The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
Forex Traders Eyeing Key Events
04/11/2011 10:58 am EST
Stronger commodities, a much weaker dollar, and central bank actions including a rate hike by the ECB are all weighing on world currency markets. Here’s what to watch for in the week ahead.
The US dollar weakened significantly this past week as monetary policy divergences became more prevalent and commodities continued to soar. Precious metals marched higher with gold hitting new record highs while silver broke above $40 and oil topped $110 a barrel.
Currencies whose countries export commodities were beneficiaries as highlighted by new post-float highs in AUD/USD, which climbed above 1.0500, and multi-year lows in USD/CAD, which fell below 0.9600.
The European Central Bank (ECB) lifted rates by 25 basis points (bps) to 1.25%, the first move on interest rates since May 2009, but gave no indication that it will be the beginning of a series of rate hikes. This is largely different from the Fed’s policy stance, which has maintained its commitment to keep rates low for an “extended period.”
Moreover, while recent speeches by some members of the Fed have suggested cutting short the plan to purchase $600 billion in assets through June, last week’s Federal Open Market Committee (FOMC) minutes showed little evidence that the idea has gained traction among the FOMC voting members.
In the week ahead, FOMC voting members Dudley, Evans, and Yellen are set to deliver speeches, and we would note that these members are considered to be dovish. The monetary policy outlook remained the key driver as the dollar index sunk to new 16-month lows, and though budget talks and the looming government shutdown were viewed mostly as political theater unlikely to have significant economic impact, it gave investors yet another reason to sell the buck.
The exception to USD weakness has been against the Japanese yen, which has continued its sharp reversal lower following the G7 coordinated intervention. Japan was struck with another earthquake last week, this time with a magnitude of 7.1. While reports of the earthquake were initially met with risk aversion, markets breathed a sigh of relief after tsunami warnings were retracted and resumed their appetite for risk.
The week ahead will include the Fed’s Beige Book to give clues on the outlook of the economy, speeches by FOMC voting members, and inflation data. We would anticipate a stabilization in the buck as investors take profits ahead of key levels and events.
ECB Keeps Cards Close to Its Chest
So the ECB hiked rates as anticipated, but the question now for investors is what the bank will do next. The market thinks there will be two further hikes before the end of the year with the next hike coming in July, according to the Eonia swaps market.
The 11% increase in the euro versus the dollar since the start of this year suggests that a lot of the expected ECB tightening is already priced into the single currency. So if things stay as they are, then the euro may lose its yield advantage and could come under pressure. This would happen if investors think the ECB may not deliver as much policy normalization as they originally anticipated.
However, on the back of last week’s meeting, we know two things. First, that the ECB has not yet decided if this will be the start of a rate hiking cycle, and second, that the future trajectory for interest rates depends on inflation since price stability is the ECB’s sole mandate.
So this week’s second inflation reading will be crucial for interest rate expectations in the currency bloc. The first reading saw inflation rise to 2.6% in March from 2.4% in February. Above-target inflation is unacceptable to ECB policymakers, and the March price data most likely sealed Thursday’s rate hike.
We will get the regional breakdown of the inflation figures on Thursday. We already know that inflation in Germany rose to 2.2% while even debt-laden peripheral nations have experienced inflation pressures, including Ireland, where EU harmonized inflation jumped from 0.9% in February to 1.2% in March.
It is the large jumps in inflation that the ECB wants to avoid, and right now, price pressures continue to build as energy prices surge to multi-year highs. If we see an upward revision to inflation this week, then a rate hike before July becomes a possibility.
We think that dips in EUR/USD will remain fairly shallow and a weekly close above 1.4420/1.4430 may herald further gains to 1.4700 and then 1.5000. But a caveat to this is the dollar. Arguably, weakness in the greenback is pushing the euro higher and any swift resolution to the US budget impasse could see a reversal in short dollar positions and thus weigh on the euro in the short term. In the long term, the direction of EUR/USD depends on the clarity provided by the Fed about its intentions regarding monetary policy normalization.
NEXT: UK Prices Out a Rate Hike, Bank of Canada Decision Coming|pagebreak|
The UK: Pricing Out a Rate Hike
It wasn’t that long ago that the UK was considered the first of the major central banks to hike interest rates. Yet that seems like a long time ago now. The ECB has moved first and the UK’s growth outlook has deteriorated sharply. This has weighed on interest rate expectations and three-month Sonia rates (GBP interbank swap rates that follow interest rate expectations closely) have fallen sharply.
The market is increasingly coming to the conclusion that the Bank of England (BOE) won’t hike interest rates at their next meeting in May, and instead will wait until August to do so. This is consistent with our call and we expect the BOE to remain on hold this quarter.
Economic data has been largely weak with only a couple of upside surprises. One was service sector data for March, yet we believe this was an anomaly and service sector activity played catch-up after weather-related disruptions in January and February.
But while we think the BOE may be on hold longer than the market currently expects, there are a couple of important caveats to remember. The first is the Q1 GDP release on April 27. This is the deal breaker, in our view. Lackluster quarterly growth—something below 0.8% would be viewed as a disappointment—would make a rate hike less likely in the current environment.
Another risk is the May inflation report. We think the economic backdrop, the impact of austerity measures, and weak wage growth will be enough for the Bank to maintain its cautious stance in May. The Bank tends to hike rates after an inflation report, so the next logical date for an increase in rates would be August—after the Bank’s summer report.
This makes the pound a sell on rallies, in our opinion. It has already tested the 1.6400 highs, but we think it is vulnerable to a pullback, especially versus the dollar and the euro since a lot of its recent strength was fuelled by rate-hike expectations. With this major source of support gone, sterling strength is likely to be curtailed going forward.
