What’s driving FX – Interest rates or risk?

The November US retail sales report has really set the cat amongst the pigeons. For so long we have become accustomed to judging the move in the USD based on daily gyrations in risk aversion. Well, that may all be about to change. There was an inkling that all did not look right following the release of the November jobs report which unsurprisingly helped to boost risk appetite but surprisingly boosted the USD too.

It was easy to dismiss the USD reaction to year end position adjustment, markets getting caught short USDs etc. What’s more the shift in interest rate expectations following the jobs report in which markets began to price in an earlier rate hike in the US was quickly reversed in the wake of Fed Chairman Bernanke’s speech highlighting risks to the economy and reiterating the Fed’s “extended period” stance.

However, it all has happened again following the release of the November retail sales data, which if you missed it, came in stronger than expected alongside a similarly better than forecast reading for December Michigan confidence. The USD reaction was to register a broad based rally as markets once again moved to believe that the “extended period” may not be so extended after all.

Interest rates will become increasingly important in driving currencies over the course of the next few months but if anyone thinks that the Fed will shift its stance at this week’s FOMC meeting, they are likely to be off the mark. No doubt the Fed will note the recent improvement in economic data but this is highly unlikely to result in a change in the overall stance towards policy.

Further improvements in US data this week including industrial production, housing starts, Philly Fed and Empire manufacturing may lead markets to doubt this but the Fed calls the shots and a potentially dovish statement may act to restrain the USD this week. Also, it’s probably not a good idea to rule out the influence of risk appetite on currencies just yet and with a generally positive slate of data expected, firmer risk appetite will similarly act as a cap on the USD this week.

Other than the US events there is plenty of other potentially market moving data to digest this week. More central banks meet this week including the Riksbank, Norges Bank and Bank of Japan. No change is expected from all three but whilst the Riksbank is set to maintain a dovish stance the Norges Bank meeting is a closer call. So soon after the emergency BoJ meeting, a shift in policy appears unlikely but the pressure to increase Rinban (outright JGB buying) operations could throw up some surprises for markets.

Europe also has its fair share of releases this week including the two biggest data for markets out of the eurozone, namely, the German ZEW and IFO surveys as well as the flash December PMI readings. The biggest risk is for the ZEW survey which could suffer proportionately more in the wake of recent sovereign concerns in the Eurozone. Sovereign names may still lurk to protect the downside on EUR/USD and if the USD finds it tougher going as noted above, the EUR may be able to claw back some of its recent losses.


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