5 Things Everybody Should Know About Janet Yellen

Former Treasury Secretary and head of President Obama’s Council of Economic Advisers Larry Summers officially withdrew from consideration for the next chairmanship of the Federal Reserve, according to a letter submitted to Obama on Sunday. The move was likely catalyzed by Montana Senator Jon Tester’s announcement that he would not support Summers’ nomination to succeed Ben Bernanke should it come to a vote on the Senate Banking Committee, where Democrats have a three-vote majority. The revelation came after two other Democrats on the committee — Jeff Merkley of Oregon and Sherrod Brown of Ohio — announced their opposition to Summers’ candidacy.

With Summers out of the running, the field is clear for current vice chairwoman of the board of governors of the Federal Reserve, Janet Yellen. Here are five things everyone should know about America’s (likely) next economist in chief:

1. Yellen is not a creature of Wall Street: Summers’ fiercest critics argued that he has a long history of coddling big Wall Street banks and, as Fed chair, would not regulate them with the enthusiasm necessary to keep the U.S. financial system safe. Though Summers has spent much of his career in academia or as a public servant, he has ties to big Wall Street banks. His original sin is to have been a proponent of financial deregulation during the end of the Bill Clinton years, which helped set the stage for the financial crisis. Summers fought against the passage of the Volcker rule, which prevents banks from speculating with government-insured deposits, in 2010.

(MORE: Why Summers Didn’t Get the Job)

Yellen, on the other hand, has spent the past 20 years with the Fed, save for a stint on Clinton’s Council of Economic Advisers. Though her track record on regulation is more difficult to evaluate, the Center for Public Integrity reviewed years of Yellen’s speeches, meeting transcripts, government testimony and reviews of bank failures, concludingthat she has what it takes to be America’s top bank cop. “Yellen now appears determined to ensure that banks fortify themselves against financial shocks and that regulators have the power to police the system,” it stated.

2. Yellen’s had a (relatively) good track record of economic predictions: Economists aren’t terribly good at predicting the future. Yellen appears to be better than most. The Wall Street Journal reported earlier this summer that after it “examined more than 700 predictions made between 2009 and 2012 in speeches and congressional testimony by 14 Fed policymakers,” Yellen came out as the most accurate. Yellen has also been given credit for warning about the real estate bubble as early as 2005. Why’s it matter? See the next point.

3. She was an architect of Bernanke’s unconventional monetary policies: Accurate forecasting is important because the better your forecasts, the more effectively you’ll be able to set monetary policy in the present. But as the most recent financial crisis proved, a good Fed chief needs to be willing to think outside the box to achieve its goals of low, steady inflation and full employment. This is exactly what Bernanke did — using the powers of his office to launch a massive bond-buying program aimed at lowering interest rates further down the yield curve and promising to keep short-term interest rates at near zero for years. Bernanke, however, didn’t launch these programs immediately. Behind the scenes, it was reportedly Yellen who was the most forceful advocate for the Fed doing more to help stimulate the economy.

(MORE: Obama Talks TIME’s Wall Street Cover Story)

4. The White House was reluctant to nominate Yellen: Since the White House began floating Summers’ name as the favorite for the Fed post, it has been getting a lot of criticism from lawmakers, economists and the chattering classes. President Obama was seemingly undeterred by this opposition. It wasn’t until a smooth confirmation became practically impossible with Senator Tester’s announcement, that he accepted the idea of a Summers-less Fed. This raises the question of whether Obama was hoping to have someone closer to his inner circle at the central bank. It is possible that a Yellen Fed would be more distant from the White House politically than the Federal Reserve envisioned by the President.

5. She’d be the first female head of the Federal Reserve: Confirming Yellen as the first chairwoman of the Federal Reserve would be a historic move for an Administration that has received criticism for lack of progress appointing women to senior positions. It would also add a healthy dose of diversity to the realms of central banking and finance in general. Though 45% of Federal Reserve employees are women, few are in top positions. In all G-8 countries, there has been only one female central-bank head in history: Russia’s Elvira Nabiullina, who was appointed just this year.

Read more: http://business.time.com/2013/09/16/5-things-everybody-should-know-about-janet-yellen/#ixzz2f5adFDsM

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14 Questions About The Federal Reserve You Were Too Embarrassed To Ask

As market-watchers, nothing gives us heart palpitations quite like a meeting of the Federal Open Market Commission.

And fortunately, a big one is coming up this week!

But for most people, the Federal Reserve invokes confusion, derision, or nausea.

