Central banks in the spotlight as key Fed, Bank of England and Bank of Japan meetings loom

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31 October 2016

thomasdodds

Last week was almost the mirror image of the previous one in FX markets.

T
he Euro recovered its losses, while emerging market currencies tanked. The latter’s sell off was led by the Brazilian Real and, notably, the Mexican Peso, which was spooked very late Friday by the announcement that the FBI is continuing its investigation into Clinton’s emails.

This week we turn to central bank meetings in the US and the UK. We expect no change in either monetary policy, but the tenor of the communications from the Federal Reserve and the Bank of England will be key to currency markets.

Any news about the FBI investigation and the latest polls in the lead up to the US Presidential Election should also bring plenty of volatility to the Mexican Peso and emerging market currencies in general.

Major currencies in detail:

GBP

Sterling continues to struggle to find support amid Brexit uncertainty.

Last week it managed to close nearly unchanged against the US Dollar but this apparent stability masks some nerve wracking intraday swoons. On Monday the Pound dipped briefly below 1.21 before bouncing back.

The key for Sterling this week will be the Bank of England meeting on Thursday. Last Tuesday, Governor Carney suggested that Sterling devaluation has made further interest rate cuts unlikely, by stating at a House of Lords hearing that the BoE was ‘not indifferent’ to the Pound level.

We expect further confirmation of this view at Thursday’s discussion, which may lead to a modest Sterling rally.

EUR

Focus this week will be on a spate of critical macroeconomic releases.

Eurozone inflation for October is out on Monday, as is the first read of the third-quarter GDP report. Then Thursday we get the labour market report.

We expect to see a mixed bag. Inflation should remain at an unacceptably low level of 0.5% in October, far below the ECB target and keeping the pressure on the central bank to extend its Asset Purchase Programme at the December meeting (Figure 1). Growth should have remained at an anemic 1.6% on an annualised basis.

Figure 1: Eurozone Inflation Rate (2009 – 2016)

There should be somewhat better news from the labour report, where we hope to see the first improvement in 6 months as unemployment ticks down 0.1% to a still too high 10%.

We expect the Euro to tread water all next week as hawkish rhetoric from the Fed, combined with lacklustre Eurozone economic releases, keeps pressure on the common currency.

USD

The November Fed meeting will be the main event for financial markets this week.

We agree with the consensus of economists that a hike is very unlikely. However, we expect to see quite a few hawkish gestures from the committee.

First, we think at least another member will flip to a vote for an immediate hike, making the overall tally 6-4. The statement should make it very clear that, absent a financial market meltdown, a hike in December is almost guaranteed.

Given that markets are currently pricing in just a 75% chance of a hike in 2016, we think the repricing to nearer 100% chance of a December hike will continue to provide good support for the US Dollar. A strong October employment number later in the week should add to the Dollar-bullish atmosphere and we expect to see the US Dollar finish the week nicely up against its major peers.

Technical Analysis

EUR/USD

The Euro has paused and consolidated its losses after falling to a near eight month low against the USD. The single currency traded above the 1.082 level last week, which remains the next key support level for the EUR. However, the currency remains pinned under the 1.0957 resistance level despite the majority of long positions (60%). Technicals have turned moderately bearish, reinforcing our opinion that further weakness is in store for the common currency.

GBP/USD

GBP/USD has accelerated its downward trend after breaching the post-Brexit lows, the next support level for the currency is 1.216. Short term rebounds are likely to be capped by the 1.24/1.247 resistance level. Technicals remain neutral although have turned slightly more bearish.

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