FX Week Ahead: EUR Unlikely To Break Summer Range

Developed currency markets will remain nervous this week ahead of the Friday 31 August Fed policy symposium in Jackson Hole, Wyoming. While the Fed has indicated it is prepared to further ease policy if a “substantial and sustainable strengthening in the pace of the economic recovery” fails to emerge, we think the odds are only 50/50 in terms of a QE3 announcement. Given elevated market expectations of a Fed move, last week’s EUR/USD grind higher now looks vulnerable to a correction lower this week. Adding to EUR vulnerability, uncertainty surrounding Thursday’s Italian bond auction could unsettle EUR bulls – particularly if the new 10Y bond fails to meet expectations. We therefore look for EUR/USD to continue to respect its summer trading range, sliding back towards 1.2450 this week.
XAU rise warns of growing investor concern. The latest move higher in XAU is also likely to garner greater investor attention this week. While central bank gold purchases (projected to exceed 500 tonnes this year) appeared to slip from investor radar screens in recent months, revived expectations for further Fed QE and the potential for the ECB to follow (not forgetting the additional monetary stimulus recently delivered by the BoJ and BoE) have refocused investor attention. Indeed, the SNB’s printing of more than USD60bn of new CHF in June to defend its EUR/CHF 1.20 currency floor warns central bank diversification demand is likely to grow stronger during H212. Indeed, as more private investors ask why central banks are seeking to diversify their fiat currency holdings and follow suit, renewed demand could see the XAU push through USD1,700 as early as this week. Perhaps more importantly, this deterioration in investor sentiment could see XAU move higher this week independently of the Fed policy outcome.
AUD pressure to contrast against CAD support. This week will see growing interest in macro themes as investors seek to avoid second-guessing policymakers. Such investor interest should translate into greater trading activity in peripheral currency crosses – particularly those more exposed to divergent growth themes. Given last week’s continued stream of softer Chinese data, divergent growth expectations relative to the US argue we maintain our short AUD/CAD recommendation. Indeed, notwithstanding economist expectations for a Chinese growth improvement in Q4, recent price declines in steel and iron ore warn markets are moving to price in a potentially sharper Chinese slowdown. We see a growing risk AUD/CAD breaks below its 1.0280 May low this week