Inspired by some other great "explainers" we've seen lately, here's the definitive Federal Reserve Q&A, answering all your questions shame free. Hopefully, this will help you understand this week's big meeting, as well as all future ones.

Let's get started.

What is the Federal Reserve?

The Federal Reserve — or "the Fed" — is the central bank of the United States. Let's just start with what a central bank is, since plenty of countries have them. Actually, the U.S. was pretty late to the central banking game, as Americans' spirit of individualism generally inspires disdain for large, centrally-coordinated government authorities. Central banks are tasked controlling interest rates, the money supply, and overseeing the banking system.

How is the Fed set up?

In a stranger way than most central banks. There are four tiers: The Board of Governors, the Federal Open Market Commission (FOMC), 12 regional banks, and smaller member banks.

We'll start from the top. The Board of Governors is responsible for much of the monetary policy we'll describe later. These seven people are nominated by the President, pass Senate approval, and sit in Washington making decisions. Ben Bernanke is the current chairman. His term will end in January, and people have been speculating and endorsing like crazy about who his replacement will be.

Next we have the FOMC, a commission of seven Board of Governors members and five regional bank presidents. The FOMC runs open market operations, which we'll also get to later.

Then there are the 12 regional banks, responsible for much of the nitty gritty banking stuff (like check clearing). They are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. Each regional bank has a president and oversees the thousands of member banks in its region.

Those are very random cities.

Yeah, it's weird. You can actually chalk that up to 1913 American politics. There were a lot of holdouts when Congress was voting on the Federal Reserve Act in 1913. The senator from Missouri, for example, could only be swayed if his home state became the only one to house two regional banks.

This seems complicated and arbitrary. Why do we even have a Federal Reserve?

As we mentioned, the U.S. didn't have a Federal Reserve bank for a long time. This meant that the late 19th Century was basically a series of uncontrollable economic panics. It wasn't until 1907, when the New York Stock Exchange fell 50% and depositors "ran on the bank" to recoup their money, that people warmed to the idea of a central bank and legislation passed.

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So the point of the Fed is to control economic panics? How?

Well, yes (at first).

We all know that when you deposit a check, the money doesn't just stay in your bank's vault until you need to hit the ATM because this bar is cash-only. No, banks move around and invest most of what they take in. This is how banks make money, among other ways. There are, of course, rules now about how much banks have to hold in "reserves," but the problem before the Federal Reserve was this: What happens when all the depositors want their cash back at once, a la the bank run scene in It's A Wonderful Life. As you'll recall, Jimmy Stewart's George Bailey tells the townspeople of Bedford Falls, "You're thinking of this place all wrong. As if I had the money back in a safe. The money's not here. Your money's in Joe's house... and in the Kennedy house, and Mrs. Macklin's house, and a hundred others."

George Bailey was actually talking about fractional-reserve banking. Today the Federal Reserve might say, "George, if all else fails, we can step in and be the lender of last resort." The Fed kind of did say that in 2008, albeit not to George Bailey, but to nine highly-paid bank CEOs.

How can the Fed be the lender of last resort?

We're not sure you want to ask that because the answer may scare you. We know the Federal Reserve has power to print money. Theoretically, though, it could print enough money to bail out anyone or anything in any situation. How? As a fiat currency, the dollar is not tied to anything. It was once tied to gold, but Richard Nixon got rid of that in 1971.

Debt hawks are wrong when they say things like, "The U.S. is becoming the next Greece." Greece doesn't have its own state currency, and needs to be periodically bailed out by Europe's central bank. But the United States as a whole can always just print more money!

That doesn't seem sustainable.

It's not. To be fair, it's not exactly like we're just sitting here sending truckloads of $100 dollar bills into the economy. Plenty of governments have tried to do that and bad things have happened. The good news is that the Fed keeps a watchful eye on inflation to make sure that, as the balance sheet expands, we're not seeing runaway figures.

Still, as originally intended, the Federal Reserve exists to extend credit to banks or other institutions in emergency circumstances like a bank run.

Of course, we've come a long way in 100 years, and new circumstances like the financial crisis has inspired the Fed to do a lot of new things. They admit as much in their mission statement: "To provide the nation with a safer, more flexible, and more stable monetary and financial system. Over the years, its role in banking and the economy has expanded."

Expanded? What does the Fed do now?

The Fed sets what's known as "monetary policy" in order to promote the economic health of the country. Monetary policy impacts interest rates, which obviously impact the economy. Via monetary policy, the Fed intervenes in a few key ways.

