20th of October 2010 - Forex Market Overview

DAILY Fundamental Forex Market Overview
20 October 2010 – 8:00 GMT
Wednesday

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Market Analysis Desk
Foreign Exchange Research: www.fibosignals.com/5585/resources.html
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FUNDAMENTAL ANALYSIS at 0800 GMT

USD

Risk appetite finally stabilized during the Asia session in the aftermath of yesterday's surprise policy hike by China. EURUSD traded 1.3698-1.3811, USDJPY 81.32-81.67. The dollar has been slowly giving back yesterday's gains ever since Shanghai equities opened and quickly recovered their poise. Although several Fed officials spoke, there was little market impact given that many of their views on further easing were already known. Fed Presidents Evans, Dudley and Lockhart continued to support further easing while Fisher and Kocherlakota continued to sound caution on more action. Lockhart, a 2011 FOMC alternate and 2012 voter, mentioned a pace of $100 bn of purchases a month is among the range of considerations. Chairman Bernanke did not offer any new insights. Fed Governor Duke reminded markets that a further round of easing on Nov. 3 is not yet a done deal, and that lowering the interest rate paid on excess reserves is another policy option. Investors expectations for more easing remain in place but calibration of those expectations is key, as the quantity and duration of more easing are moving targets. Press reports that a large US asset manager and the New York Fed are looking to put-back bad mortgages to a major US bank contributed to the atmosphere of risk aversion earlier, and mixed data did little to help investor sentiment as housing starts were better than expected and housing permits fell more. Between now and the Nov. 3 FOMC meeting, we expect pressure to remain squarely on the dollar.

EUR

ECB Executive Board Member Stark noted that there are risks associated with the ECB's bond purchases, and that the ECB must avoid intervening in functioning markets. He said that the bond buying program risks becoming 'quasi fiscal' in nature, and that low interest rates reduce the incentive for fiscal consolidation. These comments bring Stark a little closer to ECB Governing Council Member Weber's stance on the matter, but for now Weber is the only policymaker who has publicly called for the program to be disbanded.

Stark added that he sees clear signs of normalization in money markets and cautioned that while there is no apparent currency war yet, there is the risk that ample liquidity could trigger more defensive responses. Weber said it is too early to call an end to the crisis, echoing Trichet's comments at the latest press conference, but his comments focused more on regulatory issues than monetary policy.

The German ZEW survey was much stronger than expected at 72.6. However, the boost to the euro was limited as markets continue to assess whether QE2 is now fully priced and reduced risk-seeking worked against the euro.

GBP

Broader dollar strength kept sterling under pressure but the currency has its own obstacles to come in the next 24 hours. The BoE MPC minutes should show if a 3-way split has occurred, with policymakers Posen and Sentence possibly on opposite ends of the policy spectrum, and headlines from the Comprehensive Spending Review will be watched as fiscal austerity could hamper growth and weigh on sterling.

BoE Governor King said monetary policy is still a potent weapon but that policy must balance risks to inflation and the MPC is conscious of risks to inflation expectations. He saw upside and downside risks to inflation though he did say it could be some time before inflation falls to target. King also said the weaker pound supports rebalancing of the economy and that the G7 willingness to work together "has ebbed." He also mentioned that M4, pay and demand growth are likely better guides to future inflation. M4 data is also due today.

JPY

BoJ Deputy Governor Nishimura observed that the yen's rise is a major downward risk to the economy, and that it may contribute to deflationary forces. IMF First Managing Director Lipsky met with Finance Minister Noda, and said that the BoJ's recent easing was a welcome move. Noda said that FX intervention was not discussed at the meeting. Deputy Cabinet Secretary Fukuyama said there has been no change in Japan's position on FX intervention.

Nishimura added that China's rate hike yesterday is a good decision that would help ensure long and stable growth.

CAD

The BoC kept its policy rate unchanged as expected and revised down its growth outlook for 2010 and 2011, also in line with expectations. But the decision to tune down inflation forecasts was less expected, as the BoC pushed back its time-frame for when it sees the output gap closing. The BoC kept in place its policy guidance, saying again that further reductions in monetary stimulus would have to be "carefully considered" and seemingly expanded its view of downside risks. With the BoC on hold for now, the CAD will continue to lose luster to the other dollar-bloc currencies as a relative value G10 play. The BoC Monetary Policy Report will be released and should echo the changes outlined in the policy statement.

A. White

Chief Analyst at Fibosignals.com