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Forex Reacts to Central Banks, NFPs

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September 8, 2013 By: , No Comments

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Forex Markets experienced an injection of volatility this week, as a series of critical market event was enough to force that majority of the market to commit to one position or another.  From a macro perspective, traders had to contend with five different central bank meetings, each with a different set of expectations from the forex community.  First, and perhaps most important was the interest rate decision from the Reserve Bank of Australia, which jarred the consensus as it said almost nothing about additional cuts in interest rates before the end of this year.  Given the current economic climate in Australia (lower mining investment, weak demand for industrial metals, softening export prospects to China, and major declines in Retail Sales), this move was relatively surprising.

The RBA is instead focusing on the positives (an improving GDP number) and this give finance officials enough breathing room to allow the country to grow at a more natural rate.  This was a major positive for the currency, given the fact that it has already lost its position as the highest yielding currency amongst the developed nations.  For carry traders, this is a big sign of encouragement, as it essentially suggests that the RBA is content with leaving rates where they are (which does happen to be a record low).  Against most of its counterparts, this means that the Aussie will maintain its relative yield advantage, and this adds to the benefits of holding long positions.  When we add to this the fact that Australia also posted a better than expected GDP number this week (rising by 2.6% where market analysts were expecting a rise of 2.4%), and we can see that the fundamental backdrop is improving after big declines seen earlier in the year.

Central Banks, Non Farm Payrolls

In other areas of the world, we had central bank meetings from the Bank of Japan and the European Central Bank.  At this stage, what is most important for Japan and the Yen is the extent to which the central bank is willing to ease policy, with the expressed intent of weaking the currency.  This is done to promote the growth prospects of the country’s export companies, and is likely to continue well into next year.  This is largely because price inflation in Japan has had an extremely difficult time reaching normalized levels when compared to the rest of the world, so it is now up to the Bank of Japan to commit to more stringent policy measures and try to get the country back on an economic track that is more in line with developed nations.

On the whole, this suggests prolonged weakness in the Yen, and suggests that carry trade strategies are likely to benefit for most of next year.  With the policy outlook in Australia looking increasingly bullish, high yielding positions like longs in the AUD/JPY are very favorable at current levels.

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