1. The discount rate: "The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility — the discount window," according to the Fed. Don't worry too much about this one for our purposes.

2. Reserve requirements: How much a bank has to hold in reserves. The Fed uses the tool to control how much banks can lend out.

Federal Reserve

3. Open Market Operations (OMO): Listen up because this one is important. You might have heard how the Fed is buying assets in a program known as Quantitative Easing, and we'll get to that later. OMOs are similar, and have been the longstanding program by which the Fed implements monetary policy. The Fed has used OMOs, the purchase of government bonds on the open market, as a means to adjust the federal funds rate to a specified Fed target. The federal funds rate is a metric that controls "interbank loans." 

When the Fed reduces the federal funds rate, as it has done since the crisis, it encourages banks to take out interbank loans. That incentivizes them to lend more freely, which theoretically speeds up the economy. Conversely, the Fed would raise the federal funds rate if it thought the system was too loose and could create a bubble.

With the economy in recovery mode, the Federal Reserve wants to keep the federal funds rate as low as possible. The only problem now is that it has been at 0% since 2009.

In fact, the Federal Reserve has been operating under ZIRP — zero-interest rate policy. Simply put, nominal interest rates are as low as they can go. We've reached the boundary of conventional monetary policy wisdom.

So what monetary measure can the Federal Reserve take if rates are at zero?

We told you we'd get to Quantitative Easing (QE) later. It's later. QE is what's known as "unconventional monetary policy," which is a nicer way of saying "Sure, I guess we'll try this now."

In the wake of the financial crisis, and with rates at the "zero lower bound," the bank introduced a spate of new monetary policy options. Chief among them was "quantitative easing," a program in which the Fed purchases assets in order to increase the money supply. Since 2008, the Fed has purchased billions of dollars worth of mortgage-backed securities (those bad things that helped cause the financial crisis) and billions of dollars worth of Treasury notes. Along the way since then, the Fed introduced two new "rounds" of QE.

QE has kept interest rates low, some would argue artificially and "uneconomically" low. Either way, the upshot has been a rebounding stock and bond market in the years since the crisis.

Now, critics of QE (who like to call the third round "QE-Infinity" due to the program's endurance) have warned that this kind of asset purchasing will lead to higher inflation. Controlling inflation, as it happens, is one of the Fed's chief concerns.

So far, we haven't seen the kind of inflation people were worried about, and economist Paul Krugman gained a lot of notoriety for basically calling QE critics wrong over and over again. That doesn't mean the program isn't problematic. The Fed's balance sheet has grown immensely, to $3.6 trillion.

Will QE ever stop?

In June, the Fed sent markets in a tizzy by announcing it would look at "tapering" QE. Now, tapering doesn't mean ceasing the purchase of assets. It means buying them at a slower rate. Markets still freaked out and interest rates shot up.

Even with a taper, it looks like QE will go on for a while longer. And even when it finishes, people are unsure how exactly a central bank can unwind $3.6 trillion.

So what the Fed says or does really impacts the market?

You said it. The Fed has tried to be pretty direct by offering what's known as "forward guidance" — meaning clear communication about future interest rates. Having exhausted its normal monetary policy tools, the Federal Reserve has said it will tether policy changes to observed economic indicators. Better communication will help market actors "price in" economic changes.

Think of it this way, the Fed right now is saying, "Look, we're going to keep rates low for a very long time." Normally, the Fed only controls the short-term interest rate, but by telling Wall Street that they can borrow at low rates for a long time, firms will presumably be more eager to lend money out to the American people (at a lower interest rate too).

Central banks usually act in a shroud of mystery, but Chairman Bernanke clearly wants to uproot that. Other central bankers, like Mark Carney in England, have followed suit.

The Fed says that it will keep the federal funds rate unchanged until we hit 6-6.5% unemployment. We're currently at 7.3%. Seems clear enough, but market still get roiled every time the Fed opens its mouth or people think it just did. Central banks will always make waves in markets because what they do or say is clearly so intrinsic to the future of economy. Guessing on the future of the economy remains how traders make money, so you can imagine how angry some of them get when the they think the Fed isn't being clear about its intentions.

Money For Nothing

Pictured center: Former Fed Chairman Alan Greenspan (1987-2006)

Hold on, let's go back a second. You never said anything about the unemployment rate.

Ah sorry, yes, the Fed does concern itself with employment figures. As a 100-year old institution, the Fed's responsibilities have been revised by legislation through the years.

