Given that Federal Reserve chair Janet Yellen has adopted the word ‘noise’ to describe recent inflation data in the US, now clearly is not the ideal time to be aggressively buying the USD. As well as admitting that inflation data was on the high side – CPI up 2.1% from a year earlier – Chris Weston chief market strategist at IG says Yellen has also used her FOMC (Federal Open Market Committee) speech to prepare the market for an interest rate hike at some future point.
Despite CPI rising at its fastest rate in 2 years, Matt Simpson, market analyst at TF Global Markets says market participants would be wise to remember that since 2012, the FED has identified the Core PCE as its inflation measure which tends to be lower than CPI. “As Real PCE rose 1% in Q1 – compared to 3.3% in Q4‘13 – it paints a slightly less rosy picture than the headline CPI figure,” says Simpson.
So while Yellen remains dovish – and PCE remains below par – he says we can continue to expect USD to struggle and for higher-yields currency pairs such as AUD and NZD to benefit off of Greenback weakness.
While the market was expecting more hawkish rhetoric, Weston says Yellen’s decidedly dovish conclusion that inflation is broadly under control, reveals a strategically important code within the central bank’s policy that traders can capitalise on.
“With the FED giving an impression it will raise rates in the second quarter of this year, it’s reasonable to expect that rates will be lower for longer, and certainly until it drops the mantra that the rise in inflation is noise, we should see volatility contained,” says Weston.
Within these market dynamics, he says it makes sense for traders to take further advantage of this period of low volatility. He says the FED’s fairly neutral stance opens up the prospect of much greater central bank divergence, especially with the ECB which is potentially about to embark on quantitative easing within the next 12 months through the purchase of private assets.
“While the market is broadly OK with tensions in the Ukraine and Iraq, September and October – following the Fed’s summary of economic projections on September 16th – could hold the premise for increased volatility, especially if there is clearer evidence of inflation ,” says Weston.
He says by properly reading these major themes currently playing out, traders should be able to establish what makes for the most appropriate strategy going forward. He recommends running with what’s currently working and trade current conditions, while keeping a close eye on what’s bubbling below the surface that could break out.
“Further evidence of price action – due in part to two neutrally-stanced central banks – could see the US yield and USD move up, while gold could also start coming under more intense pressure,” Weston says.
He says the danger in traders starting to buy the USD at current levels is simply that there could feasibly be more downside in the USD in the short-term.
“Central bank divergence should provide valuable clues when deciding on what currencies to be ‘long’ USD against, and from my perspective – due to current policy -it’s worth focussing on the Japanese Yen (JPY), Swedish Krona (SEK), and the Euro.
“Due Australia and New Zealand being in separate phases of their economic cycle and for their monetary policies to diverge further, then NZD is expected to outperform AUD in the foreseeable future,” says Simpson. “This makes the Kiwi Dollar an excellent proxy for risk-on / risk-off, particularly against JPY and CHF, but also the Greenback.
However, he reminds traders that this outcome assumes we see no further geo-political tensions such as Iraq and/or Ukraine intensify, in which case the Greenback will quickly regain its title as the ‘real’ safe haven and for AUD, NZD and GBP produce deeper retracements. But at this stage he sees no threat to their bullish trends and expects AUD$US$, GBPUS$ and NZ$US$ to remain ‘buy the dip’ currencies.
Volatility remains low – as it does across most markets – and the Greenback is not particularly directional. While volatility remains low, Simpson says traders are best to not outstay their welcome on any positions, as traditional trend trading on higher timeframes is difficult.