Dollar confused amid political risk

By:
Joti Mangat
Published on:

Foreign exchange markets spent last week in thrall to US political headlines as the dollar reversed its weakening trend amid range-bound and volatile trading in G10 crosses.

Janet Yellen’s nomination to the office of Federal Reserve chairman coupled with the prospect of a short-term solution to the debt-ceiling crisis, after house majority leader John Boehner asked Republican lawmakers to extend the deadline for six weeks with no federal budget conditions attached, saw the greenback follow US equities higher.

The USD Index rose from an eight-month low of 79.750 to 80.50, with the greenback posting its biggest gains against the Japanese yen, which dropped 0.97% against the dollar, while the pound gave up 1.18% against the greenback after the release of weaker-than-expected UK economic data.

However, EURUSD, after sliding sharply at the beginning of the week, moved up above 1.35 amid volatile trading.

Meanwhile, the release of September’s Federal Open Market Committee (FOMC) minutes – from the meeting that pushed tapering back to 2014 and kicked-off the latest round of dollar weakness – indicated that the Fed is essentially divided between members calling for an immediate reduction in securities purchases and those looking to delay the tapering decision.

Some committee members noted in objection to the decision that to delay would be a mistake, given widespread market expectations and the Fed’s renewed commitment to improve communication with financial markets.

Although Yellen is widely perceived as a dove, some observers say the firmer dollar tone after the announcement was driven more by the removal of one element of uncertainty amid the US government shutdown and fiscal crisis than by any clarity around the Fed’s long-term strategy.

“The firmer dollar tone comes from the removal of uncertainty and continuity, rather than any judgement on Yellen’s policy leaning,” says Simon Smith, chief economist with FxPro, an electronic foreign exchange broker and currency trading platform based in London.

With the exception of JPYUSD and GBPUSD, the dollar’s moves have been relatively modest and remain volatile as the combination of the government shutdown and the impending debt-ceiling deadline crowd out fundamental analysis.

Moreover, the lack of economic data releases from US central government agencies since October 1 offers traders scant fundamental information with respect to the relative strength of the US economy.

Indeed, traders said that the labor department’s jobless claims numbers were virtually worthless after the government noted it would treat claims related to the shutdown separately. “The jobless numbers were so full of noise that the markets are more confused than ever on the economic impact of the shutdown,” says one currency manager.

Rabobank’s FX strategist Jane Foley adds: “Whatever the impact of the shutdown, it may take a while before there is enough evidence for economists to be agreed upon whether there have only been transitory effects or a much more significant blow.

“In view of this uncertainty, the market has started to weigh up the risks of a further delay to Fed tapering potentially into next year.”

In the place of current data and little progress on Capitol Hill to end the shutdown, the market is focused on the significance of the Yellen nomination and the split September FOMC for clues as to when the Fed might start to reduce quantitative-easing purchases causing dollar rates start to rise.

Michael Gapen, senior US economist with Barclays Capital in New York, and former Federal Reserve Board analyst, argues that Yellen’s appointment is essentially confirmation that accommodative monetary policy will remain in place, suggesting that dollar bulls might have to wait some time for more aggressive appreciation.

Although Yellen has not made a public speech in some time, presumably to avoid any potential conflict with the nomination process, she noted in 2012 that policy rates could stay at zero until 2015 in the absence of a substantial economic improvement.

“We believe she remains of the opinion that a highly accommodative monetary policy stance remains appropriate, given the lingering headwinds constraining the pace of the US recovery” says Gapen.

“In our view, she likely remains a supporter of asset purchases and sees the benefits of balance-sheet policy as outweighing the costs.”

While the market was aware that the tapering decision would be a close call ahead of the FOMC minutes release, analysts say it did confirm that the immediate fiscal concerns were a substantial factor in the decision to delay.