There was the 1946 Employment Act which called upon the government to pursue maximum employment. Then in 1977, Congress got more specific and passed the Federal Reserve Reform Act, which instructs the Fed to use monetary policy to promote employment and control inflation. That law didn't happen by accident. You might recall that the late 1970s was a terrible time for employment and inflation.

But why do people hate the Fed?

Surely you're talking about Ron Paul's campaign battle cry to "End the Fed." Or perhaps Rick Perry's veiled threat to murder Ben Bernanke for high treason.

The Fed today has what is known as a "dual mandate" to keep an eye inflation and employment at the same time. And this is one of the chief critiques that Fed haters cite.

Critics stress that the original intention of the Fed was to avoid banking panics. If the Fed has to concern itself with employment, it has an incentive to keep interest rates low to juice the economy. But if you keep interest rates low, especially during good times, bubbles can and will appear. In 2001, we saw a stock bubble. In 2007, an asset (housing) bubble. Bubbles, as history has shown us, lead to the kinds of banking crises the Fed was originally tasked with preventing.

So what's the likelihood of another crisis?

If you can answer that, you should be a central banker. This is hard stuff. The people at the Fed are genuinely trying to ensure the health and stability of the American economy. In retrospect, it's easy to see clear central banking mistakes. During his tenure as Fed Chair in the 1990s, Alan Greenspan was hailed as a demigod for having "figured out" monetary policy. It wasn't until the housing market crashed years later that people realized his policy of ultra-low interest rates and deregulation fostered an economic powder keg.

Monetary policy can have reverberations years — perhaps decades — later, so it's best to pay attention. It's not easy work, but hopefully now you understand it a little better.

Read more: http://www.businessinsider.com/what-does-the-federal-reserve-do-2013-9#ixzz2ez06iBq3

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FX Macro And Sentiment Analysis - Week 37 - 2013

Forecast for US Dollar: Neutral

The event dollar traders – and really investors in all asset classes – have long waited for is finally upon us. Speculation surrounding the FOMC’s Taper decision has run rampant, spurring expectations and fear of an explosive reaction to a big shift in the market’s support structure. In fact, the discussion over this inevitable event has proven so prolific that we have already seen forecasts amongst economists and banks establish a clear consensus for a moderation of stimulus at the September meet while yield sensitive assets (like the benchmark US Treasury) have suffered sharp adjustments. Much of the actual impact an event like this has comes through the ‘surprise’ factor, but is there any surprise left in this event? Could this be a ‘buy the rumor, sell the news’ event for the dollar? 

To establish how the market responds to the Federal Reserve’s policy decision, we must establish what an ‘inline’ outcome would be. Over the past weeks and months, the members of the central bank’s board – both voters and non-voters – have repeatedly stated their support for Chairman Ben Bernanke’s timeline laid out after the June meeting – one of the quarterly events that was accompanied by updated forecasts and the press conference. With that platform, Bernanke stated that it was likely that they would begin reducing the $85 billion-per-month stimulus program (QE3) ‘later’ in 2013 and end sometime in mid-2014. Considering this is the last policy meeting with a schedule press conference until December, the first move this month would best fit the timeline. 

Given the massive drop in Treasuries, mortgage backed security funds, emerging markets, gold and other yield-sensitive assets; it is clear that a tapering is being priced in. Yet, it isn’t clear as to how certain the market is of the size. The New York Federal Reserve’s survey of Primary Dealers (large financial institutions that must deal in Treasury auctions and are considered by the central bank a barometer for the market) showed expectations of a $15 billion reduction at the first meeting and an aggressive pace after a similarly-sized move in December. However, a recent Bloomberg poll showed economists only expect a $10 billion cut to Treasury purchases only. Clearly there debate over this outcome and some adjustment will follow. 

In the scale of scenarios, themost overwhelming surprise would come from a decision to hold the program at $85 billion per month. An 80 percent surge in the benchmark 10-year Treasury yield in the span of just four months (not to mention the move from other global sovereign debt) shows a significant shift in expectations and positioning. If this unlikely scenario were realized, risk-sensitive assets that are dependent on the environment of artificially-low volatility would rally. However, such an outcome would be known to be a simple delay and not a permanent freeze on the necessary withdrawal. As such, risk benchmarks still hovering near record highs are unlikely to find much follow through. Carry trades that have seen an improved yield outlook (NZDUSD and AUDUSD) will progress further. Yet, perhaps the most prolific short-term rebound would come on part of US government bonds. Such a dramatic drop these past months can lead to an equally spectacular rally. In turn, a flood of capital looking to buy cheap Treasuries, could actually lift the dollar. 

