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All Eyes on the fed

August 2015

Why dollar bulls are expected to continue to rule the roost

The start of the month showed heightened activity in the currency markets, especially from the Euro zone as Greece continued to make headlines. The euro swung like a pendulum, as negotiations between the troika and Greece took many twists and turns. Euro was broadly sold post the bailout as caveats seemed highly restrictive. The economic data also disappointed broadly with CPI coming in line at +0.2% and Zew sentiment at a dismal 29.7. Euro has taken support near 1.0850 levels. Positive news from Europe, especially Greece regarding bailout has given some wings to the common currency during the last few weeks.

Stable Yen
The Japanese yen has been the most stable currency among the majors as BoJ kept its expansionary monetary policy on course. The manufacturing PMI as well as trade balance surprised on the up side, giving some pullback in the USDJPY pair after an astounding rally. Lower commodity prices are likely to improve the trade balance and prevent inflation from gaining traction, thereby making the inflation targets of BoJ more difficult to attain. Lower commodity prices are likely to underpin the Japanese Yen in the short term. The pair is expected to consolidate in 121-125 for a while, before an eventual break higher.

The Great Run
The pound had an astounding run this month after BoE governor reiterated his stance, paving way for an interest rate hike. Governor’s comments were cheered by the markets, giving impetus to the pair. Uncertainty in the Euro zone regarding Greece, also resulted in rebalancing in the allocations, with GBP being bought against the Euros. The CPI inflation came unchanged at 0.00% and retail sales disappointed. The Monetary Policy Committee has indicated that inflationary risks could increase going forward, strengthening the case for a rate hike in February 2016. The pair has been a clear outperformer and seems poised to head higher, if inflation trajectory materializes on the upside.

Awaiting the Dragon
China’s woes came to the forefront as the stock market tumbled like a pack of cards, after reaching dizzying heights. The crash in the stock market left many retail investors worried. The crash prompted the regulatory authorities to intervene heavily to prop up the market. On the economy front, data continued to disappoint with manufacturing as well services PMI disappointing. GDP numbers came unchanged at 7%. People’s Bank of China, on the other hand, cut its benchmark rates as well as reserve requirements to support the economy. Although, share market troubles have ebbed for now, Chinese economy is still stuttering. This is evident from the crash in commodity as well as base metal prices. According to a report, as much as 70% of the copper and nickel imported by China was warehoused and was being used to fund carry trade into higher yielding assets like real estate and equities. Thus huge stock piles of these metals still remain warehoused. Therefore the demand for such commodities is likely to remain subdued for a protracted period.

Dollar Bulls
Fundamentally, the US dollar staged a remarkable recovery after the outcome of last Federal Open Market Committee, primarily on the back of improved macro-economic indicators from the U.S. The U.S economy made further progress towards the Fed’s goal of maximum employment with unemployment rate falling to 5.3%. Monthly gains in non-farm payroll employment averaged 210,000 over the first half of the year, sufficient to bring the total increase in employment to 12 million jobs. While labour market improved, consumer spending and production softened as evidenced by the flat growth rate (GDP) as well as disappointing retail sales. Housing sales have been rising and seems to be a cause of concern, and Fed would want to stave off any asset bubble.
Although it is now reasonably certain that Fed would hike the rates sometime this year, the timing and the pace of hikes would be crucial. Global markets are factoring in a gradual rate hike, as evidenced by the Fed fund rate futures. The pace of hike would again, as Fed states, be data dependent. As long as this uncertainty persists, dollar bulls would continue to rule the roost.

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