Word Play

The two key events last week were the release of the Federal Open Market Committee (FOMC) Minutes from the October meeting and a speech by European Central Bank (ECB) President, Mario Draghi. Trading during the first two days of the week was rather lackluster. That changed on Wednesday as the USD climbed against all the major currencies, as traders bid up the USD on hopes that the 2pm release of the FOMC Minutes would cement the view that the Fed was finally ready to pull the trigger on an interest rate hike at its December meeting. After the release the USD sold off as the Minutes failed to deliver the market’s conclusion. Art Cashin, UBS Director of Floor Operations, beautifully put the minutes into perspective. He outlined the word play in the key paragraph:

During their discussion of economic conditions and monetary policy, participants focused on a number of issues associated with the timing and pace of policy normalization. Some participants thought that the conditions for beginning the policy normalization process had already been met. Most participants anticipated that based on their assessment of the current economic situation and their outlook for economic activity, the labor market, and inflation. These conditions could well be met by the time of the next meeting. Nonetheless, they emphasized that the actual decision would depend on the implications for the medium-term economic outlook of the data received over the upcoming intermeeting period. Some others, however, judged it unlikely that the information available by the December meeting would warrant raising the target range for the federal funds rate at that meeting.

If we analyze the words in the paragraph we can draw a proper conclusion. We see that “some” (a minority not a majority) of the Fed members think the conditions are “already” strong enough to call for a rate hike. We also see the “some” members don’t feel that they will have enough data by the December meeting for a rate hike. Finally, and most importantly, we see that “most” (a majority) believe that conditions “could” improve enough by the next meeting to allow for a hike. Thus, it still looks like the Fed is data-dependent. Talk about markets hanging on every word.

The AUD was the best performer last week, putting in its largest five-day advance in six weeks as it broke out of its downward slump dating back to early October. There was no change on the domestic side of the equation for the Aussie, so the breakout was due the Fed Minutes as explained above. The AUD has declined about 11.5% YTD, so it’s only logical that on a week where the USD corrects that the AUD bounced back the most on short covering flows. The AUD extended its gains on the Friday after head of economic analysis for the Reserve Bank of Australia, Alexandra Heath, stated that the Australian economy was withstanding the slump in trade following the end of the mining boom.

The Swiss franc was the worst performer on the week, and the reason it was down was due to ECB President, Mario Draghi. In a speech in Frankfurt on Friday, Draghi said that ECB policymakers would, “do what we must to raise inflation as quickly as possible”. This was reminiscent of his other famous declaration during the Eurozone’s debt crisis in 2012 when he stated that he would do, “whatever it takes” to save the single currency. He went on to reiterate that he and the ECB Governing Council are fully ready to act on December 3rd to rapidly deploy a range of monetary policy measures designed to lift the inflation rate within the single currency region from the level of 0.1% recorded in October. So again, it was a play on words that single handily moved the euro once again. Ironically, back in 2012 his word play was the catalyst to arrest a fall in the euro while Friday’s words were used to derail the euro. Thus, with the Paris attacks and Draghi’s comments, more monetary stimulus is a certainty next month.

And this brings us to the reason why the CHF was the worst performer last week – when the ECB moves in early December it will kick off another round of central bank stimulus by those countries that would see their currencies move up from incoming flows from the Eurozone. Those countries would be Sweden, Denmark, and Switzerland. Incidentally, those three countries currently employ negative rates to deter euro flows. If you recall, Switzerland broke its three year euro peg in January just before the ECB started its QE program. Thus, the pressure will be on the Swiss National Bank to deter more euro flows due to the ECB’s next move.

With holidays in Japan and the U.S. in the week ahead, liquidity in the markets will be the less than ideal for trading activity. Having said that this, Fed policy speculation will likely continue to preoccupy traders. Preliminary PMIs in Europe, revised Q3 U.S. GDP figures, as well as improvements in measures of consumer confidence and durable goods orders are expected in the week ahead. All of this will likely offer additional fodder for December rate hike bets, amplifying the projected policy divergence between the Fed and its G10 counterparts.