A Taper of approximately $10 billion along with increasingly dovish forward guidance – an effort to ‘reassure’ is guaranteed – would be the most difficult outcome to account for. There has been exceptional adjustment to this outcome in some markets but relatively little in others. The immediate volatility for the dollar with this scenario would be the most restrained. However, looking at the underlying changes this would lead to, it is likely to eventually support the dollar. An initial unwinding of ‘Taper’ premium from the greenback will be followed with counter-balances by other central banks, a rise in presumed risks and an outlook of competitive yield growth in the US. 

For the most decisive support for the US dollar, a $15 billion or larger reduction alongside a status quo tone would carry the most weight. The mechanics in supporting the currency through this outcome require we tap into something far more elemental: market-wide investor sentiment. A glaring holdout to the Taper adjustment we have seen these past months, US equities led by the S&P 500 are perhaps the poster-child of ‘moral hazard’ – taking on excessive risks as participants feel they are will be absorbed by someone else. This is where the dollar’s potential really lies. If record leverage translates into disorderly unwinding the safe haven will soar.

Forecast for Euro: Neutral

The Euro broke to fresh multi-week highs against the US Dollar, but the Dow Jones FXCM Dollar Index (ticker: USDOLLAR) continues to hold key multi-month lows. All eyes now turn a highly-anticipated US Federal Reserve policy announcement to drive FX moves. 

The Federal Open Market Committee (FOMC) decision on September 18 will be the major driver of currency volatility in the coming days, and European event risk is relatively limited. What could the Fed do to break the US currency and broader markets out of increasingly narrow trading ranges? 

Fed Officials are widely expected to announce the start of the so-called “Taper” of the central bank’s Quantitative Easing measures. According to a Bloomberg News survey, most economists polled believe that the FOMC will cut its monthly purchases of US Treasury debt by $10 billion. Yet it’s the wide range of estimates that underlines how little we know of the Fed’s next steps. According to the same survey, 33% predict zero tapering while some anticipate as much as $20 billion in cuts. 

We look to interest rate markets to guide us. US Dollar interest rate futures showed a sharp drop in Fed interest rate forecasts following a disappointing US Nonfarm Payrolls report for August. Yet the initially strong reaction to the labor data has since turned into consolidation; no one seems to be willing to make big bets ahead of the Fed. 

The fact that the Euro trades near its highs and the USDOLLAR is just barely holding lows suggests that the EURUSD could break higher in the days ahead. Currency volatility has dried up in a major way, and it feels like the next big move is just around the corner. 

Our retail FX sentiment-based strategies have bought into Euro strength and remain positioned for a move higher. Whether or not se see the major break depends almost completely on the Fed’s next steps. It’s difficult to predict what the FOMC might do and much less how markets might react. 

In the meantime, we’ll brace ourselves for continued choppiness as currencies move in progressively smaller trading ranges.

Forecast for the British Pound: Bullish

The British Pound struggled to hold its ground during the final days of August, with the GBPUSD tagging a weekly low of 1.5426, but the Bank of England (BoE) interest rate decision may help the sterling to preserve the bullish trend dating back to July should the central bank highlight an improved outlook for the U.K. economy. Indeed, the BoE is widely expected to keep the benchmark interest rate at 0.50% while maintaining its asset-purchase program at GBP 375B, and we may see the Monetary Policy Committee refrain from releasing a policy statement should the group vote unanimously to retain its current policy. 

It seems as though Governor Mark Carney is becoming upbeat on the economy as he sees a more broad-based recovery in the U.K., and the central bank head may show a greater willingness to retain the wait-and-see approach for an extended period of time as the MPC continues to operate under its inflation-targeting framework. Another 9-0 vote should help to shore up the GBPUSD as it dampens the scope of seeing a further expansion in the BoE’s balance sheet, and we may see a growing number of central bank officials scale back their dovish tone as growth and inflation picks up. 

Despite the forward-guidance for monetary policy, expectations for a further rise in economic activity may heighten the outlook for inflation, and it seems as though the central bank is slowly moving away from its easing cycle as the economy gets on a more sustainable path. In turn, the inflation ‘knock out’ may become a more likely scenario for the U.K., and the BoE may take steps to ensure its credibility as price growth has held above the 2% target since December 2009. 

