FX Week 14 July 2013

FX Week

FX overreacts to Fed

FX markets were abruptly affected by the Fed’s June minutes released last week, as well as by comments from Fed Chairman Ben Bernanke, with the USD selling off sharply, taking EUR/USD from 1.28 to above 1.32 at one stage. However, we saw this reaction as exaggerated, as the central thrust of the Fed comments was largely similar to the Fed statement made in June (following the same FOMC meeting) in our view, as well as to Bernanke’s press conference at the same time. It was also largely consistent with the message from a number of Fed officials made over the last month aimed at calming the reaction in financial markets. In fact, the FX market reaction on Wednesday evening seemed incongruous to us as it was not mirrored in similar moves elsewhere.In fixed income markets for example, yields only fell back marginally compared to the overreaction in FX. It might be expected that bond yields would be more likely to be affected if a material change to Fed tapering policy had been announced, but this was not the case with the 10-year yield ending the week only 17bps below the July peak. With the USD also recovering its poise on Thursday and Friday, with EUR/USD falling back to 1.3050 from 1.32, it seems as if this has already started to be recognized, with the USD’s initial weakness more a reflection of thin liquidity than any substantial alteration of Fed tapering prospects
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