With most of Europe still out on holiday, spiking markets on thin volumes elsewhere suggest plenty of nervousness heading into this Wednesday’s FOMC meeting. What are the implications of the FOMC anticipation for this week’s action?
CAD a bit out of whack
The Canadian dollar has not been a very enthusiastic participant in the rally against the USD over the last couple of sessions, showing signs of hesitation despite very supportive external factors recently (massive rebound in energy prices, pro-risk trades rising, etc.). A plausible reason for the market’s caution here is the upcoming Canadian general election, set for Monday, May 2. The consensus is that Brian Harper’s conservatives will emerge on the other side slightly stronger on the other side, with a stronger, if still minority, government. That being the case, and therefore with little prospect for any change of policy direction from a new government in the near future, we would suggest that politics is actually little cause for pause here and that the more dominant factor for Canada is its very large economic exposure to its neighbor to the south. Still, BoC expectations have moved wider against those for the Fed recently and last Thursday’s bounce in USDCAD will need to find other sources of support than Canadian political uncertainty to see any sustainable follow-through higher.
The Canadian dollar has not been a very enthusiastic participant in the rally against the USD over the last couple of sessions, showing signs of hesitation despite very supportive external factors recently (massive rebound in energy prices, pro-risk trades rising, etc.). A plausible reason for the market’s caution here is the upcoming Canadian general election, set for Monday, May 2. The consensus is that Brian Harper’s conservatives will emerge on the other side slightly stronger on the other side, with a stronger, if still minority, government. That being the case, and therefore with little prospect for any change of policy direction from a new government in the near future, we would suggest that politics is actually little cause for pause here and that the more dominant factor for Canada is its very large economic exposure to its neighbor to the south. Still, BoC expectations have moved wider against those for the Fed recently and last Thursday’s bounce in USDCAD will need to find other sources of support than Canadian political uncertainty to see any sustainable follow-through higher.
Chinese reserves
There has been a lot of noise last week over the weekend on the issue of China’s ballooning FX reserves, which increased almost $200 billion in the first three months of this year. This article from Zero Hedge is a good example of the ongoing discussion on the issue. The critical point is, as the article states, how the reserves are created in the first place – through global imbalances and China’s unwillingness over the years to allow its currency to float properly. To this we would pose the question: how much of those reserves will be needed to pay for the fall-out of the coming property bubble implosion in China and what will that development mean for the market’s current rosy view of the global economy’s prospects?
There has been a lot of noise last week over the weekend on the issue of China’s ballooning FX reserves, which increased almost $200 billion in the first three months of this year. This article from Zero Hedge is a good example of the ongoing discussion on the issue. The critical point is, as the article states, how the reserves are created in the first place – through global imbalances and China’s unwillingness over the years to allow its currency to float properly. To this we would pose the question: how much of those reserves will be needed to pay for the fall-out of the coming property bubble implosion in China and what will that development mean for the market’s current rosy view of the global economy’s prospects?
Chart: GBPUSD vs. interest rate spreads
We saw a key technical break higher in GBPUSD last week, a break that is not supported by interest rate spreads, which have normally been quite tightly correlated with the action in the spot market. Is this a sign of inefficiency and the market too eager to sell the USD relative to the pound, which is struggling under a similar set of circumstances, or does it simply represent a tip of the hat to UK fiscal austerity while the USD is foundering on fears that QE3 is only a thousand point dip in the Dow away from materializing in the months ahead? This week is likely to provide an answer.
We saw a key technical break higher in GBPUSD last week, a break that is not supported by interest rate spreads, which have normally been quite tightly correlated with the action in the spot market. Is this a sign of inefficiency and the market too eager to sell the USD relative to the pound, which is struggling under a similar set of circumstances, or does it simply represent a tip of the hat to UK fiscal austerity while the USD is foundering on fears that QE3 is only a thousand point dip in the Dow away from materializing in the months ahead? This week is likely to provide an answer.
