Since Federal Reserve Board Chairman Ben Bernanke first hinted back in May that the Fed at some point would reduce the amount of monthly bond purchases (QE3), talk of a taper and its effect has dominated all market sectors. Currencies are no different. But the one constant in financial markets over recent years is a gnawing uncertainty. The economy has experienced slow, tepid growth and, just as the recovery looks to gain steam, there is a downturn. All Fed action is data-dependent and the data is screaming, “ugh!” Things are better but we aren’t out of the woods yet.
A consensus was building that the Fed would begin tapering at this September’s FOMC meeting, which would be U.S. dollar positive, but weaker jobs growth in the July employment report may have pushed it back to the 50/50 range.
“The entire tapering debate is the biggest catalyst for the dollar at the moment,” says Andrew Wilkinson, chief economic strategist for Miller Tabak & Co. LLC.
George Dowd, head of Chicago foreign exchange for Newedge, sees tapering occurring earlier than consensus based on better employment numbers (we spoke before the July report came out; one more employment report will come out before the Fed meets next). Dowd expects a taper in September and thinks it may be more substantial than expectations.
“You have to look at where they are going to go with the purchases as well,” he says. “Currently they are purchasing $45 billion in Treasuries and $40 billion in [mortgage-backed securities]. The market consensus for the September meeting is they go 35 and 30; I think they can go 30 and 30.”
While the taper is generally bullish the dollar, Wilkinson believes — like the initial reaction to taper talk — the dollar rally may have gotten ahead of itself.
“What changed in [July] is that the market has dealt with the distinction between tapering and raising interest rates. It shouldn’t be confusing. Price action tends to mislead investors and that is exactly what happened. Rising bond yields immediately impacted the stock market and the logical conclusion was that the Fed is tightening, and that wasn’t the case,” Wilkinson says. “What has transpired over the early part of the summer is that the dollar is not set to benefit any time soon from rising yield differentials on account of official interest rate rises, so as the market discounts that, investors’ appetite for dollars become less.”
Sharpe + Signa Managing Director Garen Ovsepyan agrees. “Fed tapering is dollar-positive in terms of market sentiment; however, as far as money markets are concerned, tapering is not necessarily a hike in rates,” he says
Ovsepyan points out that the dollar consistently has failed to take out significant technical resistance at 83.50. “If the Dollar Index trades convincingly above 83.50 at least on a weekly basis, we adjust our view from bearish to neutral or possibly mildly bullish.”