IB FX View

Currency fog lifts after FOMC and State of the Union

Thursday January 28, 2010

It’s taken until Thursday for the haze descending over the currency market to lift. But the trend is becoming clearer today in light of fresh information in the form of dissent about what the Fed shouldn’t say to describe the economy and President Obama’s agenda for a political fix for the economy. Also shaping the fate of forex markets is deepening concern that’s about to drop the Portuguese economy into the European fiscal battle zone, adding to existing concerns over the health of the euro. The improved tone toward recovery around the world is pushing the dollar higher, while an appetite for the “risk-on” currencies has suddenly returned to the mix. 


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U.S. dollar – In its December policy statement, the Federal Reserve made reference to the variety of policy actions that should contribute to a strengthening of economic growth. In yesterday’s statement the FOMC referred to the pace of “economic recovery”, which although expected to be moderate would over time bleed the abundant stockpile of currently idle resources. At the same time inflation is likely to remain low. It’s a subtle but suitable shift and the sort of tonic required to lift the spirits of investors that had lost direction and allowed a splintering of views to derail them from taking risk.

The other eye-catching detail within the FOMC statement is the expression of optimism from Kansas City Fed chief Thomas Hoenig who marginalized himself when asking that the committee drop the “extended period” phrase. His view is that the remedial monetary and financial policies have worked through the system so successfully that at some point monetary policy can be adjusted to a more normal level. If the Fed is right that inflation will remain constrained and that the economy can lean on the buffer of abundant resource utilization, Mr. Hoenig’s view is likely to remain an isolated one for some time. However, even if the economy flat lines from here with modest economic growth, investors will see that it is only a matter of time before rates will start to shift as normality resumes.

The dollar index rose to a near six-month peak as the euro traded at its weakest price since July. President Obama’s State of the Union address chose to focus on measures to aid job creation and steered clear of further news on punishing financial institutions. Taking that fine line has encouraged traders to once again adopt positions in riskier currencies. Later on Thursday the Senate votes on chairman Bernanke’s nomination to what is probably a second term in office, which again might nudge the dollar firmer still.

Euro – The euro slumped to $1.3930 where it hasn’t traded against the dollar since mid-July. The euro received positive data Thursday indicating strengthening sentiment in January while December data was revised up. EC economic sentiment rose from 94.1 to 95.7 and was far better than the expected downturn for sentiment predicted by analysts. Despite rises, the various component indices within the survey are at relatively low levels. However, the outweighing factor today remains a worsening of the fiscal situation. Today in Davos, the Greek finance minister made an outright denial that he’s looking to China in part to mend a €54 billion budget shortfall, stating that he’s overwhelmingly looking to Europe for funding.

Following the announcement of its budget earlier this week, once again Portugal is back in the firing line and playing out the market’s fear that peripheral nation’s are drawing attention of the worst kind. Ratings agency Standard & Poors said that following the budget it still remains concerned about the frail state of its public finances. The impact from the financial collapse of America seems to have set many European nations back 15 years in terms of the budgetary situation they worked so hard to improve in preparation for the Union.

British pound – As the appeal of “risk-on” trades resumes, count the British pound in the group. These days it acts more like the Aussie dollar than a core currency. Today sterling is benefitting from the risk flows and as with the dollar, investors are warming to the possibility that interest rates may have to go up, albeit “at some point.”

Yesterday’s words from policy maker Andrew Sentance are still ringing in traders’ ears when he threw the cat amongst the pigeons by throwing down the gauntlet to the MPC when it next meets and has to face the thorny issue of inflation. Hard to control price increases stemming from the service and import sectors may be reflected in changes to the multi-year inflation profile when the Bank of England publishes its Inflation Report next month.

The ongoing circus surrounding the euro leaves the sideshow of weakening euro-crosses. The pound rose to a five-month high against the euro and is currently trading at 86.26 pence.  

Japanese yen –The yen fell and its stock prices reversed Wednesday’s losses following the Obama speech. The lack of any concrete plans to curtail bank risk removed one argument for further chasing the yen higher against the dollar as risk aversion can now take at least a temporary back seat. The dollar improved to ¥90.29 while the euro moved up to ¥126.53 and the Aussie dollar added to ¥81.46.

Aussie dollar – The same lack of a plan to curb risk taking from within President Obama’s speech provided a catalyst for the Australian unit to rebound sharply. In early trade the Aussie has added 0.75 cents to 90.25 U.S. cents after trading as low as 89.11 cents in the final hour of U.S. trading Wednesday.

Canadian dollar –The Canadian dollar is this morning at a three day high versus the greenback and currently stands at 94.48 U.S. cents. The “risk-on” mentality today is supportive as it’s helping commodity futures prices rebound. Yesterday’s energy supply data in the United States sent prices of gasoline, natural gas, heating oil and crude oil lower, and while nothing has changed today, futures prices are reversing along with prices of metals. It looks like that tide is turning after a week of anti-risk price action.


Andrew Wilkinson                                                                    

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com       


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