By Jay Meisler
While a Fed interest rate liftoff seems a matter of when, not if this year judging by recent Fedspeak, it poses a dilemma for the forex market. What I mean by this is monetary policy divergence is seen as supportive for the dollar while the recent bout of risk-off led by weaker equities is making it difficult to see this play out as many had forecast.
This is especially true for both the EUR and JPY, two favored funding currencies for carry trades that have been highly correlated to equity moves. One reason is liquidation of long equity positions creates demand for these currencies as carry trades get unwound.
This has seen USDJPY give back all of its gains for the year (2014 close 119.73) and EURUSD briefly test 1.17 last week, not that far from its 2014 close (1.2098), before a quick retreat. This comes in a market where many analysts were calling for parity in the EURUSD, which is currently trading around the midpoint of its 2015 range.
So this is the picture as all markets look ahead to the September 17 FOMC decision and whether the Fed finally bites the bullet and raises rates or holds off until October or December given the current unsettled state of global markets. For forex traders, attention should remain on equity markets as long as there is a tight correlation between the dollar and stocks. When equity markets stabilize (or recover) and/or the correlation loosens, monetary policy divergence should take over and be supportive for the dollar.
Jay Meisler, founder