The GBPUSD certainly appears to have carved a near-term top around the 1.5700 handle as it failed to put in a close above the 38.2% Fibonacci retracement (1.5680-90), and the relative strength index may highlight further weakness in the exchange rate as the oscillator fails to retain the bullish trend carried over from July. Nevertheless, the upward trending channel in the GBPUSD may continue to take shape should we see a material shift in the policy outlook, and the pair may continue to carve a series of higher highs paired with higher lows as market participants scale back bets for additional monetary support.

Forecast for Japanese Yen: Neutral

The Japanese Yen was the worst performing currency this past week, dropping by -1.91% to the top New Zealand Dollar, another -1.83% to the British Pound, while only a mere -0.27% to the US Dollar. Last week in this forecast I said “with the domestic tone shifting for Japan, it will be necessary for incoming growth and inflation data to remain buoyant in order for the Yen to enjoy further reprieve.”

Clearly, this was not the case. Indeed, the misses on the 2Q’13 GDP reading set the tone for a weaker Yen right from the start of trade in Asia on Monday, as signs of a weaker than expected economy leave open the door for speculation on additional easing by the Bank of Japan. As noted last week, a considerable factor for any forecasted Yen strength hinged on these growth readings besting expectations. 

With the economy chugging along at an acceptable pace nevertheless (+3.8% annualized versus +3.9% expected), further chatter emerged about the prescribed sales tax hike due in the 2Q’14, with BoJ officials purportedly endorsing the fiscal measures and even offering monetary assistance should the economy see pressure. Additionally, to help offset the drawdown in consumption, the Japanese government is considering a corporate tax cut to help balance out the sales tax hike impact. In light of the fact that overall consumption here suffers – accounting for approximately 60% of Japanese GDP – these fiscal adjustments are perceived to be net-negative for the Yen. 

Compounding the shakier than expected domestic picture have been positive developments on the geopolitical stage, with Russia and the US agreeing to peace talks in Geneva, Switzerland, to figure out how to strip the Syrian regime of chemical weapons. As we’ve seen over the past few weeks, any progress that reduces the threat of US military intervention has been perceived as “risk positive,” in that stocks have rallied alongside the US Dollar, while the Japanese Yen, crude oil, and precious metals have fallen. Should these tensions remain in their current state or ease further, they will likely be another negative influence for the Yen. 

With little important data on the Japanese economic calendar for the coming week – only the August Trade Balance figures and the weekly domestic/foreign flow of stocks/bonds figures are of interest, and they haven’t generated truly significant price action – attention turns to the highly anticipated Federal Reserve September meeting this Wednesday. 

According to consensus estimates compiled by Bloomberg News, economists are calling for a $10B reduction in the pace of QE3, with the cuts coming to Treasuries purchases, from $45B to $35B. The pace of mortgage-backed securities (MBS) purchases will remain on hold at $40B. We see the risk of a cut of $15B in Treasury purchases, which might spark a US Dollar rebound (to the Yen’s detriment). But if the cut is only $10B, and Fed Chairman Bernanke uses the press conference to reestablish forward guidance – which has been weak considering US yields are hovering near two-year highs (pre-US losing its ‘AAA’ rating) – there is a chance for a Yen rally. 

The Fed is keenly aware of the risks of a 1994-esque bond market meltdown, caused by the successive, linear pace of Fed policy tightening. Accordingly, to avoid such sentiment from evolving, Chairman Bernanke and the Fed are likely to emphasize that the reduction in QE3 will be in sporadic increments, depending on incoming US economic data. The most recent NFPs, Advance Retail Sales, and Consumer Confidence reports suggest that only a minor reduction in QE3 is appropriate. 

Ultimately, the Yen is at risk for further weakness, but a more dovish Fed – to balance out markets’ hawkish interpretation given bond market dynamics across the global – leaves open the door for a mid- to –late-week rally in the Yen against the US Dollar should US yields take a step backwards this week. 

Forecast for Australian Dollar: Bullish

We’ve argued in favor of a significant Australian Dollar recovery since early August. We noted that an improvement in Chinese news-flow will probably help stabilize economic growth expectations for the East Asian giant. China is Australia’s largest trading partner and a critical source of demand for the country’s pivotal mining sector. That meant that stabilization in China was likely to translate into an improved the outlook for Australian exports and the business cycle overall. This in turn would prompt a supportive shift in RBA monetary policy expectations and lay the groundwork for an Aussie recovery. The case for an upside scenario seemed all the more compelling given a backdrop of highly over-extended speculative net-short positioning and we proceeded to enter long AUD/USD after an attractive technical setup presented itself. 

