Fedspeak has whipsawed FX markets over the past week. The long risk/short-USD trade was initially boosted by comments from San Francisco Fed President Williams, only to be undone by subsequent hawkish remarks by New York Fed President Dudley, who appeared to open the door to a September hike. However, the July FOMC minutes did not give the impression of an impending Fed move, taking some steam out of the USD recovery.
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Despite somewhat confusing Fed communication this week we believe the Fed has signalled it is unwilling to let tightening expectations fall much further. Against this backdrop, the USD sell-off should be coming to an end.
The USD already looks cheap versus rate differentials in the G10, particularly against the commodity-based currencies such as AUD and NZD.
Furthermore, we think commodity-exporter central banks have the scope and the willingness to ease more to counter any undesirable strength in their currencies. Consequently, we have added a short AUD/USD trade* this week.
Chair Yellen’s speech in Jackson Hole next Friday is unlikely to signal the timing of the next hike although she also won’t shut the door to a move at any of the remaining meetings in 2016. Incoming data, in particular durable goods orders next week, may ultimately prove more important for near-term Fed expectations and the USD.
The EUR/USD rally is not convincing as the focus shifts to August PMI data next week. Meanwhile, UK Q2 GDP data is likely to be seen as dated by Brexit. We still believe that a lot of the bad news is in the price and, with some of the recent data coming in better than expected, GBP/USD will struggle to break below post-Brexit lows.
We are sceptical of a further recovery in oil and we believe hopes for an output freeze at next month’s producers’ meeting are overdone.