The USD has come under pressure across the board. Even though there were no big changes to the FOMC statement, there were slight dovish undertones. In fact, the statement could be interpreted as a subtle upgrading of downside risks to both growth and inflation. In fact, the main section of the statement began with the phrase “moderation in economic growth appears to be continuing”. The Fed, however, did stick with its tightening bias, noting that “some inflation risks remain” and the “extent and timing of any additional firming that may be needed” will depend on data. While the market continues to see no more rate hikes from the Fed, it expects a cut only in summer 2007. In contrast, analysts at BNP Paribas see the Fed being forced to cut rates as early as end-2006 as the data begin to point to a quicker than expected slowdown. In addition, the more than 20% drop in oil prices since early August should quell the Fed’s fears of upside risks to inflation.
Next week’s releases of housing and confidence data will be crucial, says BNP Paribas in their morning FX report note. Worse than expected data will question the market’s optimism on the US growth outlook and provide the first push for the USD to break out of its recent range. Overnight, ECB’s Weber was hawkish saying that the steadily strengthening Mark did not hurt German exports.
The EUR is seen remaining stuck in the tight range of 1.2650 to 1.2770 with a break out of this band yielding a quick move to 1.2555 on the downside and 1.2860 to maximum 1.2925 on the upside.
The JPY continues to see speculative unwinding but the flat US yield curve implies that USD/JPY losses will be limited for now. In terms of EUR/JPY, extreme positioning indicates the possibility for further downside. However, the technical outlook is not particularly bearish. The pair yet needs to break below 148.20 support to trigger losses.
In New Zealand, the current account deficit widened by N$3.08bn in Q2, worse than market expectations for a N$2.73bn reading. This brings the annual deficit to around 9.7% of GDP , its worst level since 1975 when the deficit was around 13% of GDP. While the huge current account deficit saw the NZD coming under pressure overnight, the continued increase in imports (up 10.5% q/q, 9% y/y) is a signal to the RBNZ that more tightening may be needed.
The NZD is clearly overvalued and requires significant depreciation to try and handle this deficit, but analysts at BNP Paribas do not expect significant losses in the currency in the near term.
The market continues to be attracted towards select carry trades and with the RBNZ’s recent tightening bias, we expect NZD/USD to remain well supported.
Canada’s Prime Minister said overnight that he intends to cut personal and business taxes in order to boost foreign investment. Easy fiscal policy together with robust domestic fundamentals means that the BoC will be in no rush to move into a cutting cycle. The comments might provide the CAD with some short-term support and hence make the break of 1.1270 (uptrendline resistance in place since May 2005) difficult. However, the bearish outlook on oil prices does not bode well for the commodity currency and it is only a matter of time that this level is broken. In addition, we see reason for further medium term downside, as a slowdown in US growth (especially that emanating from the housing sector) will hit an already fumbling export and commodities market.
SNB’s Blattner was on the newswires yesterday suggesting that the SNB is not looking to step up the pace of rate hikes, but did provide another warning regarding the CHF, saying that if exchange rates create inflationary pressure it could present a problem. While EUR/CHF has come off from last week’s high of 1.5967, the currency pair remains relatively well supported. Nonetheless, like EUR/JPY, the pair is vulnerable to short covering that could see a move towards the 1.5830 support area in the near term, ahead of long term up trendline support at 1.5815.
The BoE Minutes for the September MPC meeting showed the expected 8-0 vote in favour of unchanged rates. But, MPC members expressed concerns regarding a pick up of long term inflation expectations and rises in average earnings. Blanchflower (last month’s dissenter) appeared on the verge of voting for a cut according to the minutes. The UK BSA/BBA data showed that UK mortgage approvals reached their highest level ever for an August, with approvals at GBP5.158bn against GBP5.039bn in July. The PSNB showed a record deficit for the month of August, with a deficit of GBP7.6bn compared to consensus forecast for a GBP5.5bn deficit, but this had no impact on the market. GBP remains supported on positive domestic data and also the BoE indirectly signalling a bias to hike. We expect Cable to gradually move higher, especially with the slight dovish undertone of the Fed statement.
