DON’T EXPECT FX VOLATILITY TO SUBSIDE NEXT WEEK

January 24th, 2014

Don’t Expect FX Volatility to Subside Next Week
GBP: Hit By Dovish Comments from BoE Carney
EUR: Supported by Optimism from ECB Draghi
USD/CAD Retraces, Ignoring Drop in CPI
AUD: RBA Policymaker wants A$ at 80 Cents
NZD: Gold and Oil Unchanged
JPY: Hit Hard by Risk Aversion

Don’t Expect FX Volatility to Subside Next Week

At the beginning of the week, we warned our readers not to become complacent because of the lack of U.S. economic data. The abundance of key economic reports from other parts of the world along with the earnings season meant there could still be big moves in currencies. While data from China, Canada, Europe and Australia played a role in this week’s breakout in FX, today’s volatility was triggered by something we did not expect to occur this week – which was the massive liquidation out of emerging market assets. If investors continue to dump emerging market currencies in the coming week, the majors could be vulnerable to steeper losses. In addition to the moves in emerging markets, there’s also a heavy economic calendar to keep forex traders busy. The most important event risk of the week is the Federal Reserve’s monetary policy announcement. Ben Bernanke will have to decide at the final FOMC meeting of his career whether or not asset purchases should be cut by another $10 billion. He expected to do so back in December but that was before the shockingly weak non-farm payrolls report and mixed consumer spending numbers. We will spend a lot more time talking about what to expect from the FOMC next week but right now what is important for forex traders to realize is that the Fed policy uncertainty means continued volatility for currencies. With a RBNZ meeting on the calendar along with fourth quarter GDP numbers from U.S. and U.K., the IFO report, unemployment numbers and retail sales figures expected from Germany, it should be an active and exciting week in currencies. This means that we will be watching the key levels in EUR/USD, GBP/USD, USD/JPY and NZD/USD closely for breakouts.

We’ve got a major crisis of confidence in emerging market currencies and when that happens, the liquidation can last longer than most expect. There’s a reasonable possibility for another 5% move lower in EM currencies before everything stabilizes. In our 2014 outlook, we talked about how this will be the year of DM (developed markets) versus EM because slower growth in China will encourage investors to move money out of emerging market assets, particularly money that is parked in countries heavily reliant on Chinese growth like Brazil and South Africa who supply raw materials to China. Countries with massive current account deficits like Turkey are particularly vulnerable. With Chinese growth expected to slow for the next 5 years, emerging market currencies could underperform for some time to come. For the major currencies, an additional sell-off in global markets would lead to more risk aversion, which means a deeper sell-off in pairs such as USD/JPY, AUD/USD and GBP/USD ahead of next Wednesday’s FOMC rate decision. If the U.S. central bank decides to provide a bit more support to the U.S. and the global economy by keeping asset purchases unchanged this month, we could see a relief rally in EM and DM currencies but the chance is slim.     KATHY LIEN