Forex: British Pound – CPI Setups Up Break, BoE May Drive it Through

Talking Points:

Dollar Fully Retraces ‘No Taper’ September Plunge
British Pound: CPI Setups Up Break, BoE May Drive it Through
Euro Extends its Rebound but Yield Outlook Continues to Shrink

Dollar Fully Retraces ‘No Taper’ September Plunge
The Dow Jones FXCM Dollar Index (ticker = USDollar) closed above 10,600 for the first time since September 17 this past session. That means that the greenback has unwound all the losses it has suffered since the FOMC surprised the market two months ago by deferring a heavily-expected Taper. There are a number of ways to interpret this recovery. Is the market growing more certain of a December cut to the expansive QE3 program? Perhaps the recent dovish turn for the Fed’s global counterparts is setting the greenback in a better light? Or perhaps the slow turn in monetary policy by the world’s largest central bank is losing its influence over the currency?

Rates and rate forecasts are an elemental and unwavering catalyst for the FX market, so it is unlikely that Taper speculation has simply vanished or even materially escaped the market’s attention. In assessing this catalyst’s influence on the markets, we find the 10-year Treasury yield has moved back up towards 2.80 percent while the iShares MBS (mortgage-backed securities) ETF has tumbled. These are benchmarks for the Fed’s policy targets, and the front-run effort is arguably most sensitive here. Meanwhile, we can measure intensity and conviction by seeing how fluidly the speculation / fear of a near-term QE cut is transferring over to the standards for ‘moral hazard’ (risk taken on the assumption that it will be absolved by the central bank). We find the S&P 500 a few handles off its record high while the VIX volatility index hovers below 13 percent. The Taper discussion is returning but it isn’t yet seen to be eminent domain.

British Pound: CPI Setups Up Break, BoE May Drive it Through
The sterling was sent reeling and GBPUSD was driven into the floor of its two-month range at 1.5900 this past session on the release of soft inflation data. A second wave of dovish data can jump start a broader and deeper bear wave for the pound. With Tuesday’s event listings, we were presented with a range of inflation data – consumer, retail, housing, factor – but the market’s interest was focused on the CPI statistics. A 2.2 percent headline figure matched the softest reading in nearly 4 years and the 1.7 percent core reading was indeed the weakest in that time frame. This offers tangible support to the BoE and dovish rate speculators who believe the first hike is unlikely until 2016.

The event risk for the forthcoming session will put the data into context and give us a clear view on the central bank’s intentions. Where the October labor report (due at 9:30 GMT) will likely generate volatility, the true litmus test comes with the BoE’s Quarterly Inflation Report. This is an update on growth and inflation forecasts along with forward guidance. A reiterated position to maintain rates at their lows to 2016 could eat away recent gains while capitulation in the form of scenarios for an early possible hike can vindicate hawks and bulls. Yet, the most likely path is one that is ‘status quo’. If we are indeed going to see a carbon copy of the last Report, the recent drop in the CPI will be revisited.

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Euro Extends its Rebound but Yield Outlook Continues to Shrink
The euro was up against all of its major counterparts both through the past session and on the week. It is fitting to label this bullish run a ‘rebound’ from the steep selloff suffered over the past two weeks on the back of an exceptionally weak inflation report and then an unexpected ECB rate cut. The latter development carries serious implications as short-term market rates (particularly the three-month Euribor) have dropped back to four-month lows and the already-tepid yield forecast is at its lowest level since late June. The euro has a history of denial, but market-based risk-reward considerations – rather than the ambiguous world of unrealized, future concerns – are not so easily ignored. This retracement puts the currency in an especially dangerous position if Thursday’s 3Q GDP figures are weaker than expected.

Yen Cross Bulls Look for 3Q GDP to Motivate BoJ’s Second QE
The yen crosses remain buoyant with USDJPY without striking distance of 100 this morning. A move to the top of a range for this benchmark pair is a low resistance move. Making the bid to overtake 100 alongside similar thrusts to multi-year highs for other yen crosses requires a more robust fundamental drive. Many are looking to traditional risk trends to provide a bullish inertia. Yet, while the correlation between the yen crosses and Nikkei 225 is remarkable, the traditional scope of ‘risk on’ is limited by the fundamentals that could support that theme. To move us to the next leg of a structural bull trend for the yen crosses, we need something with greater scope – possibly a second BoJ stimulus program. Presuming a QE2 for Japan is pure conjecture until there is something urgent to galvanize it…perhaps a week 3Q GDP report.

New Zealand Dollar Dips but Refuses Break on RBNZ Report
The RBNZ (Reserve Bank of New Zealand) was busy this morning with the release of the Financial Stability reports and Governor Wheeler’s testimony on the annual assessment and financial update in Parliament. The central banker repeated concerns mentioned at previous policy meetings including an explicit claim that the high exchange rate was a threat and the greatest risk to the system was the local housing market. These concerns led the kiwi to slip, but a true break was avoided. There is little new here. The market wants a true risk/carry move.

US Oil Drops to Fresh 5 Month Low Ahead of Inventories Report
The benchmark US crude futures contract (December WTI) dropped 2.2 percent Tuesday – the biggest single-day decline since June 20. Further highlighting the importance of this move, we now find this commodity benchmark at fresh five-month lows. There is a notable sense of economic easing in this move through its supply-and-demand aspect, but this may also be a systemic response to tightened regulation on speculative participation. Coming up, we have the DoE short-term outlook for November.

Gold: Another Bearish Close Marks Four Month Low
The 1.2 percent drop from gold keeps gold in a particularly bearish light. In the past 10 trading days (2 weeks), the metal is still down 9 sessions – a situation only seen 4 times over the past half decade. Volume is still relatively light in this continued press to four-month lows. Meanwhile, ETF holdings are still at three-year lows while futures open interest has jumped to a three-and-a-half month high – a possible sign of increased insurance buying in derivatives as investors attempt to avoid outright unwinding. If the pound were a more prominent reserve currency, the upcoming BoE report would carry more weight. More likely, we will have to wait for the dollar and euro to give gold guidance.

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