What August G10 Price Action May Mean for September

FX trading was particularly difficult in the month of August. The most commonly traded currency pair the euro and the dollar were essentially unchanged on the month. The euro eked out a 0.27% gain or about 4/10 of a penny. The Swedish krona (+0.22%) and the Australian dollar (-0.07%) were for all practical purposes flat. The best performing G10 currency was the high yielding New Zealand dollar, which gained almost 2.9%. The low yielding Japanese yen was second, gaining 1.8% against the dollar. The Norwegian krone came in third with a 1.4% rise, encouraged by higher oil prices and ideas that the Norges Bank could be among the first central banks to hike rates. The Swiss franc, which the Swiss National Bank has been determined to prevent from rising appreciated 0.8% against the dollar and about 0.5% against the euro.

The weakest currency was the British pound, losing a little more than 3% of its value. Recall that the Bank of England surprised the market in early August by extending its quantitative easing strategy. As we noted yesterday, the BOE may be contemplating cutting the interest (0.5%) it pays on reserves held with them to make the QE strategy arguably more effective. The Canadian dollar fell 2%. This does not appear to reflect a shift in Canadian fundamentals but rather a bout of profit-taking after the Canadian dollar rallied more than 6.5% in July.

It is difficult try to extrapolate from one month's price action to the next. It seems reasonable to expect that at the end of Sept, the euro, Swedish krona and Aussie will not be essentially flat. Indeed the risk is of greater volatility. The 3-month implied euro volatility trended lower through August reaching 11.395% on August 27th, the lowest since the middle of last September. The low level of volatility in many of the European currency pairs suggest that hedging using options (buying a call or a put) may be a more attractive alternative than forwards. In the current environment, higher euro volatility is likely to coincide with a strong dollar. But given that US short-term interest rates fell against Europe/Germany, a necessary (even if not sufficient) dollar support is not yet in place.

Sterling's heaviness was fundamentally driven, but the Canadian dollar weakness is not so much. The Canadian dollar may recover. The yen's gains are precarious as the economy, outside of exports and industrial production to build those exports, remains in poor shape. However September marks the end of the fiscal half year and the normal repatriation may be augmented by Japan's equivalent of the US Homeland Investment Act, giving companies a tax incentive to repatriate capital.