FOREX: WHERE DO CENTRAL BANKS STAND?
It has been an extremely quiet day in the foreign exchange markets and in the words of my colleague Boris Schlossberg, it feels like a Sunday. Even though U.S. markets were the only ones closed for trading today, the absence of U.S. traders and U.S. equities as a guide for the dollar was certainly felt across the globe. The lack of economic data from Europe also contributed to the lack of volatility in the forex market. The U.S. dollar weakened modestly against all of the major currencies but the trading range in the EUR/USD was limited to 70 pips and the range in USD/JPY was limited to approximately 50 pips. With the dollar ending the NY trading session near its low, there is a good chance that the sell-off in the greenback could gain traction on Tuesday. The only pieces of U.S. economic data due for release tomorrow are the Treasury International Capital flow report and NAHB housing market index. As usual, it would be interesting to see if dollar weakness prompted foreign investors to reduce their exposure to dollar denominated assets. The greenback hit a year to date low in November and did not strengthen until the last month of the year.
Where do the Central Banks Stand?
On quiet trading days such as today, we love to explore topics beyond the day to day fluctuations in the forex market. A topic that is extremely relevant to the outlook for the major currencies is how central banks compare in their degree of dovishness and hawkishness. Of the 8 major central banks, the most hawkish is undoubtedly the Reserve of Australia who raised interest rates 3 times in a row last year and is slated to raise them again in February. In fact, we could see another 75bp of tightening from the RBA when all is said and done. The Reserve Bank of New Zealand is next in line to raise interest rates. They have been riding on the coat tails of the Australian economy and have been open raising rates in the first half of the year. Next in line are the Bank of Canada and the ECB. The BoC previously indicated that they plan on raising rates this year, but most likely not until June at the earliest. The ECB has recently toned down their degree of hawkishness amidst problems in their member nations but they are still more likely to raise rates before the Fed. The market is divided on how much tightening the U.S. central bank will deliver before the end of the year. Based upon Fed Fund Futures, there is only a 43.8 percent probability that U.S. rates will be at or above 0.75 percent by November. Depending upon how the U.K. economy performs this year, there is scope for a small degree of tightening towards the end of 2010. The Swiss National Bank and the Bank of Japan on the other hand are expected to remain on hold throughout 2010. Interest rates are the number one driver of currency fluctuations which means that the willingness of a central bank to raise rates compared to their peers will determine how their currency trades.
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