US Dollar Eyes FOMC Minutes, China Yuan Drop Sinks Risk Appetite

Talking Points:

China Fixes Yuan at Five-Year Low, Triggers Broad-Based Risk Aversion
US Dollar Looks to Dec. FOMC Minutes to Inform 2016 Rate Hike Path Bets
Gauge Trends and Spot Reversals in Leading Currencies with DailyFX SSI

The sentiment-sensitive Australian, Canadian and New Zealand Dollars dropped while the safety-linked Japanese Yen pushed higher as risk aversion gripped markets in Asian trade. The move followed China’s move to set the daily reference rate for the onshore Yuan exchange rate at the lowest in five years.

Newswires suggested the move reflected Beijing’s determination that the economy needs additional stimulus, which implies a deteriorating growth outlook. Curiously, the prospect of additional policy support might have been expected to be supportive for sentiment considering a slowdown in China has been baked into consensus forecasts for some time.

With this in mind, today’s move may prove to be a reflexive, knee-jerk response rather than a sober evaluation of China’s FX policy on its merits. The PBOC spooked investors when it began to rapidly revalue the Yuan in August, catching markets off-guard and sending asset prices scrambling. Today’s response may reflect fears of a similar scenario, but the ingredients for a repeat appear to be absent.

First, much of what happened in August occurred because investors seemingly misunderstood what China was doing. Policymakers called the initial devaluation a “one-off”, then devalued again. Traders panicked at an apparent FX policy reversal overnight but soon understood that China was (somewhat clumsily) communicating a change in the way it set the Yuan exchange rate. In this context, the second devaluation was consistent with the new regime rather than a reversal of its “one-off” adjustment pledge.

Something similar may be happening this time around. The markets’ memory of August volatility sparked a risk-off response in the face of a seemingly dramatic Yuan fixing, but yesterday’s drop in the freely-traded offshore CNH – since August a pace-setter for setting the daily CNY rate – amply telegraphed the direction of today’s announcement (if not its precise magnitude). Furthermore, stimulus expansion may yet be seen as supportive, pointing to officials’ resolve to fight economic malaise. All told, this means today’s China-inspired volatility may fail to find lasting follow-through.

Looking ahead, the spotlight is on minutes from December’s FOMC meeting. At issue is the disparity between the Fed’s 2016 policy outlook and that of the markets. Fed Funds futures show investors are anticipating two rate hikes this year. Meanwhile, Janet Yellen and company projected four increases in the range for the baseline lending rate through year-end. With that in mind, volatility risk appears to be on the upside for the US Dollar in the event that hawkish commentary forces investors to adjust their views.

Losing Money Trading Forex? This Might Be Why.

Asia Session

GMT

CCY

EVENT

ACT

EXP