The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The Forex Trading Week Ahead
08/09/2010 11:15 am EST
Interest Rate Spreads May Have Stopped Undermining USD
The greenback lost further ground this past week as data continued to portray a stalling US recovery and speculation mounted that the Fed would announce additional easing on Tuesday. In addition to weak data, one of the main drivers of USD weakness since the beginning of June has been a widening in interest rate spreads against the USD relative to other major currencies, especially in EUR/USD. EUR rates increased as markets priced in the withdrawal of ECB long-term lending facilities and convulsed through the European sovereign debt crisis. US short-term rates also moved modestly lower as incoming data painted a weak outlook. Those spreads have stopped widening (from about -2 bps at the end of May to a peak at -50 bps at the end of July; last at -44.5 bps) and there is reason to believe they may begin to narrow in the weeks ahead, potentially signaling a medium-term top for EUR/USD. With the worst of the euro zone sovereign debt concerns likely past, there is room for EUR rates to drop back, narrowing its advantage over the USD. At the moment, we have no evidence of EUR rates moving lower (US rates have moved up), but we will be watching this relationship closely in the weeks ahead. For the moment, the inertia is still against the USD, and until we see more concrete shifts in rates, the buck remains a sell on bounces.
All Eyes on the Fed
Markets are rife with speculation that the US Fed will feel compelled to initiate another round of quantitative easing to force rates lower and support the economy. In the minutes from the latest FOMC meeting, members indicated the outlook would need to worsen “appreciably” to prompt additional action from the Fed. While the data and outlook have indeed weakened since the last FOMC meeting, we think it is still within the range of expectations that the Fed has long held for the US recovery. Policymakers have been under no illusions that the US recovery would be extremely uneven and fragile, and recent data simply confirm those expectations. Still, calls for additional Fed action have been increasing in recent weeks. Among the initiatives suggested, a massive program of buying US Treasury, agency debt, and possibly mortgage-backed securities would have the greatest impact, potentially sending US rates and the USD sharply lower. But that's the Fed's last bullet, and the economic outlook has not sufficiently deteriorated from the Fed's expectations to warrant such a move at this meeting. More likely, the Fed will provide some cosmetic adjustments (reinvesting maturing bond proceeds, rather than allowing their balance sheet to shrink gradually, and somehow making a more explicit commitment to keeping rates near zero for an extended period) that show they're concerned. Those moves, however, are likely to leave markets disappointed, raising the potential for a risk selloff and a flight out of Treasuries (since the Fed won't be buying them at this juncture), sending rates and the USD higher. This promises to be one of the more significant Fed meetings this year and the reaction should be accordingly volatile.
Sterling Faces Headwinds But Could Still Win Back Ground
Sterling took a hit on the release of the worse-than-expected UK June industrial production data, even though this has a lot to do with earlier-than-expected seasonal maintenance in oil facilities. Sterling’s recent gains (on the back of stronger-than-expected Q2 GDP) have made it vulnerable to weaker data. In all likelihood, the coming quarter will be a tough one for the UK economy since it will bring with it the initial impact of the government’s austerity measures. While weaker data are likely to keep the sterling crosses volatile, it remains possible that sterling can appreciate further. The next key focus for the pound is next week’s quarterly BoE inflation report. Typically, governor King has shrugged off the strength of CPI, suggesting that inflation will be pressured lower by excess capacity in the economy. While it is unlikely that he will steer away from this line too much, stronger Q2 data suggested that excess capacity levels are a little lower than previously thought, suggesting that the Bank may have to revise higher its inflation projections. Such an outcome is likely to be supportive for the pound. The following week, the markets face the release of the monthly UK PSNCR data. The previous set of budget data were far-worse-than-expected. That said, insofar as the subsequent release of Q2 GDP was almost twice the market consensus, there may be some room for an improvement in the borrowing data in July. Whether or not sterling performs better versus the USD or the EUR depends very much on the trajectory of EUR/USD. The weakness of the USD post-payroll suggests room for disappointment if the Fed does not launch QE2 on August 10. In this scenario, sterling would be positioned to recover more ground versus the EUR in the latter half of the week.
MORE: Mixed Outlook for EUR; Key Price Levels to Watch|pagebreak|
ECB Policy Supports EUR Near Term; Medium-Term Outlook Less Certain
With the exception of a disappointing German June production report, German economic data are suggesting that the recovery is faring far better than that in the US at present. For the past two weeks, the ECB has bought very small amounts of bonds, suggesting that this program (which started in May) may be about to draw to a close. ECB president Trichet would not be drawn on providing an outlook for this program, although his tone at the ECB press conference does suggest that the recovery in the German economy will allow the ECB to continue to withdraw exceptional policy measures. In contrast to Germany, other parts of the euro zone (in particular Spain, Greece, Ireland, and Portugal) will struggle to record any growth this year. Too much tightening of ECB liquidity provisions could bring the debt crisis back to the boil. When the EUR was initially launched, it was envisaged that individual governments would use fiscal policy to fine tune uneven economic conditions, which would inevitably result from a “one size fits all” monetary policy.
Governments in Ireland, Greece, and Spain failed to do this in the “fat” years, and their failures led to asset price bubbles in Ireland and Spain and to a badly managed budget in Greece. Now in the midst of their fiscal retrenchment, they haven’t got the spending power to offset any tightening in monetary conditions. The sovereign debt crisis in Europe has not evaporated, and the ECB will have to tread carefully to keep the lid from blowing off. Ahead of the FOMC meeting on August 10, EUR/USD may be squeezed higher. However, the medium-term outlook for the EUR is still mired in fiscal concerns.
