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John J Hardy
The British pound has continued to strengthen this Tuesday as investors contemplate an interest rate hike sooner rather than later. GBPUSD is trading near cycle highs.
Article / 27 January 2014 at 8:51 GMT

Market sorting through the wreckage ahead of FOMC

John J Hardy John J Hardy
Head of FX Strategy / Saxo Bank
Denmark

• Market worries stem from several fronts
• JPY is again the go-to currency
• The EUR became a safe haven

Friday’s equity session ended near the lows, the first real sign of capitulatory selling in a long time in asset markets. Is this an expression of worry about the state of affairs in emerging markets, or the US earnings season? Or is the market fretting about the ongoing US Federal Reserve taper and trying to send the central bank a message as it meets this week (the final meeting with Ben Bernanke as chairman)?

I suspect it is a mixture of all of the above and the fact that we came into this year insanely overbought technically in asset markets. Once again, as noted on Friday, the JPY is the go-to currency when asset markets go white-knuckle on us. And it’s too early to say whether this bout of nervousness is over — the key event risk to determine where we stand on risk/sentiment is fast approaching with Wednesday’s Federal Open Market Committee (FOMC) meeting.


 Scot Olson
Emerging markets, corporate earnings and the Fed have rattled markets.
Photo: Scott Olson / Thinkstock.com


Euro safe haven, believe it or not

The somewhat surprising development late last week was the big jump in EURUSD back above the key resistance on Thursday. Some are apparently playing the US dollar from a pro-cyclical perspective, thinking that the euro and the JPY are the safe haven currencies when risk goes off and the prospects of Fed tapering are thrown into doubt. I suspect there is little fuel for a further EURUSD rally from here from this perspective — the market is under-appreciating the risks to the Eurozone this year and eventually, the greenback will trump the euro as a safe haven if this bout of nervousness continues. Still, we need to see EURUSD back below 1.3600 to prove that point. Until then, it is in a bit of no-man’s land up as high as 1.3800.

Sterling sold

Friday saw a mini-meltdown in sterling after the market’s over-anticipation of Bank of England (BoE) Governor Mark Carney's removal of forward guidance proved way overplayed. Carney on Friday made mention at Davos of considering a “range of options” on further policy guidance. The market also reacted to his mention of sterling’s strength, which was particularly loud considering the lack of discussion of the matter in the most recent BoE minutes, which had perhaps emboldened traders to bid sterling higher recently. Anyway, the damage to sterling in the key pairs looks rather significant, though we need more than a one-day sell-off to prove that the highs for the currency are in here versus the euro and the USD. Some of the sterling weakness may also be due to the fact that sterling longs have become a somewhat pro-cyclical trade due to the strength in the UK recovery.

Chart: GBPUSD

We saw a technically significant reversal on Friday as we cut well back through the old highs after posting marginal new highs for the cycle above 1.6660. Look for whether 1.6550 provided resistance here tactically and really, we need a follow-through leg lower to the 1.6300 area to really embolden the bears here.

 gbpusd
Source: Saxo Bank

Looking ahead

The key data point this morning is Germany’s IFO survey, which has remained extremely elevated over the last couple of months and is one of the most influential of the German activity surveys. US data ahead of Wednesday’s FOMC decision includes the New Home Sales data for December out today (this survey bounced back very strongly after a few weak data points in July-September) and Durable Goods Orders for December and the Conference Board Consumer Confidence survey for January, both out tomorrow. The first estimates of Q4 GDP are up on Thursday and the latest batch of PCE inflation data on Friday.

Meanwhile, it’s all about the FOMC decision on Wednesday and what message the Fed tries to send. I suspect the mentality among Fed members at this meeting will be to hope that the bad news of late is just a case of the jitters that will hopefully blow away. It is simply too embarrassing for the Fed to backtrack so quickly on its new policy direction after December’s decision to start the taper — so let’s not expect that a few-percent correction in equity markets or a budding emerging markets (EM) crisis is going to derail the Fed just yet. I suspect eventually, the Fed can be derailed if asset markets go into meltdown mode or if the EM crisis deepens and spreads, but it is too early days just yet.

Keep an eye on EM currencies, as a further acceleration in the devaluation from here could keep risk appetite weak at the knees. There is a strong risk of the negative spiral continuing without dramatic measures from central banks and improvement in sentiment.

Economic Data Highlights

  • New Zealand Dec. Performance of Services Index out at 57.5 vs. 56.4 in Nov.
  • Japan Dec. Adj. Trade Balance out at minus JPY 1148.6 billion vs. minus JPY 1335.1 bn expected and vs. minus JPY 1293.8 bn in November.

Upcoming Economic Calendar Highlights (all times GMT)

  • Germany Jan. IFO Business Climate Survey (0900)
  • Euro Zone ECB’s Constancio to Speak (1130)
  • UK BoE’s Cunliffe to Speak (1130)
  • US Dec. New Home Sales (1500)
  • US Jan. Dallas Fed Manufacturing Activity (1530)
  • Euro Zone ECB’s Weidmann to Speak (1800)
  • Australia Dec. NAB Business Confidence/Conditions (0030)
  • Japan Jan. Small Business Confidence Survey (0500)

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