Steen Jakobsen
The Bank of Japan has abandoned quantitative easing and the European Central Bank may taper its bond-buying programme, so what is the role of central banks in 2017, asks Saxo Bank’s chief economist Steen Jakobsen.
Article / 16 September 2016 at 14:30 GMT

FX4 Next Week: Fireworks on the menu

Head of FX Strategy / Saxo Bank
  • FOMC and BoJ meetings may spark more volatility
  • The perception is that the era of easy money is ending
  • Divergence is possible: BoJ loosening again/Fed sounding hawkish
  • Fireworks are inevitable and traders should tread with caution 

September 21 – what we've all been waiting for. Pic: iStock

By John J Hardy

This week offered considerable volatility in some of the traditionally riskier currencies like the commodity dollars and emerging market currencies, where selling was the general theme on the sudden revival of market volatility after a very quiet summer. 

The major currencies offered few developments of note, on the other hand, as we all look nervously at next week’s pivotal Bank of Japan and Federal Open Market Committee meetings. Those meetings have the potential to drive further volatility on the idea that the major central banks are nearing the end of the QE era. There’s even some chance we get divergent policy signals if the Bank of Japan soldiers on with more negative rates while the FOMC offers hawkish guidance. In any case, fireworks are inevitable and traders should tread with caution as these central bank meetings will drive trading themes across all markets next week.

GBP downside

The Bank of England this week signaled an intent to cut at the November meeting, and there is nothing from the recent noises from the EU to suggest that Brexit negotiations will be an easy process. In that light, GBP faces a long period of uncertainty that could crimp the large capital flows needed to offset the UK’s large twin deficit and keep sterling under pressure again versus the US dollar and possibly against the euro as well. In general, we also suspect that sterling will weaken on a continuation of the recent market volatility as it did over the past week.

Trading stance: trading GBPUSD may prove difficult next week in spot terms due to the volatility around next Wednesday’s FOMC meeting, but bears may maintain the upper hand as long as the pair continues to close on a daily basis below 1.3300. Some bears may prefer to consider options structures, like a 1.3150 1-month put (about 100 pips with spot trading near 1.3200, or a 1-month 1.3050/1.2850 put spread, which costs about 50 pips) . Those looking to avoid the USD side of the equation might consider EURGBP upside potential as long as the pair remains above the 0.8425/50 zone next week for a rally well above 0.8600.

Source: Saxo Bank. Create your own charts with SaxoTraderGO click here to learn more 
AUD higher versus NZD if divergent momentum confirmed

This is a repeat theme from last week, as we spent all of this week watching momentum continue to unwind even as AUDNZD dribbled lower. We should see resolution next week, given the Reserve Bank of New Zealand meeting on the menu for Thursday. The confirmation of divergent momentum would be a sharp rally, possibly not until after the RBNZ that takes the pair back above the 1.0313 resistance, which is the low from early July. 

The BoJ and FOMC meetings could have a strong bearing here, if we see risk appetite failing to maintain its comeback attempt and especially if we see bond yields head higher, as this could trigger a significant unwind of the NZD outperformance that was driven for much of this year on the “reach for yield” theme.

Trading stance: Again, we have a divergent momentum setup, but the pair needs to turn the corner and begin to rally to confirm that this latest selloff will not sustain. A sharp rally that takes the pair well back above the 1.0313 prior low may prompt bullish interest for a move back toward 1.0600 or higher.

 Source: Saxo Bank.
USDCAD upside

The Canadian economy is poorly positioned from here, with a massive private debt bubble to deal with in the event the Canadian real estate market is slowing down – and there are increasing signs that it is. Additionally, the CAD is not necessarily set to benefit if the US economy weakens further as Canada is a satellite economy of the US. Furthermore, oil prices have been on the defensive and a break lower could compound CAD’s recent weakness. Moreover, the rise of Donald Trump in the polls has sparked a focus on NAFTA – the free trade deals that the presidential hopeful and his supporters so loathe. CAD could come under fire here from multiple angles, particularly if general market volatility levels remain high.

Trading stance: USDCAD bulls may look to scoop up dips as long as USDCAD remains well clear of 1.3000 for an eventual break of the 1.3250 area or may prefer to wait for that break (may require waiting until after the FOMC meeting before testing the long side). More cautious traders may consider options structures for a move toward 1.3500 or higher in the coming month.

Source: Saxo Bank. 
Trading BoJ and FOMC reaction in USDJPY

Some of the noise from press sources this week seems to underline the risk for a damp squib of a BoJ meeting that sees the bank perhaps indicating it wants to optimise its mix of purchases to keep the yield curve sloping higher, together with a minor rate cut further into negative territory. 

But it’s not just about the BoJ this week, but also about the FOMC, and there is considerable energy likely in the reaction to the 24-hour window in which these central banks will issue their statements and hold their respective press conferences. From the Fed’s side, we could see longer-term policy guidance lower (the dot plot for 2018 and beyond) while the Fed guides expectations higher for the near term, tipping off an intention to hike in December. 

The market seems ready to send the JPY higher if the BoJ does nothing. However, the JPY has seen a massive repricing from its lows and may have already discounted the ineffectiveness of the BoJ asset purchase programme, or at least mostly done so. So any spike higher in the yen may not sustain for long. After all, the obvious “next step” for policy now that it is abundantly clear that QE doesn’t help is fiscal stimulus with central banks merely playing a supporting role. Japan is the closest to this realisation and this policy mix in a country with an already staggering deficit, could mean higher long yields (which the BoJ seems to want anyway). Higher long yields tend to be a negative for the JPY.

Trading stance: last week we discussed longer dated options structures for USDJPY upside, and USDJPY bulls may still consider 1- to 2-month upside call spreads or vanilla medium-low delta calls. But given the potential for a volatile, two-way reaction, some may want to keep a portion of their trading powder dry to trade the initial reaction or fade it or both. 

Some may consider, for example, 1-week USDJPY downside one-touch options in the event USDJPY trades to 99.00 or lower (with market at 102.00 on Friday, a 99.00 one-touch cost 31% of the payout, a 98.00 costs less than 21% of the payout). Others may choose to fade an initial plunge shortly after the meeting by buying upside options – one-touch, vanilla, call spreads, etc.. The operating assumption for all of the trading themes above is that any downside potential could be sharp and potentially large, but won’t last and will yield to a rally.

Source: Saxo Bank

– Edited by Clare MacCarthy


John J Hardy is head of FX strategy at Saxo Bank 


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