Will The FOMC Halt The Dollar's Advance?
USD Into FOMC: A Quant Insight
With the meteoric rise of the US Economic Surprise Index driven by improvement in surprises across sectors, we may see a shift in policy tone from the Fed which advised caution on over-reacting to isolated data surprises last month.
We investigate deeper into the sources of improvement in the ESI and find that in addition to positive surprises, data momentum is also picking up, making it more difficult for the Fed to continue emphasizing growth fears.
We find that the aggregation in the US raw data surprises has been a good historical indicator for hawkish Fed bias and performs well in trading EURUSD around Fed announcements.
With hedge fund positioning suggesting a long USD bias and the US ESI at 2-year highs, we are likely to see a USD bid into the next Fed meeting.
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Last week's advance was only the second week since the start of May that the yuan moved higher. The optimists claim the firmer yuan, and official comments suggesting capital outflows have eased, show that China does not seek a continued depreciation of the yuan. The cynics warn that by allowing the yuan to rise ahead of the G20 finance ministers' meeting will deflect criticism about its foreign exchange policy, and that the decline will likely continue afterwards.
It is tempting to construct a narrative for the dollar's gains based on the string of stronger than expected US economic data. However, the US economic calendar has been light in recent days, and the interest rate channel is quiet. The implied yield of the September Fed funds futures increased by a single basis point. The yield on the 2-year Treasury note increased two basis points, while the yield on the 10-year was up less than a basis point.
The main drivers in the foreign exchange market can largely be found in developments outside the US. Rate cut expectations in Australia and New Zealand, for example, weighed on their respective currencies. Speculation of "helicopter money" in Japan undermined the yen, until many participants accepted that BOJ Governor Kuroda's June comments noting the BOJ purchases of bonds directly from the government is banned. Sterling was taken down by signs that despite the residual strength before the referendum, there has been a significant hit in sentiment, picked up in the flash PMIs. Draghi said little new at the press conference following the ECB meeting, which left the euro stuck around the $1.10-level.
The US Dollar Index rose to its highest level in four months to approach the 61.8% retracement objective of the slide since last December's peak, just shy of 100.60. The retracement objective, 97.25, corresponds to the upper Bollinger® Band. The Dollar Index closed firmly, and the technical indicators we use suggest that there is scope for additional near-term gains. However, given that pre-referendum the Dollar Index was near 93.00, it is not surprising that the indicators are stretched. This warns that a corrective or consolidative phase may be around the corner.
As the single biggest component of the Dollar Index, the euro's technical condition is similar. It spent last week confined to about a one cent range. It was the first week since the end of January that it did not trade above $1.1100. Prior to the referendum, the euro's five-day average was $1.13. Now it stands near $1.1030. The technical indicators suggest the euro may make new lows, but they may be marginal at best. The $1.0915 low recorded in the immediate reaction to the Brexit decision is the next immediate objective. On the upside, $1.1060 was the best the euro could do post-ECB, and downtrend line from the June 24 high and mid-July highs comes in near $1.1030 at the start of the new week and finishes near $1.0970.
The dollar pushed higher against the yen and surpassed the JPY106.85 pre-Brexit high before reversing sharply (key reversal on the daily bar charts) on July 21. A month-old (but we think still relevant) interview with the BOJ's Kuroda led many to re-think the likelihood of "helicopter money". Despite the bearish price action, there was no follow-through dollar selling ahead of the weekend against the yen. Technical factors remain constructive and another attempt on the JPY107.50 area looks likely, though a break of JPY105.40 would negate the favorable tone.
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