Important Price Levels to Watch
EUR/USD: Upside Bias Remains While Above Trend Line Support
Weekly price action saw EUR/USD trade higher by about 280 pips from the 1.3050 lows towards post-NFP highs into 1.3330. On its ascent higher, the key 0.382 Fibonacci level (November 27, 2009 - June 11, 2010 primary downtrend) around 1.3150 was breached on continuous dollar supply flows. The move higher has been fully supported by a steeply rising trend line (extended from the July 1, 2010 lows at 1.2200) and its 200-hour simple moving average, currently into 1.3110. The weekly technical bias remains higher while above trend line support towards 1.3520/25, the 50% retracement for the primary downtrend from November 2009 to June 2010. Below 1.3150 would constitute a break of trend line support and the aforementioned 0.382 Fibonacci level, which may see the psychologically and technically (July 16-20 highs) significant 1.30 level in view next.
GBP/USD: Closing in on Psychologically Significant 1.60 Resistance
Cable strength continued as the pair traded higher from its 1.5690 weekly lows to highs just short of 1.60. Key resistance into the 1.5850/75 zone, 0.618 Fibonacci level (November 2009 – May 2010 decline), and December 2009 lows were breached and should now serve as near-term support. The bias remains higher while above stated support and is further confirmed by a break above its hourly bull flag consolidation pattern. Projections for the flag break extend towards 1.6320, also the 0.786 Fib level for the November 2009 – May 2010 primary downtrend. This may provide a short-term cap on continued sterling strength into the week ahead. Conversely, a move back below 1.5850 would substantiate a short-term reversal and may see the 1.57 (November 2009 lows) ahead of 1.5570 (0.500 Fibonacci level) next.
USD/JPY: Multi-Month Low Around 84.82 in Close View
Data-centric dollar selling has seen USD/JPY trade from weekly highs around 86.88 to a low print around 85.03. The dollar’s descent against the yen has been defended by declining trend line resistance (extended from the 92.88 June 4, 2010 high) along with its 21-day simple moving average. Both currently converge into 86.50/87.00 and combined with the daily Ichimoku Tenkan line (86.50) and Kijun line (87.00) should provide staunch resistance on short-term corrections
MORE: Key Data to Watch This Week|pagebreak|
Key Data and Events to Watch This Week
The data stream for the US kicks off on a busy Tuesday with July NFIB small business optimism and 2Q preliminary non-farm productivity and unit labor costs. June wholesale inventories and IBD/TIPP economic optimism are also due ahead of the much-anticipated FOMC rate decision Tuesday afternoon. Wednesday sees MBA mortgage applications for the week, June trade balance, and the monthly budget statement for July. On deck for Thursday is the July import price index, weekly jobless claims, and Federal Reserve governor Elizabeth Duke is set to speak at the Chicago Fed. Friday rounds out the week with July CPI and retail sales, followed by the preliminary University of Michigan confidence survey results for August and June business inventories. Federal Reserve Bank of Kansas City president Thomas Hoenig is also scheduled to speak on Friday.
The euro zone starts off the action on Monday with German June trade balance and current account numbers, as well as August euro zone Sentix investor confidence. Tuesday sees final July CPI, July wholesale price index, and June French manufacturing and industrial production. France’s June current account is set for release on Wednesday. The ECB will publish its monthly report for August on Thursday, and euro zone June industrial production will be released that day as well. On deck for Friday is Germany’s 2Q preliminary GDP, while France sees its 2Q preliminary non-farm payrolls, wages, GDP, and July CPI. Euro zone 2Q preliminary GDP and June trade balance will wrap up the week.
UK data kicks off on Monday with BRC July retail sales and July RICS house price balance. Due on Tuesday is June trade balance, June DCLG house prices, and July nationwide consumer confidence. Wednesday finishes up the week for the UK with July jobless claims and the claimant count change, June average weekly earnings, June ILO unemployment rate, and the Bank of England’s quarterly inflation report.
The Bank of Japan’s monetary policy meeting starts things off on Monday, followed by July bankruptcies and July Economy Watchers survey results. Second quarter housing loans are also on deck for that day. Tuesday sees the BOJ’s rate announcement, July machine tool orders, June machine orders, July domestic CGPI, and the cabinet office monthly economic report. Thursday will round out the week with final June industrial production, final June capacity utilization, and July consumer confidence numbers.
Canada has a light week ahead starting on Tuesday with July housing starts and June new home prices. Wednesday will see June international merchandise trade, and Friday closes out the week with June new motor vehicle sales.
Monday in Australia kicks off the data down under with June home loans, July ANZ job advertisements, and foreign reserves. July NAB business conditions and confidence is set for release on Tuesday. Wednesday sees August Westpac consumer confidence, and Thursday has August consumer inflation expectation and July employment data, while New Zealand sees July business NZ PMI and food prices. New Zealand rounds out the week with REINZ housing price index and retail sales numbers due on Friday in NZ.
Be on the lookout for important China data as well. Wednesday is the only busy day with July trade balance, PPI, CPI, retail sales, industrial production, and China fixed assets investment index due for release.By Brian Dolan, chief currency strategist, FOREX.com
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