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US rate hike expectations would subside on continued market turmoil - BTMU

FXStreet (Łódź) - Derek Halpenny, European Head of Currency Strategy at the Bank of Tokyo Mitsubishi UFJ comments on yesterday's violent swing in stocks, suggesting that if the volatility lingers it might push back Fed rate hike expectations.

Key Quotes

"The US equity market ‘crash’ on the open yesterday when the Dow Jones fell 368 points in a matter of minutes has highlighted the changing financial market conditions as the Federal Reserve moves to end its third quantitative easing program. This time was supposed to be different due to the gradual, far more cautious approach in ending the program relative to QE1 and QE2."

"But the scale of the drop in 10-year yields from 2.19% to 1.86% suggests a market detached from fundamentals and driven by position adjustment. In that sense the depreciation of the dollar is understandable."

"The DXY index fell 0.8% but was a lot lower at one stage – EUR/USD jumped 2.1% on an intra-day low-to-high basis. The most common question we had yesterday was – has the dollar lost its safe-haven status?"

"One would have thought investors would have rushed for the dollar on a day of such turmoil. It certainly looks like the dollar has lost some of its safe-haven appeal but we believe it would be premature to reach that conclusion just yet."

"The momentum trade since July has been very much to buy the dollar – the DXY index is up nearly 9% over that period and the price action yesterday reflected the reversal of the most popular trades, long USD/JPY, short EUR/USD and AUD/USD. If this episode of extreme risk aversion was to persist we would be very sceptical of the ability of the euro and Australian dollar to continue advancing."

"The only major pair that behaved like you would expect was USD/JPY but the price action there was also consistent with the reversal of the momentum trade. Still, while the dollar got sold heavily yesterday we would argue that the US remains in the best position to ride out any financial market turmoil."

"While a more prolonged period of market turmoil will push rate expectations in the US further out, the same would have to be said about everywhere – in a sense while the outlook may be changing in terms of monetary policy, the relative outlook will not change dramatically. Indeed, the euro-zone is probably in the worst position."

"QE remains extremely difficult politically for the ECB to implement but we may now be witnessing the start of an ‘external shock’ that pushes the euro-zone into deflation. Currency devaluation is helping to at least partially reduce those deflation risks."

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