Central bank policies in the US, Europe, and Japan are likely to be focal points for currency traders this week, and currency pairs like EUR/USD, USD/JPY, and GBP/USD will be most impacted as a result.
The past week’s data releases continued to paint a bleak picture of the US economic recovery. Retail sales in August stagnated (0.0% vs. prior 0.2%), regional Fed reports pointed to contraction in the manufacturing sector with September Empire manufacturing at -8.82 and the Philadelphia Fed index at -17.5, and weekly jobless claims climbed stubbornly higher to 428,000 from the prior 417,000.
The Fed has extended this week’s Federal Open Market Committee (FOMC) meeting to two days in order to have adequate time to discuss monetary policy, as several options are available to the committee. There should be no surprise in the target rate, as the FOMC pledged to keep rates lows through 2013, and the committee will announce its decision on policy at the conclusion of the two-day meeting on Wednesday, September 21.
With the rising CPI figures released this week (headline CPI rising to 3.8% year over year from the prior 3.6% and the core reading climbing to 2.0% from the prior 1.8%), it is highly unlikely that the Fed will announce QE3. The market is largely expecting the next move to be a shift in the duration of the Fed’s current holdings, which would be less bearish for the US dollar than outright asset purchases.
The so-called "Operation Twist" (first seen during the Kennedy Administration in 1961) would see a flatter yield curve with the short end of the yield curve moving higher while longer-dated yields move lower. Should this scenario play out, we would expect to see little impact on the dollar. A dovish policy statement is likely to see the dollar correct lower, but the US dollar bias is higher while the dollar index remains above the top of the daily Ichimoku cloud, which is seen around 75.00.
The most visible impact in the FX markets may be seen in USD/JPY, as the pair has been highly correlated to yields. A rise in short-term Treasury yields would be supportive of USD/JPY and may see the pair advance. Japanese officials have been vocal about the strength of the yen and its negative impact on economic activity with the markets on alert for intervention. In our view, we anticipate the Bank of Japan (BOJ) to stay on the sidelines ahead of the Fed decision.
MPC Minutes to Provide Insight on the QE Debate
Earlier this week, the UK saw the release of a Bank of England (BoE) survey on inflation that showed that consumer expectations on inflation climbed to a three-year high to 4.2% from 3.9% at the last quarterly survey in May. Retail sales (excluding auto fuel) for August declined by -0.1% month over month from the prior +0.2% while the year-over-year change fell by -0.1% (prior 0.0). The data underscored the BoE’s dilemma of providing additional stimulus in the form of another round of QE to support the economy while inflation remains high.
BoE member Adam Posen said on Tuesday that the Bank should expand its asset-purchase facility by a minimum of 50 billion pounds and as much as 100 billion pounds. He said, “We should start with a minimum of 50 billion pounds in gilt purchases in secondary markets, tilted toward the longer end of the maturity spectrum, over the next three months.”
Additionally, monetary policy committee (MPC) member Martin Weale noted that the risk of a double-dip recession in the UK has increased. He said that “More asset purchases were warranted if it seemed likely that inflation was going to undershoot.” The dovish comments weighed on the pound with GBP/USD currently trading below the 100-week simple moving average (SMA) that comes in around 1.5825.
On Wednesday, September 21, the Bank of England will release its monetary policy committee minutes. The minutes will give markets more insight into the ongoing discussions within the BoE on an additional round of asset purchases. If the minutes indicate that the MPC is leaning more towards more QE, the pound is likely to suffer and we would view GBP rallies as short opportunities.
NEXT: Greek Debt Crisis Remains in Focus
|pagebreak|Greek Debt Crisis Remains in Focus
The European debt crisis remains a major uncertainty for global financial markets with a Greek default becoming more a question of when and how orderly as opposed to if. The beginning of this week saw Greek two-year yields above 76%, several peripheral yield spreads over Germany at their highest levels, and record high five-year CDS for Spain, Italy, Portugal, Greece, France, and Belgium.
As a result of continued commitment by EU officials to implement the July 21 agreements, which eased worries of an imminent Greek default, financial stresses in the Eurozone have receded with Greek two-year yields testing 50% as well as yield spreads and CDS tightening. Angela Merkel said that Germany has a “duty” to help secure the euro’s future in an attempt to ease markets.
European finance ministers have gathered in Poland for the start of this weekend’s EcoFin meeting to discuss the European Financial Stability Facility (EFSF), Greek aid, and a collateral deal. The market remains skeptical on a tangible outcome, which has put pressure on the common currency. EUR/USD was rejected from the 38.2% Fibonacci retracement of the decline from the highs above 1.4550 to the near 1.35 lows, and the pair is currently trading around the 1.38 figure.
Also weighing on the euro is the shift in stance by the ECB. The Bank has turned more dovish, noting that the risks to growth are to the downside and inflationary risks are no longer to the upside. In the week ahead, Europe will see PMI’s out of Germany, France, and the Eurozone to give indication on the state of the economy in the region. The market is also keeping a close eye on Italy’s Aa2 credit rating, as Moody’s placed Italy on watch negative three months ago today.
Key technical resistance in the EUR/USD can be found around the 1.4030 zone, which is where the 50% Fibonacci retracement of the previously mentioned move comes in, as well as where the 200-day simple moving average lies.
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Additionally, the 200-week SMA is currently around 1.4015 and the daily Ichimoku Kijun line and the weekly Tenkan line converge around the 1.4020/1.4025 area to provide added resistance. The convergence of several key daily and weekly technical levels is likely to limit further upside in the EUR/USD pair.
By Brian Dolan, chief currency strategist, FOREX.com
