Monetary Policy Expectations Are Driving Foreign Exchange

Monetary policy is said to have lost its impact on the foreign exchange market, as investors scratch their heads at the resilience of currencies with negative interest rates. Yet the price action in the action cannot be understood without recognizing the ongoing importance of monetary policy expectations.  

Two members of the UK MPC seemed to distance themselves from the dovishness of recent comments from Governor Carney and the minutes from the BOE meeting this week. They want more hard data post-Brexit. Sterling rallied a little more than two cents before the weaker than expected retail sales, whose survey period extended until July 2, saw it drop nearly three-quarters of a cent, leaving it little changed from yesterday’s NY close.  

For the record, June UK retail sales fell 0.9%, which is half again as large of a decline as the median forecast (-0.6%). Food sales were off 1.2%, and non-food purchases fell 0.8%. The weaker consumer confidence surveys warn of downside risks going forward. We suspect that on balance the majority of the MPC will be inclined to ease policy next month, recognizing that monetary policy acts with a lag, even though the mark down of sterling may boost exports and spur some import substitution by domestic producers.  

Initially, the focus in Japan was on fiscal policy. We had been highlighting the reports that suggested a large package (~JPY20 trillion) was under consideration, but in recent days, the media has been emphasizing a smaller package (~JPY10 trillion). However, today the talk is back at the larger figure, and this helped the dollar push through the JPY106.85 resistance we identified to reach almost JPY107.50.   

However, the dollar reversed lower, falling through yesterday’s lows seen near JPY105.85 (setting up a possible key reversal) in response to BOJ Governor Kuroda rejection of helicopter money.  The market may have exaggerated the significance of Kuroda’s remarks, but it shows the nervousness of the market going into next week’s BOJ meeting after the dollar has rallied 7% against the yen since the US employment data on July 8.  Our first target is near JPY104.65, and then possibly JPY103.75.