• Markets tend to overreact, the dollar gives back
  • ECB announcement on Thursday
  • More central bank meetings this week, more volatility expected

Financial markets tend to initially overreact to unexpected data or surprising news, and then common sense prevails to appropriately adjust bond and stock prices and currency rates.  Last week’s surprising announcement by the Swiss National Bank (SNB) to abandon its currency floor with the euro rattled the financial markets and pushed many bond yields into a negative territory. It also rallied the dollar to multi-year highs against major currencies, mostly driven by investors who were seeking a safe-haven place to park their money.

This week opened with the dollar giving back some of the gains from the previous week as the post-SNB announcement panic diminished somewhat.  The dollar is trading at an 11-year high against the euro and near 2-year high against the pound.  The Swiss franc dropped by 15 percent on Thursday and remains close to a 3-year low against the dollar.

That said, the dollar is in a good position to rally again this week when the European Central Bank (ECB) announces a much anticipated bond purchasing program on Thursday.  Most analysts believe the SNB abandoned its euro-franc floor last week to cut its losses in anticipation of the ECB launching the aggressive program to further weaken the euro, which they hope will combat deflation and inject more credit into the financial system.  A weaker euro would have put more pressure on the SNB and force it to buy more euros to maintain the euro-franc floor at 1.2000.

Leading up to the ECB announcement this week, more questions and uncertainty will preoccupy the foreign exchange market.  What if the ECB’s program is too small?  What if the ECB offers no details?   The uncertainty will support two remaining safe haven currencies, the dollar and the yen, this week.

Stay tuned.  The week promises to be another volatile one.

EUR-USD has stabilized overnight in the Asian market and climbed marginally higher.  The currency pair is trading below a newly established resistance level of 1.1640 and poised to go lower this week ahead of the ECB monetary policy meeting on Thursday.  The January EU Economic Sentiment report will be released today.

GBP-USD has traded within a well-formed range of 1.5060 to 1.5223 so far this year.  However, this could change on Wednesday when the Bank of England (BOE) releases its policy meeting minutes from two weeks ago and also makes this month’s interest rate decision.  The BOE is expected to keep the short term interest rate unchanged in response to a sharp drop in consumer prices in December.  And if the minutes show a rising concern over the continued falling prices in the coming months then the pound could weaken particularly against the dollar.

USD-JPY is trading below 118.00, and the yen continues to gain support as a safe-haven currency.  The Bank of Japan will announce its monetary policy decision tomorrow.  Analysts are expecting the bank to continue to buy Japanese government bonds in hope of fending off falling prices.  The USD-JPY is forecast to go higher after the ECB announcement this week as the uncertainty fades.

USD-CAD failed to break above the 1.20 resistance level last week and returned to consolidation near a 1.19 support level.  Lower oil prices continue to blight the Canadian export efforts.  Therefore the Bank of Canada is expected to leave its policy rate at 1 percent on Wednesday.

AUD-USD extended its rally and made a fresh 3-day peak at 0.8237 last week.  The rally started after the release of an employment report which showed 37,400 new jobs were created and the unemployment rate tumbled to 6.1 percent in December.  There is no major market event expected this week.

Have a great week.