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FX Technical Analysis (2016-10-24)

by James Chen

Fundamental Recap: After EUR and CAD Volatility, Markets Look to Fed and Election

Last week brought some pronounced movements in currencies after two major central bank events prompted traders to run for the exits when it came to the Euro and Canadian dollar. At the same time, the US dollar renewed its surge, which compounded the moves for both the EUR/USD and USD/CAD currency pairs. Looking forward, the key events on the immediate horizon that will be important for a broad range of markets, including currencies, commodities, and equities, will be the next Fed meeting on November 2 and the US presidential election on November 8.

Looking back at the EUR/USD breakdown last week, the European Central Bank (ECB) on Thursday kept its monetary policy and stimulus program unchanged, as widely expected. However, during the press conference that followed, ECB President Mario Draghi gave dovish indications when he left the door open for further stimulus measures possibly to be implemented at the next ECB meeting in December. As central bank watchers were looking for any hint that the ECB might begin to taper its extensive quantitative easing (QE) program, as has been previously alluded to by Draghi, they were severely disappointed. It appears that the ECB’s vast asset-buying program may likely increase instead of decrease. Draghi also reiterated that the central bank would not abruptly end its QE program without tapering first. These rather dovish indications by the ECB helped prompt a sharp drop for the euro against the already-strengthening US dollar, leading to a EUR/USD breakdown below the key 1.0950 support area, and now targeting the 1.0800 support level to the downside.

As for USD/CAD, Wednesday’s Bank of Canada (BOC) meeting also ended up leaving monetary policy unchanged, as expected. At the same time, however, the BOC also downgraded its outlook for economic growth, and BoC Governor Stephen Poloz commented that there were discussions among members of possibly increasing stimulus measures. These clearly dovish signs were exacerbated by lower-than-expected economic data readings from Canada on Friday, including core retail sales coming out at 0.0% vs +0.4% expected, and retail sales at -0.1% vs +0.5% expected. Also, the consumer price index, a key measure of inflation, came in lower at 0.1% vs 0.2% expected. These data points prompted a further drop for the Canadian dollar against the strong US dollar, leading to an extended three-day surge for USD/CAD towards the 1.3400 resistance level.

Looking forward to this week, it will be a relatively light week in terms of major economic data points, although there are several Fed speakers scheduled to speak in the beginning of the week, as well as Governors from both the Bank of Canada and Bank of England slated to testify before their respective governments. Also, the ECB’s Draghi will be speaking early in the week. Beyond this week, but still on the immediate horizon, are the two major events that the markets will be focused on in the near-term – the next Fed meeting and the US presidential election, both only a couple of short weeks from now in early November.

As for the Fed, the likelihood that it announces a long-anticipated rate hike in November is still very low only because the election, a potentially significant risk event, follows just six days later. However, as the “safer” candidate in Hillary Clinton continues to widen her lead over the more market-moving Donald Trump, the risk imposed by the election could continue to diminish. This possibly leaves the door open, however narrowly, for the Fed to make a move in November. A December rate hike, though, is broadly acknowledged as much more likely to occur than one in November. In any event, anticipation of a Fed rate hike by the end of the year continues to remain strong, which has boosted and may continue to boost the US dollar significantly while keeping gold prices capped.

Finally, although the election appears more and more likely to swing further towards Clinton, particularly after Trump’s widely-panned performance and remarks at the final presidential debate on Wednesday, there still may be some time for Trump to win back support and/or for Clinton to lose support. While this may indeed be a possibility, market volatility due to the prospects of an unpredictable Trump presidency has decreased markedly in the past few days and weeks. Financial markets have begun to shrug off the risk imposed by the election due to Clinton's increasing lead. Equity market volatility has remained low and flat in the aftermath of the last debate, while the US dollar has continued to rally and safe-haven gold prices remain depressed for the time being. The Mexican peso, which has been projected to benefit significantly if Trump fails to win the White House, surged to a new one-month high against the US dollar on the heels of the debate, and could continue to recover in the event of a Clinton victory.

Overall, if the US presidential pendulum continues to swing towards Clinton, the election could increasingly become a business-as-usual, non-event. In this case, equity markets and the US dollar are likely to remain supported as gold continues to lag in anticipation of the next major risk event in the December Fed meeting.

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