USD Swings on Tapering

June 25, 2013

The FX markets are subject to high volatility, mainly triggered by dovish comments on Fed QE and the ongoing liquidity concerns in China. Though the PBOC sees the liquidity risk controllable, the abstention to add cash in the system generated significant swings in the equity and currency markets so far.

In the currency trading, USD remains the main driver of volatility and speculative fluctuations. Due this afternoon, US May durable goods and June consumer confidence data should add some volatility in G10 trading.

USD – Bull Market

The FX markets continue recording high volatilities on Fed, almost a week after the FOMC meeting. The markets are still willing to price in the QE tapering sooner than later, however the lack of clarity and the uncertainty wide-open the door to colossal speculation and heavy swings in the currency markets.

Clearly, the current jittering hides a set of important questions behind the scenes. The markets, and several Fed officials, are still not fully convinced with Fed tapering the QE too early, as signs of sustainable recovery are still lacking. Indeed, Fed’s Dudley, Fisher and Kocherlakota voiced dovish statements on Fed yesterday, insisting on Fed’s failure to reach the employment and inflation objectives and the necessity to continue the QE until unemployment falls below 7% with inflation under 2.5%.

In reaction to Fed doves, the US 10-year government yield eased from 2.6647% (highest levels since August 2011) to 2.50%, the S&P futures registered decent sell-off, USD was broadly offered. At this stage, the high volatility is likely to squeeze the markets for the days ahead. EURUSD 1-month vol nears 10%, alongside with USDJPY vol above 17%.

Despite the conflicting opinions in the market place, Fed reducing the QE is still being priced in, though with less enthusiasm. The focus is now shifting to GDP growth to be released on Wednesday (with some volatility expected in reaction to durable goods orders and consumer confidence this afternoon). The US economy is expected to have grown 2.4% (annualized) in the first quarter, according to a Bloomberg survey. Any positive surprise should give reason to hawks and for further USD-strength.

Quick Note on Futures Positions

June 18th CFTC data shows that the USD-longs have been reduced aggressively on position adjustment before the Fed meeting last week. Traders are likely to rebuild their USD-longs, and this operation should push the dollar to further highs against its G10 peers and the EM currencies.

Data also reveals that the Euro net futures positions turned positive last week on the back of the speculative longs in Euro before Fed. Today, EURUSD rallied to 1.3151 early in the session on dovish Fed comments, with offers building at 1.3180/1.3200 zone. At this stage, the recent EUR-buying is clearly not supported by the Euro-zone fundamentals. Ahead of us, EU officials will regroup tomorrow to discuss about the unification of banking rules within the Euro-zone, before the Brussels summit on Thursday. Euro will be subject to event risk; caution is needed on the downside.

CFTC data also shows significant decline in GBP and JPY shorts, and substantial rush into the Swiss franc. Regarding AUD, the net short positions stabilized, after being aggressively built since end of March.

Now, these significant capital moves were clearly due to the massive position adjustments before Fed meeting on June 19th. The normalization is likely to continue until new data stream, and potentially accelerate with any supportive news out of US.

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