Looking ahead
We still have more than a little cognitive dissonance at the moment across markets – precious metals are spiking around almost out of control, supposed on the perils of owning fiat currencies. (We have discussed the possibility that the last bout of aggravated volatility in silver in particular may have something to do with the combination of a long holiday weekend, the expiry of May options on Tuesday, the day ahead of a critical FOMC meeting. See more on silver and gold market behavior in our post from last Thursday. The silver move went increasingly parabolic overnight, which raises the odds of a near term exhaustion for a time. The move in Asian hours was attributed to a move by the Shanghai Gold Exchange to hike margins on silver. But we digress…). Equities can find nothing but upside all over the world even as the market frets the demise of the world’s reserve currency, as if such a development isn’t the least cause for alarm (nor apparently is there any alarm at the moment over the events in Syria or the renewed rise in commodity prices like crude oil, food, etc., which are increasing more rapidly than the USD is decreasing.)
We still have more than a little cognitive dissonance at the moment across markets – precious metals are spiking around almost out of control, supposed on the perils of owning fiat currencies. (We have discussed the possibility that the last bout of aggravated volatility in silver in particular may have something to do with the combination of a long holiday weekend, the expiry of May options on Tuesday, the day ahead of a critical FOMC meeting. See more on silver and gold market behavior in our post from last Thursday. The silver move went increasingly parabolic overnight, which raises the odds of a near term exhaustion for a time. The move in Asian hours was attributed to a move by the Shanghai Gold Exchange to hike margins on silver. But we digress…). Equities can find nothing but upside all over the world even as the market frets the demise of the world’s reserve currency, as if such a development isn’t the least cause for alarm (nor apparently is there any alarm at the moment over the events in Syria or the renewed rise in commodity prices like crude oil, food, etc., which are increasing more rapidly than the USD is decreasing.)
Most jarringly, we have very strong US and European bond markets at the same time as we are seeing a spike in fears of US fiscal and central bank credibility. Something simply does not fit here. It seems we are headed, at least in the near term, for an important test of what appears to be a rather crowded short USD trade with this Wednesday’s FOMC meeting and series of US treasury auctions (Tue-Thu, with $35 billion of 2-year notes on the block tomorrow followed by 5-year and 7-year auctions on Wednesday and Thursday, respectively). The demand levels - particularly foreign - at the auctions will be very interesting to watch in light of the recent fall in US yields from close to their recent peaks. The nagging aspect of these auctions is, of course, the presence of the Fed and we won’t have a better picture of real market demand until the July auctions, assuming QE2 expires as announced at the end of June. Still, the Fed doesn’t control the German Bund market or other major sovereign bond markets, which one case use as coincident indicators here.
Chart: USDJPY
The same level that was important for USDJPY as it descended from on high lately, the 55-day moving average (and daily Ichimoku cloud level at the time, though now it is much lower) around 82.50 is now influential as a resistance level. This week will be a critical one for USDJPY considering the potential for US interest rate volatility on the new FOMC monetary policy statement/Bernanke press conference and huge US treasury auctions Tuesday through Thursday.
The same level that was important for USDJPY as it descended from on high lately, the 55-day moving average (and daily Ichimoku cloud level at the time, though now it is much lower) around 82.50 is now influential as a resistance level. This week will be a critical one for USDJPY considering the potential for US interest rate volatility on the new FOMC monetary policy statement/Bernanke press conference and huge US treasury auctions Tuesday through Thursday.
Another critical focus this week is the behavior in intra-European sovereign risk spreads, as last week left us hanging a bit, with signs of some contagion as the spiraling Greek and Portuguese situation spread to a degree to Spanish debt spreads.
Be careful out there – this week is likely to see a further acceleration of volatility.
Be careful out there – this week is likely to see a further acceleration of volatility.
Economic Data Highlights
- Japan Mar. Corporate Service Price Index out at -1.2% YoY as expected and vs. -1.1% in Fe.
- Japan Mar. Supermarket Sales rose +0.3% YoY vs. +0.6% in Feb.
Upcoming Economic Calendar Highlights (all times GMT)
- US Mar. New Home Sales (1400)
- US Apr. Dallas Fed Manufacturing (1430)
- Australia Feb. Conference Board Leading Indicator (0000)
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