Foreign Exchange Market Recap "And The Beat Goes On" - September 26, 2016


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And The Beat Goes On

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At the start of last week, Mr. Market was waiting patiently for announcements from both the Bank of Japan and the Federal Reserve mid-week. The BOJ had been reviewing their policies of government bond purchases and negative interest rates while the Fed once again seemed poised to possibly raise rates. As events ultimately turned out, the BOJ did make a significant change while the Fed did nothing. Well, not entirely nothing: The official statement leaving rates unchanged had three dissenters (George, Mester and Rosengren) so the vote was 7-3 and, in a post-announcement Q&A, Chair Yellen implied a possible rate hike in December.

The BOJ unveiled yet another easing program. This latest one is called "QQE with Yield Curve Control". As the name implies, the BOJ will begin targeting the yield on 10 year Japanese government bond (JGB). Such bonds are issued by all governments, generally are both liquid and deep, and serve as a bellwether interest rate indicator. The idea is to buy sufficient bonds to maintain a zero yield - this tactic will grant the BOJ a measure of flexibility rather than having to buy a fixed amount of JGBs as required by QE. Coupled with the BOJ's recent announcement of selling the long end of the curve and buying the short end, the intent is for the 10 year to act as a sort of fulcrum, fixed in place while yields on either side rise or fall. It isn't entirely clear whether the BOJ has given up on negative rates just yet, but rising long term yields will take pressure off Japanese insurers and pension funds while negative short term yields, so the theory goes, will weaken the Yen. Ultimately, the goal (as always) is to weaken the JPY and spark a domestic recovery in Japan's massive export sector. This new manoeuvre may or may not work – the history of the BOJ's attempts to revive the Japanese economy and weaken the JPY over the past 26 years is rather unimpressive, and by week's end the Yen had rallied.

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Returning briefly to America, Chair Yellen's intimation of a possible hike in December was initially dismissed by investors but has now gained a measure of credibility. Post-Yellen, a number of major hedge fund managers and other market players made the point that the zero interest rate policy may have outlived its usefulness, and that it was time for the Fed to be 'normalising' rates. Dollar bulls bought aggressively on those sentiments.

In the True North, Friday's release of July Retail Sales (-0.1% vs call +0.1%) and CPI (+1.1% yoy vs call +1.4%) disappointed and subsequently fueled a major selloff in CAD as core inflation hit a 2-year low. The currency had actually rallied sharply post-Fed and briefly traded under 1.3000 before losing ground, ending the week at virtually the same level it had started last Monday. This week sees nothing until July GDP on Friday. It will be worth a look, as Q2 growth ended sharply stronger than expected.

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Down Under, the AUD was the big winner on the week. Philip Lowe was sworn in as new governor of the Reserve Bank of Australia and made a number of interesting remarks. Of note to investors, Mr. Lowe indicated the RBA would look at cutting administered rates from 1.50% to 1.25% depending on economic conditions, but appeared to rule out any sort of QE or 'highly unconventional monetary policy' as he termed it. Aussie rates, even if cut (and Mr. Market is giving that possibility 50/50 odds), are still relatively high and the currency bounced higher.

There was little of note in the Eurozone, save for the ongoing banking crisis which, presumably, will be resolved either by bailout or muddling through, although the latter appears increasingly ineffective. Germany's namesake bank, Deutsche Bank, beset already on many fronts, was slapped with a $14 billion USD fine for mortgage irregularities and may be forced to seek state aid to pay it. And in Italy, Monti dei Paschi, the ancient Italian banking house whose many woes have been detailed on this newsletter before, may finally have to seek a state bailout. The politics of any rescue are extremely messy and, given an upcoming constitutional referendum in

November, area politicians are loathe to get involved, given the implicit 'QuItaly" (Italian version of Brexit) nature of the vote. But events may force their hand.

In the UK, about the only event of note was the high-profile resignation of treasury official Jim O'Neill, one-time chief economist with Goldman Sachs. Mr. O'Neill is widely known for coining the phrase "BRICS", an acronym for the emerging economies of Brazil, Russia, India, China and South Africa; and resigned amid reported tensions over Theresa May's approach to China.

The takeaway from all this is quite straightforward. Central banks, for good or for ill, are still in the driver's seat, none more so than the Fed. This week sees a large number of US economic releases as well as a bevy of Fed speakers – in addition to the statistics there will doubtless be a wide range of opinions expressed by the Fed members – and investors will have the unhappy task of dissecting these, respectively, numbers and words for clues to Fed thinking going forward.

Key Data Releases This Week

Forecast

Previous

MONDAY, SEPTEMBER 26

01:36

JPY

BOJ Gov Kuroda Speaks

04:00

EUR

German Ifo Business Climate

106.30

106.30

05:30

CHF

SNB Chairman Jordan Speaks

11:05

EUR

ECB President Draghi Speaks

19.10

CAD

BOC Gov Poloz Speaks

TUESDAY, SEPTEMBER 27

10:00

USD

CB Consumer Confidence

98.6

101.1

WEDNESDAY, SEPTEMBER 28

08:30

USD

Core Durable Goods Orders m/m

-0.5%

1.3%

10:00

USD

Fed Chair Yellen Testifies

10:30

EUR

ECB President Draghi Speaks

10:30

USD

Crude Oil Inventories

-6.2M

THURSDAY, SEPTEMBER 29

02:35

JPY

BOJ Gov Kuroda Speaks

08:30

USD

Final GDP q/q

1.3%

1.1%

08:30

USD

Unemployment Claims

260K

252K

16:00

USD

Fed Chair Yellen Speaks

21:45

CNY

Caixin Manufacturing PMI

50.1

50.0

FRIDAY, SEPTEMBER 30

04:30

GBP

Current Account

-30.5B

-32.6B

08:30

CAD

GDP m/m

0.6%

21:00

CNY

Manufacturing PMI

50.5

50.4

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