A cautious recovery now seems to be underway as expected. However, the week ahead will see the Aussie’s resilience severely tested as the currency takes on high-profile event risk on both the domestic and the global front. Minutes from September’s RBA policy meeting are first to cross the wires. That sit-down produced what the markets interpreted as a shift away from an overtly dovish posture to a neutral one, sending the Australian unit sharply higher and igniting pent-up bullish forces waiting for their cue to overtake momentum. With that in mind, traders will be keenly interested to parse the minutes for confirmation of the tone shift gleaned from the initial policy statement. It is rather rare for RBA meeting minutes to deviate materially from the Governor’s remarks released along with the rate decision. The potential for volatility remains however, and a stray comment that is perceived to amplify or undermine the latest improvement in the Aussie’s policy profile can send the currency higher or lower, respectively. 

Thereafter, macro-level forces come into focus as all eyes turn to the Federal Reserve as the policy-setting FOMC committee convenes for its monthly meeting. The outing is expected to produce the first “taper” of the QE3 stimulus program, with the baseline scenario calling for a $10-15 billion cutback in monthly asset purchases. The path forward beyond that remains highly uncertain however. That means the FOMC’s updated set of economic forecasts as well as Chairman Ben Bernanke’s press conference following the policy decision will be surrounded with plenty of speculation and offer ample fodder for volatility. If investors are met with Fed rhetoric that (directly or indirectly) argues in favor of a sustained QE reduction cycle into the end of the year, market-wide risk sentiment is likely to deteriorate and pull the Aussie Dollar downward. A more cautious approach that presents a Fed that still sees stimulus withdrawal as highly data-dependent and injects uncertainty into the near-term policy outlook stands to produce the opposite dynamic.

Source: Dailyfx

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GOLDMAN SACHS: Here Are The Best FX Opportunities Into Year-End

We expect the best FX opportunities into year-end in European currencies, including the Euro and Sterling. Growth surprises and revisions of consensus growth expectations are currently most supportive for these currencies. Given the ongoing healing after the Euro area crisis, more upside growth revisions are likely and will contribute further to already strong capital inflows. We also expect further depreciation of current account deficit currencies, in particular in EM. With European FX strength and depreciation pressures in EM deficit countries occurring at the same time, we continue to believe that the trade-weighted Dollar will remain range-bound. Our forecast revisions reflect these views, with a year-end target for EUR/$ of 1.38 and GBP/$ of 1.68; we had already revised lower a number of EM currencies forecasts during the summer months. In addition, we show notably more weakness in our TRY forecasts and in a number of LatAm current account deficit currencies, including the BRL, COP and CLP. Forecast revisions in EM countries with better external fundamentals have been minor (MXN, PLN).

Thomas Stolper, Robin Brooks, Themistoklis Fiotakis,  Fiona Lake, and George Cole - Goldman Sachs

Read More: http://www.efxnews.com/story/20714/here-are-best-fx-opportunities-year-end-goldman-sachs

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CA : Next Week's Market Mood: All Eyes On FOMC

At the end of last week, US data painted a rather unflattering picture of the US labour market. Not only was the non-farm payroll increase smaller than expected but the household survey indicated that the drop in the unemployment rate was entirely due to shrinking participation. That and other data suggest that, five years after the financial crisis accelerated, the global economy is still hindered by the cost of the poor use of capital in the 2000s. Nonetheless, markets remain fairly buoyant, and both equities and US/core Eurozone rates moved higher on the week. That suggests faith in an eventual recovery that is likely to continue to shape market perceptions as long as leading indicators remain robust.

The key event and debate next week surrounds the FOMC and the timing and size of the QE ‘taper’. We expect the Fed to announce a USD10bn reduction in monthly asset purchases, split equally between Treasuries and MBS. Such an outcome would not present a surprise to markets and that suggests, on the “sellthe-fact” principle, that both G7 interest rates and the USD exchange rate could retreat in its aftermath. Of course, that is merely a tactical effect but one to look out for nonetheless, after significant recent moves in the opposite direction. The other key central bank event is the first RBI meeting led by the new governor, which has the markets wondering whether measures distinct from higher rates will be adopted in defence of the INR.

The huge Verizon corporate bond sale (USD49bn) has attracted considerable attention in the busiest week ever for US corporates (over USD80bn of such supply according to Bloomberg). The depth of credit supply for the productive sector is reassuring (not least to the Fed, but such volumes also speak of the urgency with which borrowers wish to lock in rates before they rise a lot further. Our colleagues traveling far and wide report a degree of investor/borrower acceptance that this is the start of a proper bond bear market that was lacking a few months ago.

