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Currency Traders Look Past U.S. Politics to Fed Meet for Outlook

Vassilis Karamanis
·2 min read

(Bloomberg) -- Currency traders searching for the next big narrative are looking past the turmoil in U.S. politics and focusing instead on what the Federal Reserve will do.

Bets on swings in the euro are at their highest for the three-week contract, which includes the Fed’s policy meeting on Jan. 27. By contrast, two-week options that capture a U.S. House impeachment vote, U.S. President-elect Joe Biden’s inauguration and then the next European Central Bank meeting are the lowest point in the market for volatility over the next year.

This shows that the recent debate over the tapering of the Fed’s massive stimulus via bond purchases has the potential to remain the key driver for the $6.6-trillion-a-day currency market, as the pandemic slowly takes a back seat.

Investors are likely to get more insight into the central bank’s consensus when Chair Jerome Powell will take part in a Princeton Economics webinar on Thursday. St. Louis Fed President James Bullard and Boston Fed chief Eric Rosengren said earlier this week that while the pandemic is still raging, the bond buying debate isn’t timely.

However, Fed Richmond Bank President Thomas Barkin and Fed Atlanta Bank President Raphael Bostic have sounded more hawkish given the potential for a strong U.S. economic recovery in the second half.

The importance of the direction in Treasuries for currencies is shown by the 90-day correlation between the Bloomberg Dollar Spot index and 10-year yields. In 2021, the two are following the same path. The correlation had declined last year to the lowest since 2013 as the greenback extended a steep decline after the Fed cut interest rates.

Whether a return to a textbook economic theory -- where currencies closely track interest-rate differentials -- is due this year remains to be seen, with the answer probably coming at the Fed’s January gathering.

NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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