One of the most interesting features of the previous week in foreign exchange was how the rebound in the price of oil provided fuel for a comeback by the beaten-down commodity and emerging market currencies. The Russian Rouble led the rebound, followed by the South African Rand, the Canadian Dollar, the Australian Dollar and the Norwegian Krona. The recovery in oil prices also helped risk assets recover as stocks managed to reduce their losses year-to-date.
The oil price recovery was a result of statements and reports that raised the possibility of an agreement for production cuts between OPEC and lead oil producer Russia. It has been speculated that it would be difficult to reach such an agreement, but the big producers know that unless someone scales back production, the price of oil could head further down below $30. There were cautionary statements out of Moscow on the prospects of such a deal, which limited the enthusiasm of the market to drive oil even higher. Without such a deal, oil could head back down again, but at least the fact that key producers are thinking and discussing production cuts is a positive for oil. Oil has become perhaps the most important determinant of risk appetite for now, as fresh drops in Chinese stocks this week did not spook international markets too much – as long as the yuan holds stable versus the dollar.
The Bank of Japan also helped boost risk assets after it decided to try negative interest rates for the first time in its history. The Bank decided against expanding its already massive quantitative easing program and instead to experiment with negative interest rates. Other countries and central banks that have tried negative interest rates have been mainly in Europe such as the Eurozone (European Central Bank), Switzerland, Sweden and Denmark. Negative interest rates have not had much success in boosting inflation as there are ways in which holders of cash can protect themselves from the negative rates without taking on risk as monetary authorities intend. The move is perhaps a signal about the determination of a central bank to do more in providing stimulus and keeping policy loose. Although the long-term effectiveness of the BoJ’s move is doubtful, it did achieve a quick climb of dollar / yen north of 121; giving up not only all the yen’s gains so far this year (the yen was the best performing major) but also leading to a small loss overall. A strong yen could make it more difficult for the BoJ to achieve its inflation target but it should be noted that the yen has already depreciated a lot since the September 2012 dollar/yen low of 77.
Finally, the Federal Reserve didn’t make things easier for dollar bulls. The Fed made some dovish revisions to its statement as it reflected some weaker-than-expected economic developments as well as stating that financial developments were being watched. The markets quickly jumped to the conclusion that only 1 interest rate hike would probably take place this year. While it is much too early to say this, the probability of a rate hike in March that would put the Fed on a schedule of one rise every other meeting (in order to achieve the four hikes this year), is looking doubtful. The window for a rate hike next meeting was intentionally left open, but that decision will be a close call. If the Fed is again reluctant to pull the trigger, the market may start speculating that rates will not go up at all this year. And this is going to hurt the chances of the dollar rally continuing. Next week’s employment report will be very key in this respect since the labor market and the consumer are the two main bastions of American economic strength. If they start to look shaky, the argument about whether to hike or not in March could be decided early.
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