Fed fails to taper despite improvement in the labour market

EUR:

The impact of the landslide victory of Angela Merkel in the German federal election on Sunday was rather limited at the beginning of the current week. EUR/USD hovers in a tight range around the 1.35 level after rallying strongly during the course of last week. Merkel's Christian Democratic Union (CDU) party won almost the absolute majority of the vote, while the Free Democrats (FDP) did not make it to the Bundestag, with less than five per cent of the votes. The Alternative für Deutschland (AFD) also stayed below the five per cent watermark, which is good news for the eurozone. The AFD is in favour of a breakup of the euro zone and a return to the deutschmark. Merkel's victory was a vote in favour of a united Europe and against regionalism, but the market was unimpressed, as the outcome was widely expected. The only surprise was the FDP disaster.

The single currency gained last week against the British pound after three consecutive weeks of losses. EUR/GBP trades were back above the widely watched 0.84 level, after trading as low as 0.8352 last week. Anticipation of a strong election result for Angela Merkel certainly helped.

USD:

Last week started with a disappointment for dollar bulls when it became known that Larry Summers had withdrawn his candidature for becoming the next president of the US central bank. Summers was the favourite candidate for succeeding chairman Bernanke when he stepped down. It is now widely believed that Janet Yellen will become the next president of the Fed.

The dollar then took another massive hit, when the US Federal Reserve failed to taper its quantitative easing measures in its meeting last week. Apparently recent improvements in the unemployment rate were not enough to convince Fed officials to start cutting back on their monetary stimulus.

Most traders were speculating that the Fed would kick off the gradual taper of its current monthly $85 billion bond-buying program, because it was believed that the latest improvements in unemployment data would be enough for the Fed to start cutting back on its quantitative easing measures. The current unemployment rate of 7.3 per cent in the US is above the official target of 7.0 per cent, and inflation did not pick up at all. Equities and US bonds rallied after the news; the CAC 40 did reach a new high for the year at 4227 before a consolidation started. The greenback was sold across the board, and EUR/USD rallied to levels not seen since February.

Many economists, though, argue that the extended period of ultra-easy monetary policy will sooner or later lead to economic imbalances, which might create another asset price bubble. With the S&P 500 at all-time highs, these critics seem to have a valid point. The focus of the market will be on the final read of the second quarter US GDP on Thursday. Economists expect another upward revision to 2.6 per cent after the unexpected revision to 2.5 per cent from 1.7 per cent in the previous month. Should GDP surpass expectations, traders will very likely start speculating on a tapering in the October Fed meeting.

AUD:

Supported by another week of strong economic data reports from China, the Australian dollar managed to close higher against the greenback for the third week in a row. China is Australia's biggest trading partner and an important source of demand for the Australian mining sector. Economic stabilisation in China translates into an improved outlook for the Australian economy and expectation for higher rates eventually. After a so-called 'higher low' was formed at the end of August, the Australian currency rallied more than 500 pips against the greenback and traded as high as 0.9535 before a technical consolidation started, as traders took some profits off the table. From a technical perspective, we expect another run towards last week's high. There is not much event risk ahead until the US non-farm payroll numbers, which are due in two weeks only.

Gold:

Gold was very volatile last week following the Fed decision not to touch the QE3 program. Traders were mostly anticipating a $5 to $10 billion cut in the monthly bond-buying program, but the Fed apparently wanted more evidence that the recovery in the labour market is back on track. Traders who were speculating on a continuation of the recent drop in the price of gold had to cover their positions - the shiny metal rallied almost $70 per ounce on Wednesday and ended a three-week losing streak. Most of Wednesday's gains were given back, though, and the metal only gained 0.52 per cent on a week-to-week basis.

Henry Philippson is a trader at RTFX Ltd.