US Federal Reserve Decision Sparks US Dollar Volatility - What's Next?

  • Bullish Japanese Yen Outlook Clouded by Market Choppiness
  • British Pound Forecast Takes a Hit on Dovish Bank of England Rhetoric
  • Canadian Dollar, Australian Dollar, and New Zealand Dollar Rally on Commodities and Equity Gains

[B]US Federal Reserve Decision Sparks US Dollar Volatility – What’s Next?[/B]
This Wednesday, the United States Federal Reserve kept its benchmark interest rate unchanged at 0 to 1/4 percent, a record low. The decision to leave rates unchanged was widely expected but the statement released around 2:15 ET had a very mixed reaction among traders and institutional investors. Initially, Treasuries sold-off and the dollar rallied sharply against the most popular currencies. However, an out of the blue change in investor’s sentiment towards more risk-taking, possibly caused by an impressive rally in stocks, made the dollar exchange rate give back most of its early gains. In sum, the Federal Open Market Committee said that even though “conditions in financial markets have improved further in recent weeks” the committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period”. Conversely, because the current “policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth”, the committee has decided to gradually slow the pace of Treasury securities purchases. “The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets”. But that said, this is certainly the beginning of the end for quantitative easing, an event that is likely to propel a rally in treasury yields and provide support to the US dollar in the months ahead.

[B]Related Article[/B]: How should event-risk traders prepare for the FOMC rate decision?; What is at stake at August’s policy meeting?

[B] British Pound Forecast Takes a Hit on Dovish Bank of England Rhetoric[/B]
The British Pound was among the worst performers on the day, as a surprisingly dovish Bank of England Quarterly Inflation Report sunk GBP yield forecasts. Overnight Index Swaps and Short Sterling Interest Rate Futures moved substantially on bankers’ concerns that the frail banking system would be unable to support a recovery in growth. Indeed, implied December, 2009 yields dropped a substantial 10 basis points to 0.87 percent, while 1-year BoE interest rate expectations dropped a similar amount to multi-week lows. The US Dollar’s pullback meant that the GBPUSD was nearly unchanged at the end of the US session, but it unsurprising to note that the EURGBP exchange rate trades near month-to-date highs following BoE developments. UK fundamentals suggest GBP risks remain to the downside, but it continues to be important to watch developments in financial market risk sentiment. Despite the day’s interest rate-sparked moves, the GBPUSD-FTSE 100 correlation remains near all-time highs.

[B]Related Article[/B]: Bank of England Weighs on Sterling
[B] Japanese Yen Outlook Clouded by Market Choppiness[/B]
Previously sharp Japanese Yen gains led us to believe that it was embarking on a sustained reversal against major forex counterparts, but the day’s impressive volatility clouds outlook for the safe-haven currency. Indeed, our Forex Options-based forecast called for continued JPY corrections based on clearly one-sided trader positioning. Equity markets have rallied substantially on a year-to-date basis, and the S&P 500 stands a further 1.9% improved on the month of August. Said gains have come on progressively lower trading volume, and many of us here at DailyFX believe that this is unsustainable. Given the Japanese Yen’s record-high correlation to the S&P 500 and other key indices, any signs of sustained turnaround would easily lead to big pullbacks in Yen crosses. Though the S&P finished the day a full 1.15% above yesterday’s close, intraday charts show the index fell notably from intraday peaks. Very short-term momentum may in fact point to Japanese Yen gains overnight.

[B]Related Article[/B]: US Dollar/Japanese Yen Monthly Exchange Rate Forecast
[B] Canadian Dollar, Australian Dollar, and New Zealand Dollar Rally on Commodities and Equity Gains[/B]
The Commodity Bloc took top honors on an incredibly volatile day of trade, posting large gains against the safe-haven US Dollar and Japanese Yen on improvements in financial market risk sentiment. Canadian Dollar bulls were out in full force on early crude oil futures rallies, and a later pullback in the NYMEX-traded contract had seemingly little effect on the CAD. Only the post-FOMC US Dollar rally halted USDCAD tumbles, but sharp retracements in the US Dollar meant that the currency pair finished almost squarely at the day’s lows. The Australian and New Zealand currencies were similarly bid on the impressive S&P 500 recovery. Yet it serves to note that the S&P and NZDUSD both finished notably off of intraday peaks—leaving very short-term momentum to the downside. Limited Commodity Bloc event risk suggests that the Loonie, Aussie, and Kiwi will continue to trade off of broader financial market moves. It remains critical to watch whether the S&P 500 and other key assets can break their recently choppy trading ranges.

[B]Related Article[/B]: Australian wage gains slowest in 5 years

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