Talking Points:

Dollar Recovery and S&P 500 Rally Tied to FOMC Outcome
Euro Exposed Should German Jobs Data and Spain 3Q GDP Disappoint
New Zealand Dollar Heading into RBNZ Decision as Rate Outlook Collapses

Dollar Recovery and S&P 500 Rally Tied to FOMC Outcome
FX traders should ask themselves heading into Wednesday’s top event risk – the FOMC rate decision: what would it mean if speculative appetite drops even if the central bank confirms a QE3 Tapering late into 1Q 2014? The group is set to announce its bearings for monetary policy at 18:00 GMT, and the consensus is clear. Both economists and the market-at-large expect the central bank to maintain its steady pace of $85 billion in Treasury and mortgage backed securities (MBS) purchases a month. The point of speculative contention for this event, however, is not whether the Fed moves at this particularly meeting but rather the timing for the inevitable downshift in stimulus.

The decision to delay the Taper (a reduction in the monthly stimulus effort) back in September was a ‘close call’ according to officials. That would suggest this meeting faces a high probability of downsizing this critical element of market support…that is, if it weren’t for the budget standoff this month. As a side effect of the budget standoff, the US government was partially shut down for a few weeks which both shaved an estimated 0.6 percentage points off GDP and delayed the collection and release of key economic data (such as the nonfarm payrolls). Couple that with a notable cooling in economic forecasts globally and European policy groups holding off from additional accommodation, and the Fed is put in a difficult position for maintaining global financial calm as much as supporting domestic economic health.

Looking for a consensus, rates suggest the market is expecting the first reduction in the unprecedented quantitative easing program sometime in the first quarter of next year. For a specific date, a Bloomberg survey of economists’ expectations suggests the Taper will be saved for the March 19, 2014 announcement (one of the quarterly events with updated forecasts). That helps to set the baseline for the market reaction. If the statement that accompanies the decision – which is likely to be our only guidance – doesn’t intensify its accommodative language to feed hopes of another five months of exceptionally loose policy, there is likely excess premium that will be worked off. The S&P 500 closing at record highs will be exceptionally at-risk of correction. The US dollar will likely benefit, but its recent bounce takes some of the edge off.

‘Meeting expectations’ is the most probable outcome. The problem is that the market is already positioned for an extension of exceptional support from the central bank. A withdrawal is still inevitable. Meanwhile, record highs in equities must be evaluated against a backdrop of record leverage, lukewarm growth and cooling earnings. A move to further build exposure to risk will likely be limited, though the dollar has room to retreat. Yet, if sentiment fails to hold on the ‘moral hazard’ status quo, conditions will change catastrophically. A shift in risk appetite in spite of explicit external support would suggest a tipping point that would likely lead to widespread deleveraging (a very dollar bullish theme).

Euro Exposed Should German Jobs Data and Spain 3Q GDP Disappoint
Global investors’ focus will be trained on the top US event risk Wednesday. That distraction will significantly temper reactions to key event risk from the euro’s docket over the coming session – though it will not fully disarm volatility. There are two events of particular interest through today’s session: Spain 3Q GDP (8:00 GMT) and the German employment change for October (8:55 GMT). Both have proven themselves as market movers with the proper level of ‘surprise’. While the jobs figure has a better history of short-term volatility response, the broader reading of Spain’s economy carries more fundamental weight. After the head of Italy’s statistical group (Istat) remarked that the country contracted in 3Q, this data takes on additional significance. EURUSD will be of particular interest as it taps into both European and US event risk.

New Zealand Dollar Heading into RBNZ Decision as Rate Outlook Collapses
There are two basic factors that go into gauging the strength of a carry currency: the market’s appetite for yield and the level of return that is to be expected. Underlying risk trends are on hold until the Fed either confirms or crushes expectations. In the meantime, yield expectations are proving a fluid dynamic. Just over a month ago, the market was pricing in 100 bps worth of hikes in a 12 month outlook. Tuesday, those forecasts stood at 59bps. With the RBNZ decision on tap (20:00 GMT), we are likely to see volatility arise from this confused market.

British Pound Stumbles Despite Strongest Housing Read in 5 Years
Is the UK housing market in a bubble? This is a point of debate that comes up regularly. It is important to remember that bubbles can continue to inflate for an indefinite amount of time. Therefore, for medium-term (swing) FX traders, these are concerns that will offer little immediate trading guidance. In fact, the data released this past session suggests the sector is still rather stable. The 66,700 mortgage approvals through September and £15.6 billion in gross lending are both five-year highs.

Australian Dollar Exposed on Rate Forecast if Risk Appetite Gives
The recovery in interest rate expectations for the Australian dollar – transitioning from a forecast of multiple cuts back in August to neutral in September to a possible hike in October – has stalled. The 12-month rate forecast – measured by swaps – is slightly negative this morning and 10-year yields are below 4.0 percent. If risk trends were to slip, this currency would be particularly exposed.

Japanese Yen Crosses May Not Offer the Best ‘Risk On’ Opportunity
The trouble with a feeding risk appetite from currently levels is that the fundamentals are fragile and the market is already extended in its exposure. That is as true for the yen crosses as it is for US equities. For the yen pairings, we have a proactive effort to devalue the Japanese currency, but there is already a heavy carry presence. Yet, the yield made from this exposure is painfully low – due in part to stimulus…

Gold Ready to Run to $1,400 if Fed Confirms QE3 Through 1Q 2014
Gold posted its biggest drop (0.6 percent) Wednesday since its current bull leg began back on October 14. This has set technical traders on edge as the move tentatively shifts momentum. Yet, this technical development will ultimately be rendered moot as the Fed decision can charge the metal higher or force its collapse depending on the market’s interpretations. If the statement supports an unfettered QE3 program through the open of 2014, any significant dollar selling will likely be matched by a gold rally.

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ECONOMIC DATA

GMT

Currency

Release

Survey

Comments

04:00

JPY

Vehicle Production (YoY)

-7.6%

The print has not been positive since August of 2012.

07:00

CHF

UBS Consumption Indicator

1.32