Political Risk, Hawkish Yellen Drove Forex Volatility Last Week

Politics were at the forefront at the start of the week as investors reacted to surprise events in German and New Zealand.

The Euro was under pressure against the U.S. Dollar when the Forex markets opened on Monday as investors reacted to the German election last week-end in which far-right Alternative for Germany won seats in parliament for the first time, leading to worries that anti-European political movements on the continent, including those in Spain and Italy, could be more worrisome than initially thought.

The EUR/USD finished the week at 1.1814, down 0.0133 or -1.11%.

The outcome of the election surprised many traders because it likely means a more fragmented German parliament. It ultimately means German Chancellor Angela Merkel is going to have to work hard to form a coalition. Dealing with Germany’s first four-party government in decades is not expected to be an easy task.

The weakness in the Euro last week was predictable. When faced with uncertainty, investors tend to pare positions in the currency and move funds into credit markets. However, after the initial reaction and as conditions began to settle, investors began to realize that the European Central Bank (ECB) is still the ultimate underlying factor for the currency. Since the ECB is the powerful force in the European debt markets, the sell-off was orderly.

New Zealand Dollar

The New Zealand Dollar also slid against the U.S. Dollar at the start of the week after elections in the country set the stage for a period of political uncertainty.

The NZD/USD settled the week at .7194, down 0.0134%

The Kiwi was pressured by the results of New Zealand’s general election on September 24 which failed to deliver a clear result. According to protocol, party leaders now have to forge alliances to achieve a ruling coalition, which could result in either another term for the current center-right government, or a win for the center-left Labour Party.

U.S. Dollar

All major currencies were also pressured by hawkish remarks by Fed Chair Janet Yellen especially the Australian Dollar and Japanese Yen. Yellen’s strikingly hawkish tone on interest rates drove the U.S. Dollar Index to a five-week high.

The AUD/USD settled the week at .7830, down 0.0129 or -1.63% and the USD/JPY finished the week at 112.456, up 0.476 or +0.43%.

Yellen sparked a spike higher in the dollar after she said the Fed needs to continue gradual rate hikes despite broad uncertainty about the path of inflation. She also acknowledged the Fed’s struggles to forecast one of its key policy objectives – 2 percent inflation.

The chances of a rate hike in December rose to 76 percent from just about 38 percent a month ago, according to CME Group’s FedWatch tool, after Yellen’s comments. The indicator settled at 71 percent at the end of the week.