With the economic calendar devoid of major US data until later this week, a potential military strike on Syria, Chinese economic data, and prospects for Fed tapering are the week’s three biggest FX event risks.
Syria will continue to dominate the headlines this week, and currency flows will be affected as the US Senate prepares to vote on a limited military strike. President Barack Obama will be struggling to win Congressional support for intervention in Syria, and at this moment, it's a very tough call because the majority of the Senate and House are still undecided. Democrats have control of the Senate, and if they reject the move, it would be a major loss for the President.
For the financial markets, a strike on Syria would do more harm than good. If the Senate approves military action this week, we can expect an increase in volatility that could lift oil prices, drag stocks lower, pressure high-beta currencies, and spark a safe-haven bid for the US dollar (USD). However, if the Senate rejects the action, we could see a relief rally in stocks and a continued selloff in the dollar.
When military operations began in Libya on March 19, 2011, oil prices began a move from $100 to $113 a barrel. The US dollar also rose in reaction to the strike, but the gains in the greenback were short-lived, and we expect a similar knee-jerk reaction in currencies in the event of military intervention in Syria.
Chinese Economic Data
A light economic calendar in the US at the front of the week puts the focus squarely on Chinese data. Continued signs of stabilization have offset some anxiety in the FX market.
Last night, China reported its highest trade surplus this year, and there's a reasonable chance that the industrial production and retail sales figures due later this week will also surprise to the upside.
Over the past month, manufacturing activity has improved around the world, and China is benefitting from the uptick in demand. If the data continues to be strong, it could provide underlying support for global equities and commodity currencies.
Any Fallout for Fed Tapering
Reduced expectations for tapering by the Federal Reserve could also lead to the adjustments of long dollar positions. While we believe that the central bank could take advantage of the decline in yields and make a symbolic change in asset purchases, the outcome of the decision should be negative for the dollar and positive for bonds.
Friday's non-farm payrolls (NFP) report puts the odds of Fed tapering in September versus December at 50/50, but even if monetary policy is changed this month, the move would be downplayed by a dovish Federal Open Market Committee (FOMC) statement.
See also: Why the Time to Taper Is Still Right Now
This week's retail sales report is not expected to provide much help to the greenback, either. Even though consumer spending should have increased in the month of August, the momentum in spending is likely to be weak.
By Kathy Lien of BK Asset Management