Forex markets: The key event for the forex markets in August was the FOMC meeting

Sep 5, 2011

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In August the key theme for the forex markets was the fear of serious slowdown in global growth. Compounded by the outcome of the FOMC meeting, this translated into generalised dollar weakening. The euro undeservedly benefited, but the ECB meeting and the imminent review of Greece might “finally” drive it down.. .…

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A still tougher task is to effect a reversal in the yen, which has risen to new all-time highs thanks to its now anachronistic status as a safe haven currency. Sterling exposed to possible falls: the BoE has adopted a sort of easing bias.

DOLLAR – The key event for the forex markets in August was the FOMC meeting at the start of the month, at which the Fed pledged to keep rates on hold through to 2013, in order to offset the downside risks to growth. This switched the focus to the risks of a global slowdown, which has become the main theme for the forex markets.
The net effect was dollar weakening in nominal effective exchange rate terms. And it is thiswhich explains the upward trend of EUR, which has risen from 1.40 to 1.45 EUR/USD – despitegrowing concerns over the sovereign debt issues (Greece, and Italy too).

This also explains the consolidation of JPY, which has steadily “flattened” not so much within a
range as at a very strong point level of 77 USD/JPY. Even EUR however, despite having some
directionality, has moved within a narrow range of 1.40 – 1.45 EUR/USD.
While the dynamics are similar, the roles of these two currencies are very different: (a) the strength of yen is due to generalised risk aversion on fears of a sharp global slowdown, while (b) the firming of EUR is the virtually symmetrical result of USD weakening caused by the prospect of US rates virtually at zero out to 2013.

EURO – In the euro’s case the global slowdown theme has overshadowed local themes (sovereign debt problem), which should have overburdened it; instead EUR has held up well remaining firmly above 1.40 EUR/USD.
This situation is not likely to continue for long. Next week brings (1) the review of Greece, on the outcome of which will depend the release of the next tranche of aid, and (2) the ECB meeting. Fears of some setback and the uncertainty pending the verdict on Greece and the likelihood that Trichet will remove any residual expectations of further rate hikes put downside risks on EUR which, in a downtrend, technically would have scope to correct to at least 1.38 EUR/USD.

YEN – Next week also brings the BoJ meeting. Any further expansionary measures and/or declarations regarding the excessive strength of the yen might however not be enough to reverse JPY.
The role of safe haven currency at times of acute risk aversion – where the common threat of a serious global slowdown is compounded by specific or local issues – makes JPY insensitive at this time to domestic developments.
The trigger for a downward reversal is more likely to come from an unexpected improvement in the US growth outlook, via data which surprise on the positive side, or any “favourable” statements from Bernanke (speech scheduled for Thursday).

STERLING – Thursday also brings the Bank of England meeting, although expectations are for rates to be left on hold at 0.50% with no change in the APF.
At last month’s meeting the BoE set out its new monetary policy stance. Through to July there was a minority on the committee in favour of a rate hike; now, not only does the majority recognise the predominance of downside risks to growth but also reveals a sort of easing bias.
The data due out next week are not expected to be positive. This, coupled with the positive correlation with EUR, should drive GBP down vs. USD. Technically, the completion of the recent
downtrend lies at 1.58-1.56 GBP/USD.

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