Jimmy Dugan: "Baseball is hard…it's supposed to be hard. If it wasn't hard, everyone would do it. The hard…is what makes it great."
It is often said that predicting the direction of foreign exchange rates is more art than science. While there are basic fundamental principles that can drive exchange rates (trade flows and interest rate differentials, etc.), market psychology, positioning and technical factors are also key determinants. There are times that the slightest subtlety or nuance can send shockwaves through the markets. All these factors can make it difficult for those who are immersed in the market to understand what it is that drives exchange rates up or down at times as the factors are constantly changing.
We are in such a period right now. Interest rate differentials between the U.S. and other G10 countries have been a long term anchor in determining currencies’ values. Most recently, U.S. interest rate differentials have been widening more respective to other countries, implying a stronger U.S. dollar, but the U.S. dollar has been weakening over the past few weeks.
We mentioned last week that U.S.-German 2-year differentials were near 332 bps. That is the widest differential in decades; we are approaching one more Fed rate increase this week and the euro is at its best level in two months. Is it possible the market has priced in most of the Fed rate increases already?
How long this new dynamic will last is anyone’s guess and could shift in a moment’s notice. That is why I love the markets and have been in the business for so long…it is very challenging. The divergence between interest rates and the U.S. dollar is highly unusual. Markets are always looking forward and perhaps there is more to this subtlety than meets the eye and bears watching.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to rise by 25 bps to 1.50%
Expectations for rates to rise by 25 bps to 2.00%
Expectations for rates to remain unchanged at 1.75%
Expectations for rates to rise by 25 bps 5.75%
Expectations for rates to rise by 50 bps to 4.50%
Expectations for rates to remain unchanged at 1.3
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
New Home Sales
Expectations for gains of near 0.5%
Durable Goods Ords.
Expectations for a gain of 1.9% following a fall of 1.7%
Pers. Inc. & Spending
Expectations for gains near 0.4%
Expectations for a decline from 63.6 to 62.0
Canada July GDP
Expectations for a gain of 0.1%
Expectations for a decline from 103.8 to 103.2
Expectations for a gain of 0.1%: YoY remains at 2.0%
German Jobs Report
Expectations for the UR to remain at 5.2%
Expectations for a gain of 0.4%: YoY 1.3%
Asia/Japan, and New Zealand
China PMI Manuf.
Expectations for a slight decline from 50.6 to 50.5
Japan Jobs Report
Expectations for the UR to remain at 2.50%
Japan Indust. Prod.
Expectations for a gain of 1.50%
Expectations for a widening of the deficit
The EUR continues to rebound off of its lows seen in the middle of August but remains largely confined to ranges seen going back to June. Wednesday's Fed announcement will be key for the markets along with further development regarding the Brexit negotiations. Expect further consolidation until then.
The GBP too has rebounded off of its August lows but remains range bound. Brexit headlines continue to cause trauma for both bulls and bears as the market anticipates a soft or hard Brexit. Expect further consolidation this week with GBP mirroring euro price action.
The JPY has been weakening over the past two weeks against the U.S. dollar and other cross rate currencies. An improving emerging market tone along with higher U.S. interest rates had caused a squeeze in this safe haven currency. 113/$ is a sticky level to breach; expect further consolidation until the Fed meeting.
Despite no apparent progress regarding the NAFTA negotiations, the CAD has been appreciating on the back of a better tone in emerging market currencies and stronger commodity prices over the past two weeks. Expect some consolidation in front of the Fed meeting.
The CNY has been consolidating over the past month despite a weakening U.S. dollar. This past week the Chinese authorities committed to not weaponizing the CNY to boost exports and is promising further tariff and economic reforms. The stability of the exchange rate will most likely continue through this next week despite no progress on U.S.-China trade talks.
The AUD has been appreciating the past two weeks along with many other commodity-linked currencies primarily due to an improving tone in emerging markets combined with rising commodity prices. Expect some consolidation ahead of the Fed meeting on Wednesday.
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