DailyFX
Forex: Dollar Gaps Lower, S&P 500 Higher on Fresh FOMC News
John Kicklighter

Talking Points:

  • Dollar Gaps Lower, S&P 500 Higher on Fresh FOMC News

  • British Pound Looks for Inflation Data to Thwart BoE’s Low Rate Promise

  • Gold Eyeing $1,300 Despite the Dollar’s Recent Troubles

Dollar Gaps Lower, S&P 500 Higher on Fresh FOMC News

Is the September Taper off? Forex and capital markets traders alike were caught off guard with a sizable gap on Monday’s open on news relating to the outlook for US monetary policy. However, the headline this time was not directly linked to ‘on / off’ speculation surrounding the probability of a moderated stimulus program come Wednesday’s FOMC meeting. Rather, this sharp and all-encompassing move was derived from speculation on the direction and pace of the central bank’s program well after the first the Taper is on the books. Over the weekend, Lawrence Summers – the frontrunner to replace Fed Chairman Ben Bernanke when he is expected to retire when his term ends in January – announced he was bowing out of the race. That was read by the market as a ‘risk on’ development with the dollar dropping to three-month lows while the S&P 500 advanced to an intraday record high. Yet, the fundamental connection between this headline and the market’s reaction is weak; and this event may have exploited heavy speculation to further exacerbate a market imbalance before serious event risk.

Between Lawrence Summers and Fed Vice Chairman Janet Yellen, the former is considered to be more ‘hawkish’ in his views of exceptional monetary policy. Therefore, his bowing out of the contest leaves a relatively more dovish candidate to take the helm at the central bank. However, how much slack does Yellen’s nomination buy a market deeply entrenched in ‘moral hazard’? By some accounts, the FOMC member could reduce the targeted ‘full employment’ level to 5.5 percent (from 6.5 percent) and subsequently push the first Fed rate hike out to 2016. While that would certainly validate a drop from the greenback and record highs on equities, it is an ambitious leap – especially when the market is currently awaiting the Taper. The 52-pip gap down on the Dow Jones FXCM Dollar Index (ticker = USDollar) – the biggest on record – may better reflect the unpredictable and explosive nature of the markets in the lead up to Wednesday’s major event risk. That said, Monday’s equity and dollar move only further leverages risk positioning before a turbulent event.

British Pound Looks for Inflation Data to Thwart BoE’s Low Rate Promise

In the past four months, the benchmark UK 10-year government bond (Gilt) yield has surged nearly 50 percent to top 3.00 percent. Over that same period, the sterling has advanced against all of its major counterparts with particularly strong showings against the ‘high-yield’ majors. This performance has a lot to do with the interest rate outlook that has developed for the country since Mark Carney took over as Governor. In this currency and yield rally, the market has projected a competitive monetary policy regime that would see higher yield for the United Kingdom than its global counterparts can manage. And yet, those same assumptions confound the projections Carney made in his forward guidance to keep rates at their currently level until 2016. A market playing out its doubts is not unusual, but defying policy can only last so long. A key update to how bold the yield forecasts will be comes in the form of the August inflation data. The year-over-year CPI reading is expected to ease slightly to 2.7 percent. This series hasn’t dropped below 2.0 percent since November 2009.

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