Currency Markets May Be About to Get Some Direction

Updated on
  • New Fed Chair’s testimony could show just how hawkish FOMC is
  • Traders to keep an eye over upcoming Italy election, SPD vote

HSBC's Bloom Says Fed Won't Respond to the Dollar

Major currencies were range bound in the second half of the week as neither the Federal Reserve minutes nor the European Central Bank account of their latest meetings provided markets with much direction. But traders may be about to get a clearer narrative.

The dollar found itself recently amid two opposing forces causing it to whipsaw: in the red corner, verbal intervention by the Trump administration and investor focus on the increase in the U.S. deficit. Opposite stood higher wages, a hawkish Fed and a stock sell-off amid higher yields.

New Fed Chairman Jerome Powell’s testimony before Congress on Tuesday, moved forward from Feb. 28 due to a scheduling issue, and the Senate Banking Committee on March 1 could see one side of the ring getting the upper hand.

Powell could offer a clear view on his assessment of the economy and explain how comfortable policy makers are with their baseline scenario of three hikes this year, or even signal faster tightening ahead. Traders will pay close attention to any remarks over elevated asset valuations and broader market imbalances.

Should he open the way for faster-than-anticipated hiking, investors could place more focus on higher rates rather than anything else. Given that the greenback and U.S. yields have regained their positive correlation after the stock rout earlier this month, the dollar could extend its rebound.

And it may do so convincingly against the euro. Common currency bulls have yet to meet a fresh catalyst that would support the notion of adding more longs in their portfolios while the next ECB meeting is two weeks away.

On top of that, traders increasingly feel the need to hedge against a euro-negative outcome from the Italian elections due March 4 and Germany’s SPD vote the same day. Risk reversals show demand for euro puts gets stronger as we head into the risk events, which has weighed in the cash market as well.

A word of caution from history though: In the week before the first round of the French elections in April 2017, the euro actually gained as some traders took profits on their shorts and natural hedging demand eased. Signs that political stability in the euro area won’t be challenged and/or ECB officials pointing to a language shift next month could see similar moves in euro-dollar.

What to Watch:

  • Nafta trade talks resume on Sunday, Feb. 25 in Mexico City with U.S., Mexican and Canadian negotiators
  • On Monday, German Chancellor Angela Merkel’s Christian Democratic Union holds convention to vote on the proposed coalition pact with the Social Democrats
    • ECB President Mario Draghi addresses the European Parliament in Brussels; Luis de Guindos, nominated to be the next ECB vice president, also to appear
  • Feb. 27 sees EU chief Brexit negotiator Michel Barnier briefing European affairs ministers meeting in Brussels, while he will also speak to permanent EU representatives the next day. They’re expected to adopt the withdrawal text, which will be published
  • On Friday, U.K. PM Theresa May is due to outline her Brexit strategy in a speech
  • Policy makers to speak include St. Louis Fed President James Bullard, Fed Governor Randal Quarles, Bank of England Deputy Governor Jon Cunliffe
  • Euro-area inflation estimate; U.K. manufacturing PMI; U.S. durable goods, GDP, PCE deflator; see data calendar
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