates reflects the activeness of central banks struggling to ease the pain in their economies. Not only did the RBNZ lower rates three meetings in row, but more importantly, they warned that further easing is likely. The New Zealand dollar could extend its losses in the coming week as economic data reinforces the central bank's concerns about their economy. With the trade deficit expanding in the second quarter and retail sales sliding, we're looking for a major deterioration in the current account balance and a significant slowdown in second-quarter GDP growth.
#6 - Beware of a Reversal in the Australian dollar. One of the best-performing currencies this past week was Australia's dollar. Between better-than-expected employment data and a strong turnaround in copper prices, AUD/USD enjoyed a very nice recovery. However with the minutes from the most recent monetary policy meeting scheduled for release next week along with speeches from RBA officials, traders should watch for a reversal. Given the slowdown in the Chinese economy and the prospect of even weaker growth going forward, it's difficult for the RBA not to be concerned about the outlook for the domestic economy. Any tinge of dovishness and hint of further easing could erase AUD's recent gains. Considering that we're also looking for U.S. dollar weakness, it could be a choppy trading week for the majors.