Risk Aversion Dominated after China Rate Hike, Dollar and Yen Soared

By: Milla Shaw in Forex Consultant on Oct. 18, 2010

Risk assets tumbled sharply today, triggered by unexpected rate hike from China. DOW was down 165pts to close below 11000, Crude oil broke 80 psychological level while Gold breached 1330. Dollar and yen were both pushed up sharply against other major currencies. Dollar index broke 77.93 near term resistance while confirmed short term bottoming. Among the major currencies, Australian dollar was hardest hit on concern of slowing export to its major trading partner China. Canadian dollar was also noticeably weaker than others after BoC left rates unchanged and revised down growth forecasts.

To cool inflation, China unexpectedly hiked rates for the first time since 2007. One year deposit rate was hiked from 2.25% to 2.5% while lending rate was hiked from 5.31% to 5.56%. To prevent inflow of speculative money, it’s believed that China would tighten up capital controls further. The rate hike would probably eased some pressure on yuan appreciate as it will take part of the job to cool inflation. Though, it’s believed that China would continue to use both means. China will release CPI on Thursday and markets expect CPI to climb further to 3.6% in September, highest pace in almost two years.

BoC kept the overnight rate unchanged at 1% and revised lower growth forecasts for 2010 and 2011, saying ‘the output gap is slightly larger and that the economy will return to full capacity by the end of 2012 rather than the beginning of that year’. Policymakers said that a weaker US outlook, moderate growth in emerging economies and slowdown in domestic economic outlook suggest further reduction in monetary policy stimulus would need to be ‘carefully considered’. Canadian dollar tumbled after the announcement as the statement was more dovish than previously expected. More in BOC Leaves Interest Rates Unchanged, Revised Down Economic Forecasts.

BoE Governor King said in a speech today that some gauges of inflation in UK are “extremely subdued”. King emphasized that “continuing high level of inflation poses the risk that inflation expectations may move up” but slack in the economy will push price-growth below the bank’s target is “at least as large.” UK will be in the spotlight in the next 24 hours as finance minister George Osborne will announce the Comprehensive Spending Review, which would set up the details of the austerity plan progress. In addition, BoE will release minutes of October meeting, which would reveal hints on the timing and scale of the next QE program.

According to the RBA minutes, the decision to leave the cash rate unchanged at 4. 5% was ‘finely balanced’. The central bank considered raising interest rates at the October meeting but global economic uncertainty and rising Australian dollar have eased inflationary pressures. While policymakers concluded that it would be appropriate to hold the cash rate steady for now, they acknowledged it could not wait indefinitely to see whether risks materialized. The RBA pledged to act with flexibility, pending evaluation of further information at the next meeting. More in RBA On Hold, Strength In Aussie Eased Needs For Tightening.

Dollar index’s break of 77.93 resistance today confirms that a short term bottom is at least formed at 76.15 on bullish convergence condition in 4 hours MACD. Bias will now remain on the upside as long as 76.92 minor support holds and we’d expect further rebound towards 38.2% retracement of 83.56 to 76.15 at 78.98 next and possibly further towards 80 level.

In the bigger picture. It’s a bit early to conclude that dollar’s down trend has reversed. But after all, dollar did manage to draw strong support from the long term rising trend line from 2008 low of 70.70. This kept dollar index inside a multi-year sideway triangle pattern. 80 psychological level will be a key level to focus on and sustained break there will indicate that whole fall from 88.0 has finished and we’d then see further rally towards upper end of the triangle.

CAD/JPY’s fall continues further as expected and affirm our view that whole decline from 94.46 is resuming. We’d expect 78.41/52 support zone to be taken out in near term and that will also confirm that medium term rebound from 2009 low of 68.38 is completed at 94.46. IN that case, we’d expect further fall towards 68.38 low next.

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