IB FX View

An end to the exit talk?

Wednesday November 4, 2009

The two low-yielding soft currencies (the dollar and yen) are lower today as FOMC decision day has finally arrived. We can now look back with the benefit of hindsight and say that the recent boost to the dollar and yen were due to worries over the prospects for the U.S. economy and how that might transmit less cause for other central bankers to push for removal of monetary stimulus. That causes a wider yield differential and harms the appeal of the dollar. Instead, dealers have concluded that it’s business as usual and that the economy continues to progress, which means that it’s once again time to ditch the dollar.  


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The dollar has slipped to $1.4840 against the euro this morning following opposing news from respective PMI surveys. The Eurozone PMI data indicated ongoing expansion for October while the U.S. data eased back from expansion to break even.

Such patchy data makes it difficult for the FOMC to step up and announce steps towards the exit as many economists suggest they do. The tone of Wednesday’s statement from the Fed is likely to convey an unchanged message in which they see a patchy economic recovery warranting an extended period of easy monetary policy.

The surge in commodity prices has been spearheaded by a new record high for gold this week with bullion reaching $1,096.20 per ounce today. News broke earlier in the week that the India’s Reserve Bank had bought 200 tons from the IMF during September and serves to undermine the confidence in the dollar as a store of wealth.

With rising gold comes an increase in the price of crude oil to $80.48 and of course both are positive developments for the natural resource-rich nations of Canada and Australia. The Canadian dollar has been especially strong since gold jumped on Tuesday and today buys 94.23 U.S. cents. On Friday data will likely compound September’s positive employment picture when 30,600 jobs were added. For October, the consensus view is the creation of a further 10,000 jobs.

Following the RBA’s rise in interest rates this week investors continue to respond to central bank comments surrounding the impact of a stronger Australian dollar. Here’s where the comparison with Canada contrasts nicely. The Bank of Canada has attempted to talk its dollar down as the impact on activity bites. But the Australians seem to be more willing to take local dollar strength on the chin and have stated that a rising dollar performs some of the work of monetary policy for them. Interest rate expectations have therefore been pared, but the Aussie continues to recover and today buys 90.73 U.S. cents.

The British pound is also responding to stronger purchasing managers’ data today  – the strongest reading since August 2007 – and is currently up against the dollar at $1.6552. The euro buys a pretty much unchanged 89.62 pennies. The PMI data is another factor making history out of the recent GDP contraction as traders prefer to be forward rather then backwards looking. Once again there is no expectation for the Bank of England to make any change in monetary policy when it announces on Thursday.

Recent sterling weakness has come hot on the heels of any suggestion of further expansion of the asset purchase program. Such a requirement has hitherto been taken as a sign of weakness. But now that further data and expectations of a recovery taking traction is in the air, investors are taking the view that should the Bank announce the £50 billion expansion that the majority of analysts now expect, it will be viewed as a reinforcement for economic activity. It may be detrimental for longer yields, but that’s a side show. The point is that investors are buying the pound on the view that the medicine will make the patient better and that rather than be fearful of swallowing it, they are simply accepting it’s on the prescription pad already.

We noted in yesterday’s commentary that implied currency volatility had recently stepped up. We expect this to remain the longer the euro is making its mind up with $1.50 being a focal point. The recent subsidence in risk appetite, which drove the pair back towards $1.46 is perhaps over and so the potential for a second wave move back above $1.50 should continue to underpin currency volatility for a while longer.


Andrew Wilkinson                                                                    

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com       


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