New US Risk Factors That Replace Debt and Politics

DailyFX

Talking Points:

  • 2 Big US Event Risks Now Resolved
  • The New Timetable for Fed Tapering
  • A Developing Problem Area for the US Economy?

It’s back to the basics for the foreign exchange market this week with the US government re-opened for business and slowly returning to “normal” conditions. In the short term, this means delayed economic reports will start to trickle in, but in the medium term, the bigger implication is a return to value for currencies.

Over the past few months, the two biggest risks for the FX market were 1) the US fiscal crisis, and 2) potential tapering of asset purchases by the Federal Reserve. Now that both of these risks have been pushed out to 2014, currency flows over the next 11 weeks will be driven by the individual performance of major economies and the direction of monetary policies.

In the US specifically, the focus will be on a number of delayed reports including tomorrow's non-farm payrolls (NFP) release. While economists are looking for stronger job growth, the steep slowdown in labor market conditions in the service sector suggests there's scope for a downside surprise. And, even if the data beats expectations, policymakers will most likely take the reports with a grain of salt.

Instead, the Fed has its eye on next month's releases, which will show how much the US government shutdown cost the economy in the month of October. We believe that a large part of these reports will be weak, keeping the US dollar (USD) under pressure throughout the fourth quarter.

The New Timetable for Fed Tapering

Chicago Fed President Charles Evans, who is a voting member of the Federal Open Market Committee (FOMC) this year, made it clear in his comments this morning that the central bank is watching incoming data, and unsurprisingly, he believes that it will take a few months to sort out the US labor market picture.

It will be difficult for the central bank to pull the trigger on tapering within the next few months because of the potential distortion in many upcoming economic releases. We won't get a true indication of how the US economy is really holding up until December, when the November reports are released, and in our opinion, that timing is too tight for the Fed to legitimately move forwards with tapering.

As this leaves the first move for the Fed in 2014, rates will remain suppressed for the rest of the year, making it difficult for the dollar to rally. So, while the greenback is trading higher against major currency counterparts this morning, the move is most likely nothing more than a quiet relief rally.

See also: The Case for a Dollar Relief Rally

A Developing Problem Area for the US Economy?

The greenback was hit hard last week, and on a percentage basis, today's rally is nominal in comparison. The move was supported by US existing home sales, which dropped only 1.9% in the month of September compared to a -3.3% forecast. However, there is more than meets the eye because sales in August were revised down to flat from a prior print of 1.7%. Taken together, the housing market could become a growing area of concern for the central bank.

By Kathy Lien of BK Asset Management

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