Political events also bear watching, with elections in Bavaria, this Sunday, offering a preview of important national German elections one week later. The Syria question, conversely, remains of limited economic impact and indeed it is worth remembering that the rise in oil prices arguably reflects as much increased economic activity as it does Middle East turmoil.

Read more: http://www.efxnews.com/story/20715/next-weeks-market-mood-all-eyes-fomc

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NORDEA: What's On The Cards For EUR/USD This Week?

We are all in. Broad signals of growth momentum from global PMIs – both manufacturing and services, also the euro area divergences receding. Thus, no surprise, even with US, UK 10Y government yields hitting 3% last week, stocks, commodity currencies,  EMs caught breath. We can afford to live with the 3% nominal rate in the 3% real growth world, can’t we? (yes, but [insert here]).

Figure 1. 10Y sovereign yields

If we can live with this sentiment for a while, the commodity currencies could bounce more here. This applies also for EMs (ZAR, RUB). Note also, the macro data surprise indexes for commodity currencies are on the low side, historically, while the short positions are on the high side, giving room for sharper reversals. Hope you joined in my recommendation to short EURAUD in July (still very much valid). No secret, I switched to AUDUSD in August, which now it faces a technical moment of truth – make it, or break it (Figure 2). (Also, the AUDJPY now at a key juncture). Starting with a small beat on exports today, there is plenty of data from China hitting wires this week (IP, capex, retail sales on Tuesday)… could do the trick.

Figure 2. AUDUSD

Taper the USD. Friday’s payrolls is a goldilocks – not good enough to suggest Fed are behind the curve, but not too bad either, thus keeps the baseline for Septaper open, but market expectations closer to a mini taper, ie 10-15bn per month. Unemployment rate at 7.3%, just 0.3% away from the 7%, where the QE should end, according to Bernanke (and that’s mid-2014 in their forecast), makes my old idea of a lower threshold (remember Kocherlakota suggested 5.5%) an increasingly attractive option. This would take the USD yields (in particular, FX-relevant short yields) down, and hurt the USD, giving more space to EMs and commodity FX. I suggest we all start anticipating this now, and make it happen! Two-bar-USD-reversal, that is (Figure 3).

Figure 3. USD index.

Look through the recent interest rate increase - outcome of the ECB meeting. The money market rates left stable - even a few basis points higher Euribor futures for the week. Note, the LTRO repayments have reaccelerated (EUR 10.6bn down over the past 2 weeks), thus little reason for interest rates to fall for now. As hoped for, the ECB did not change the CPI 2014 forecast, reiterated unchanged reaction function, which left the EUR relatively unscathed. A new paper from ECB on labor market last week concludes:  “We find a significant shift in the euro area Beveridge curve since the onset of the crisis, but considerable heterogeneity at country level.“ – a case for a less dovish ECB, and no unemployment rate thresholds.

This week’s data point is EMU industrial production (Thursday), the expectation bar is lower due to weaker German figures last week. But a mini “manufacturing renaissance” in Europe this year?  At least not worse than in the US (Figure 4). Still long EURUSD, hoping “bunga bunga”does not get too loud this week, and Draghi sounds like a broken record on Thursday.

Figure 4. Manufacturing – EMU vs US

Yep, can’t fight it, Carney. The BoE forward guidance is powerless in the face of manufacturing PMI at 57.2, and other figures which have gone vertical recently. Finally the EURGBP made it lower where I liked it, and a break of 0.8400 would open room for a freefall to the 0.8200-0.8250. I bet on it, but vs USD for now. This week’s highlight - the UK unemployment rate on Wednesday. Unchanged (7.8%) is a consensus, still some way to 7% target. It will take the whole 3 years to get there, according to BoE…meh. Pressure on the downside (Figure 5).

Figure 5. UK unemployment rate

 

JPY…a special case.  The USDJPY did make a break-out, to the upside last week, and now retesting (Figure 6). I still hold USDJPY short, as a hedge for now against worsening sentiment and a bet on a broad short term USD weakness. Note also, the EURJPY…still triangle…Nikkei…still triangle…and no reason for the US yields to rise more until FOMC meeting. And, pardon, but I refuse to see Olympics in 2020 in Japan as an explanation for JPY in the short term.

Figure 6. USDJPY

P.S. Overall, rather dull calendar this week. The only thing left is deriving the probabilities of tapering scenarios for September 18th. (Kill. Me. Now…)

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