Will the Bank of Canada Do Anything Loonie This Week?
On April 12, the Bank of Canada (BOC) will announce their interest rate decision. By nearly all measures, the market is expecting them to remain on hold at 1.00%, but their statement will be closely watched for any potential changes to their accommodative stance.
As a result of rising food and energy prices, economists have begun to shift their inflation forecasts higher for 2011 and 2012, however, immediate pricing pressures continue to remain subdued. Nevertheless, such a backdrop makes the BoC’s job that much more challenging as they begin to deliberate on the path of future rate hikes.
On Wednesday, the BOC will release the April Monetary Policy Report (MPR). The MPR is going to provide further economic incite and will likely touch upon turmoil in the Middle East and earthquake/tsunami in Japan, which has caused a rise in oil (energy) prices, as well as provide a slightly more optimistic bias regarding GDP over the coming quarters.
While the stronger CAD has restrained Canadian exports, something BOC governor Carney continues to highlight, it will be unable to keep the BOC on the sidelines for too much longer. Going forward, we believe the Bank is likely to remain on hold until the beginning of the third quarter, where we expect a rate hike of 25 bps at each meeting through the end of 2011 (July, Sept., Oct., and Dec.).
The CAD has been one of the strongest commodity currencies since the beginning on 2011, appreciating roughly 4.4% year to date, as it has benefitted from strong domestic fundamentals, improving global growth, and rapidly rising oil prices.
Just last week, crude oil made fresh multi-year highs around $112.55/$112.60, and firm demand from both emerging and developed economies, as well as ongoing unrest in the Middle East and North Africa (MENA) region will likely to continue to support black gold going forward.
Therefore, while commodities remain strong and the US dollar remains offered, we’ll look to be a seller of USD/CAD on rallies towards 0.9625/0.9635 and 0.9680/00 in the week ahead.
NEXT: Key Price Levels to Watch This Week Across Major Currency Pairs|pagebreak|
Key Price Levels and Events to Watch This Week
The greenback remains on the offer, driven fundamentally by widening rate differentials between the US and other central banks. The USD index broke below its short-term bear flag formation to fresh yearly lows just above the 75.00 figure.
Additionally, USD weakness is being confirmed by other asset groups. Gold broke above the key $1450 level, also the neckline of an inverted head-and shoulders pattern, suggesting a measured move objective to the $1550/$1575 area.
Technical developments last week suggest the greenback’s woes may continue, but considering the steep rate of USD declines, pullbacks should be expected and may provide better value for those looking to establish USD shorts.
EUR/USD: The ECB’s 25 bp hike to the main refinance rate may be a historic step, as the central bank could be initiating a tightening cycle before the Fed for the first time. Uncertain Fed policy direction continues to weigh on the buck, elevating EUR/USD above key technical levels, the most significant being the weekly close above primary downtrend resistance (around 1.4300), suggesting sustainable EUR strength in the weeks ahead.
The 1.4450 level (61.8% retracement for the 1.6035/1.6050-1.1875/1.1880 decline), however, is proving to be a formidable hurdle as EUR strength was capped into it on Friday trading. Below 1.4300 sees additional support into the 1.4250 pivot, which may provide decent value for EUR longs as the medium-term technical outlook has now shifted to the upside.
GBP/USD: The BOE remained on hold, as expected, and with rate differentials driving FX, the uncertain outlook for UK rates has seen the sterling underperform relative to other majors against the buck.
GBP/USD, however, looks set to close above its respective primary trend line, which technically suggests a potential reversal for the primary decline from the 2.1160 peaks. The 1.6500 level is likely to be a psychological barrier ahead of the key 1.6825/1.6850 daily horizontal pivot. Immediate support may be seen into 1.6275/00, or broken trend line resistance, ahead of the key 1.5975/1.6000 daily pivot.
AUD/USD: Commodities have been screaming higher, which has seen commodity currencies benefit substantially. AUD/USD posted post-float record highs on a seemingly daily basis last week and looked set to close near weekly highs around 1.0540/1.0550.
The 1.0600 figure is likely to provide some technical hurdles to further aussie strength, but if commodity upside continues, the 1.0900 measured move objective for the symmetrical triangle breakout may be in view next. Downside corrections may find meaningful support into the rising trend line around 1.0450 ahead of the 2010 highs at 1.0255/1.0260.
USD/JPY: Another earthquake in Japan saw USD/JPY upside capped ahead of the all-important 85.50 barrier. Rumored options-related stops above 85.50 were never hit as the declining trend line from the 2007 peaks at 124.10/124.15 and the 55-week simple moving average (SMA) effectively stunted further JPY weakness against the greenback.
Immediate support may be seen into the 84.50 daily pivot ahead of 83.50, which sees the 200-day simple moving average converge with broken daily triangle tops. Considering uncertain USD monetary policy, USD/JPY is likely to underperform relative to other JPY pairs.
EUR/JPY: With loose Bank of Japan (BOJ) monetary policy now a given for the foreseeable future and the ECB possibly embarking on a tightening cycle, EUR/JPY blew through a number of key technical levels this week. The 120.00 psychological barrier and Feb. 2010 lows proved to be no match for the pair.
Furthermore, EUR/JPY has managed to close above weekly Ichimoku cloud tops (121.90/00), suggesting upside trend continuation may be sustainable and should be a level of immediate support on downside corrections. Below may find more meaningful support into the Feb. 2010 lows around the 120.00 figure, which may provide value for EUR/JPY longs.By Brian Dolan, chief currency strategist, FOREX.com
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