The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
USD Weakness? Don’t Believe it
09/20/2010 10:48 am EST
The USD took a hit in the past week as better Chinese data supported global recovery prospects, weakening safe-haven dollar demand, and markets responded to talk that the Fed may undertake a second round of quantitative easing (QE). The greenback also likely weakened as the Chinese stepped back from dollar-buying intervention and allowed the RMB to strengthen. The Chinese data suggest a soft landing has been achieved there, and that is indeed supportive for the global outlook and especially for commodity and regional currencies (AUD in particular) that benefit from Chinese growth. However, the other developments cited above are likely temporary in nature, suggesting potential for the USD to rebound in coming weeks. The talk of additional Fed QE seems premature given the split among FOMC members, with most content to maintain current policy and others openly questioning the effectiveness of QE. While US data has deteriorated, it does not yet reflect the “appreciably” worse outlook Fed chairman Bernanke has indicated would be the trigger for additional unconventional policy measures. Judging by recent FOMC minutes, the subject of QE has barely been discussed, much less settled, so the prospect for additional asset purchases at this time seems highly remote. As such, USD weakness may dissipate following the FOMC meeting on Tuesday (September 21). USD weakness emanating from China stepping back from managing the yuan (RMB) seems similarly set to evaporate if they return to pattern (see more below).
To gauge the potential for a USD rebound, we will closely monitor the 1.2920/50 support level in EUR/USD, which was the recent range high and the break level for recent EUR gains, and upside potential remains while price holds above. Keep in mind the German ZEW economic sentiment gauge has plunged from +53.0 in April to -4.3 in September, an indication of deteriorating six-month outlooks. If EUR/USD does drop back below the range break at 1.2920/50, we would anticipate a test of prior range lows around 1.2590/2620 at the minimum, and very likely a break below toward 1.2450/80 initially. Convincing strength above 1.3150/60 will be needed to mount a challenge to recent 1.3330 highs and test the psychological 1.3500 level next.
JPY Intervention May Be the Real Deal
Fresh off a victory in an intra-party election, Japanese PM Kan ordered the Ministry of Finance (MOF) to take action to counter the strong JPY, according to comments on Friday from financial minister Noda. The resulting BOJ intervention caught many market players off guard and the reported size of the intervention, estimated at between ten and 20 billion USD worth, would be unprecedented for a single day's salvo. Also, in contrast to prior interventions, the JPY being sold are not being sterilized, meaning the BOJ is not selling short-term finance bills and is leaving JPY in the market. Additionally, BOJ Gov. Shirakawa has indicated the BOJ is cooperating at the direction of the MOF on the overall intervention effort, suggesting the two institutions are in agreement on the need to weaken the JPY, in contrast to prior interventions when they worked at cross-purposes. As well, the BOJ has indicated it will provide virtually unlimited liquidity, meaning the MOF has nearly unlimited resources for intervention. Taken together, it appears the Japanese government is firmly committed to countering JPY strength and we would not underestimate their ability to prevent renewed JPY gains. As such, we would not expect to see USD/JPY much below 84 anytime soon, and the risk is for further gains to the 90.00 area, once above the 86.00/50 area. In the JPY crosses, with USD/JPY downside likely limited by intervention, any major JPY cross selling on risk aversion seems likely to disproportionately affect the non-JPY dollar pairs (e.g. AUD/USD would likely fall more than USD/JPY if AUD/JPY is being sold).
NEXT: Will Fed Begin New Round of Quantitative Easing?|pagebreak|
Increased Speculation on Quantitative Easing
Speculation that the Fed could embark on a further stage of quantitative easing stepped up a gear earlier this week when The Wall Street Journal reported that a well-known investment house expects the Fed to announce new asset purchases as early as November, earlier than the market expects.
Whether this will happen remains to be seen. There are still major hurdles the Fed has to pass before they could embark on more monetary stimulus. Firstly, it was reported that at its August meeting, seven of the 17 officials at the Fed either expressed reservation or disagreed with the plan to maintain the size of the Fed’s balance sheet and reinvest the proceeds of maturing mortgage-backed assets. This suggests that the Fed is unlikely to come to an agreement on more QE in the near term. On top of that, the tone of economic data has been somewhat stronger in September. The ISM rebounded and retail sales were also stronger in August after contracting in July. The trigger to further QE is going to be the labor market. If growth doesn’t pick up enough to see a drop in the unemployment rate, currently at 9.6%, then the chances of more QE are likely.
The UK is also pondering a further round of QE. This week, Bank of England governor Mervyn King said the Bank remains ready to act if necessary. Speaking at the annual Trade Union Congress in Manchester, King said that monetary policy remains the best tool for managing the recovery in the short term, however, if the recovery proves to be slower than the Bank expected, the BOE can “react.” Adam Posen, MPC member, speaking at a conference in Washington, said the BOE’s backup plan should be heavy duty purchases of private assets. Up until now, the Bank has only bought government debt such as gilts, however, Posen argues if further policy action is deemed necessary, then it shouldn’t be QE 2. Instead, the Bank should adopt a form of credit easing and buy private-sector assets directly from the market.
Although inflation has proven to be stickier than many expected—the headline rate moved back up to 3.1% in August— this is unlikely to get in the way of another round of monetary stimulus. The Bank remains of the view that the large amount of spare capacity in the economy should have a downward impact on inflation in the medium term. Overall, it is unlikely that further stimulus will be implemented in the UK until there is a clear view on the impact of impending budget cuts on economic growth.
