The Euro has clearly benefited from speculation that the European Central Bank will raise interest rates at their upcoming meeting, but the key question remains whether a 25 basis point rate hike will be enough to produce further gains. Overnight Index Swaps currently show that a 25bps move is fully priced in, and traders have placed an approximate 50 percent chance that the bank will move by a bigger 0.50 percent. Such forecasts suggest that the Euro could actually sell off on a 25bps move, and it will likewise be critical to listen to post-decision commentary from ECB President Jean Claude Trichet.
2. The Aussie seems unstoppable these days. What can stop this move and weaken the Aussie? Jobs? Rates?
The Australian Dollar continues to benefit from the highest short-term interest rate of any G10 currency, relatively robust forecasts for domestic growth, and buoyant commodity prices. A pronounced downtrend in financial market volatility expectations likewise helps the high-yielder. If markets show little fear of outsized exchange rate moves, investors will be much more willing to borrow currencies such as the low-yielding Japanese Yen and US Dollar to subsequent invest in the Aussie dollar. As long as financial market risk appetite remains buoyant and volatility fears are low, there is little reason to believe that the Australian Dollar will see any significant correction.
3. While many FOMC members made hawkish declarations, dove William Dudley had a very strong impact on the dollar. In this struggle between hawks and doves, who do you think will have the upper hand, and how will the dollar move?
I think William Dudley’s comments served to remind markets that not all Fed officials were growing hawkish in unison, but such individual disagreements are common and on aggregate Fed rhetoric seems to favor policy normalization through the foreseeable future. A key question remains whether the Fed will allow QE2 to phase out in June and if we can expect rate hikes in 2011. Based on recent rhetoric alone, such a phase-out seems likely. Yet any disappointments in said regard could quickly force US Dollar losses.
4. Three weeks after the earthquake, the yen is dropping. Is this likely to continue for a long time?
Recent anecdotes suggest traders believe joint G7 intervention was enough to stem Japanese Yen appreciation, and many have reportedly re-entered JPY short positions on said speculation. Yet I don’t think that intervention really explains the sudden behavior in the Yen, and I would much more likely attribute it to the “risk-on” environment across financial markets. In other words, buoyant risk appetite is driving the high-yielding Australian Dollar and other major currencies to fresh peaks against the low-yielding Yen. As a result I think that we should look to risk barometers such as the S&P 500 to drive moves in the JPY. Any significant corrections could easily force Japanese Yen appreciation.
5. The Bank of England still struggles between high inflation and a weak economy. How will they act on the rates? And how will this move the pound?
Overnight Index Swaps predict that the Bank of England will be forced to raise interest rates by as much as 80 basis points in the coming 12 months, and it’s difficult to disagree with such forecasts. On the one hand you have hawks calling for aggressive interest rate moves and, on the other, Mervyn King has suggested that rate increases would be ‘futile’ gestures. The key question will be whether hawks or doves will win over the moderates and whether headline inflation—well-over mandated targets—will come down through the medium term. Given expectations for higher British Pound interest rates, any significant disappointments could force further GBP declines.
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