FX: Brace For More Volatility

This week should be a wake-up call for all investors. The market disruption caused by retail traders swapping ideas over Reddit and squeezing out major hedge funds is unprecedented but corrections after record highs in stocks are not. For the past year, equities barreled to new milestones on a monthly basis and as this trend continued, the risk of a correction grew. However, the vaccine kept investors and central bankers confident that a strong recovery is ahead. But when rallies are as extended as the ones we’ve seen last year in stocks, it rarely takes much to spook investors into taking profits. The sharp sell-off this week was triggered by the GameStop frenzy and now that market participants no longer see a one-way rally, FX traders should brace for more volatility.

For what it is worth, despite the pullback in stocks, currencies held up fairly well. The losses in EUR/USD and GBP/USD were limited and USD/JPY rose to its strongest level in 2 months. Typically, the Japanese Yen is driven higher in market corrections but the unwinding of short dollar bets was the leading driver of currency flows. US data hasn’t been terrible and Fed Chairman Powell confirmed that it's “too early to focus on tapering dates.” Friday’s personal income, personal spending, and Chicago PMI numbers surprised to the upside. The University of Michigan Index declined but the drop was modest. Next week, the US releases non-farm payrolls, manufacturing and service sector ISM numbers – these are all market-moving releases but as we’ve seen in recent weeks they could be overlooked quickly. Currencies should continue to trade on risk flows which is positive for the dollar.

Better than expected Canadian GDP numbers helped stem the slide in USD/CAD. The Canadian economy grew 0.7% in the month of November with prices rising 1.5%. Canada releases its latest employment and IVEY PMI numbers on Friday – these key releases could determine the near term trend for the loonie. Meanwhile, it is not often that we see divergences in the Australian and New Zealand dollars but on Friday, AUD sold off while NZD rallied. Improved data were reported by both countries with New Zealand seeing increased consumer confidence and Australia seeing higher price pressures. It’s a busy week ahead for Australia with a Reserve Bank meeting, retail sales, and PMI reports scheduled for release.

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