Renminbi Strength Unlikely to Continue
In what is being seen as a gesture to US authorities eager to label China a currency manipulator, Beijing allowed the renminbi (AKA RMB or yuan) to strengthen nearly 1% against the dollar this week. The move came prior to the testimony of Treasury secretary Geithner at congressional hearings on China’s FX policy. As China reduced its massive purchases of dollars, typically in excess of $1 billion a day, the greenback experienced broad-based weakness against the major currencies.
But China’s overture did little to stem Washington’s anger over what it sees as China’s unreasonable behavior, especially since signs of a slowdown in growth in the emerging market powerhouse have receded in recent weeks. Geithner stepped up his rhetoric, saying China had substantially undervalued its currency, which puts US exporters at a disadvantage. However, he stopped short of calling for direct action, and made it clear to the committees that calling China a currency manipulator would essentially be useless.
Beijing responded in typical fashion, saying that it would not respond to pressure to revalue its currency. Later, the People’s Bank of China (PBOC), the Chinese central bank, said swings in the value of the dollar may threaten the global recovery and defended the benefits of currency stability. This suggests that China could resume its purchases of dollars in the near term, causing the yuan to drift lower in the coming weeks. The next focal point will be in mid-October when the US Treasury is scheduled to release its report on currency manipulation.
NEXT: Latest on Gold; Key Data to Watch This Week|pagebreak|
Gold Advances to New Record Levels
The yellow metal has shined this past week, outperforming the usual safe havens (USD, CHF, and JPY). Government and central bank actions this week have diminished the demand for the safe-haven currencies, resulting in higher gold prices as investors seek safety amid economic uncertainty. To recap, Tuesday saw XAU/USD gain +1.83% as the greenback declined on speculation of another round of asset purchases by the Fed as early as November. The prospect of another $1 trillion in quantitative easing, coupled with the highest price of the yuan since 1993 (reportedly due to fears of trade sanctions) sent the buck plummeting. The softening dollar aided higher gold prices as gold usually moves inversely to the US currency.
Gold extended gains as the Bank of Japan intervened in the currency markets to stem the strengthening yen, and as the Swiss National Bank held rates steady and issued a surprisingly dovish statement. As key central banks effectively weakened their currencies, safe-haven flows favored gold, pushing prices to new record levels of nearly $1,283.
While the central banks and governments continue their campaigns to be “competitive” in the area of exports by actively depreciating their currencies, the true safe haven emerges in the form of a yellow metal. There is no central bank acting to depreciate the value of gold, and it cannot be printed, as many governments may do with their currencies. This is why we have seen gold continue to break record levels. We would be reluctant to establish longs at current levels, however. We expect to see a short-term pause or correction as a result of profit taking and remain on the sidelines for now. A near-term pullback in XAU/USD is likely to find support on its 21-day simple moving average (SMA) around 1247/48; below here may see the next key support level around 1217/18, where the 55- and 100-day SMA’s converge. While the bias remains higher, the upside is likely to see profit taking ahead of the key $1300 level. A sustained break above this level should see gains extend.
Key Data and Events to Watch This Week
US economic data kicks off the week today with the NAHB housing market index for September. Tuesday sees August housing starts, building permits, and the FOMC rate decision and statement. Wednesday has the House Price index for July, and Thursday sees weekly jobless claims, August existing home sales, and leading indicators. Friday wraps the week up with durable goods orders and new home sales for August, as well as speeches by the Fed’s Lacker and Fed chairman Ben Bernanke.
The euro zone starts the action off on Tuesday as German chancellor Angela Merkel and Luxembourg PM Jean-Claude Juncker are scheduled to speak. Wednesday will see euro zone industrial new orders for July and EZ consumer confidence for September. French September business confidence and production outlook indicators are on deck for Thursday. Also due out Thursday are preliminary manufacturing and services PMI for France, Germany, and the euro zone. Friday sees Germany’s August import price index and September IFO survey results.
UK data begins on Monday with the September Rightmove house prices figures, August preliminary M4 money supply, and mortgage approvals for August. The Bank of England’s Andrew Sentence will speak in London on Monday. Tuesday’s data includes August public finances and public sector net borrowing and a speech by the BOE’s Andrew Bailey. On deck for Wednesday is the Bank of England minutes and a speech by the BOE’s Spencer Dale. Thursday finishes the week with August BBA loans for house purchase.
Japan begins the week with the release of its July final coincident and leading index numbers as well as August final machine orders on Tuesday. Wednesday finishes the week with the July all-industry activity index and August supermarket sales, as well as a speech by Bank of Japan board member Miyao.
Canada’s economic data starts with Monday’s international securities transactions and wholesale sales for July. Tuesday sees August CPI numbers and Canadian finance minister Jim Flaherty speaking in Ottawa. Wednesday finishes up with August leading indicators and July retail sales.
The calendar down under starts on Monday with a speech by RBA governor Glenn Stevens, New Zealand’s August performance services index, and the September ANZ consumer confidence index. Tuesday’s data includes NZ August credit card spending and the RBA’s September minutes. Wednesday sees the July Westpac leading index, NZ current account balance. New Zealand’s 2Q GDP figures are out on Thursday.
Be on the lookout for important Chinese data as well. Friday will see the MNI business conditions survey for September.By Brian Dolan, chief currency strategist, FOREX.com
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