The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The Forex Trading Week Ahead
04/23/2012 9:40 am EST
The staff at FOREX.com previews this week’s central bank meetings and the news and economic events that are likely to drive price action across world currency markets.
The major data release in the UK this week will be the preliminary Q1 GDP reading. There is considerable uncertainty around this figure due to some strong data in the services sector, especially retail sales, balanced by some disappointments in the manufacturing and construction sectors.
Retail sales for March rose 1.5%, more than the 0.4% expected. This was mostly due to the effects of good weather boosting demand for clothes, footwear, and gardening equipment. This helped to reverse some of the weakness in the first two months of the year.
There was also good news on the labor market front. The number of unemployed dropped by 35,000 in the three months to February, the first quarterly drop since May 2011.
However, it appears unlikely that the recent uptick in retail sales can boost the overall economy. Although consumption makes up a three quarters of GDP, the retail sales data does not have a very strong correlation with the national accounts data. Added to that, consumption picked up strongly in Q4 2011, and the performance in the first quarter is unlikely to be as impressive.
The construction sector, which makes up 7% of UK GDP, has witnessed a sharp contraction in the first quarter, potentially by as much as 10%. Added to that the forward-looking indicators like new orders have also fallen sharply, suggesting this sector could be a drag on growth going forward.
On balance, we don’t see any reason to disagree with the consensus forecast for Q1 GDP to rise by 0.1%. If the UK did manage to avoid recession last quarter, that would be the nail in the coffin for more QE at the next monetary policy meeting, in our view.
The Bank of England’s long-term dove, Adam Posen, shifted to a neutral stance at the April Bank of England meeting, which means that the majority of the Committee is now in wait-and-see mode. Posen said that his decision to shift his stance was due to the rise in core inflation. Thus, the Bank may be unwilling to add more stimuli to the economy, not because it believes the growth outlook is particularly robust, but because underlying inflation pressures are building. Thus, the UK may have avoided recession in Q1, but the outlook remains cloudy.
French Political Risk Comes to a Head
The first round of voting for the French Presidential election began Sunday, April 22, and the two frontrunners expected to go through to the second round are incumbent Nicholas Sarkozy and Socialist Francois Hollande.
Currently, Hollande is in the lead, and Sarkozy has a mountain to climb to hold onto the Presidency since he is the least-popular President to run for a second term in French history. If he fails to come first in Sunday’s vote, then it may be difficult for him to win the run-off on May 6.
As we have said in previous reports, the French Presidential election is one of the biggest risks for the currency bloc this quarter. The reason is that Hollande is viewed as the market-negative choice, and a victory for him in the first round could spook investors and cause French bond yields to rise.
Hollande’s campaign has included a radical change in remit for the ECB, and he has also pledged to review the European Union’s Fiscal Pact if he is elected. He has said that he would like to see the ECB lend directly to troubled member states, which it is not allowed to do at present, and also for the Bank to cut interest rates.
Added to that, he has pledged to increase public sector workers and also pushed back balancing the French Budget by 12 months to 2017.This would set him on a collision course with Germany, which is why Angela Merkel was seen campaigning for Sarkozy earlier this year.
See also: Europe’s Unlikely Savior
At this fragile stage of the sovereign debt crisis, any discord between Europe’s de-facto leaders—Germany and France—could trigger another wave of the debt crisis. If Hollande secures a first-round victory this weekend, then France may see more ratings downgrades (there have already been rumors that one is on the cards), and we may see some upward pressure on French bond yields.
In the bigger picture, however, neither candidate fills us with confidence that they will address France’s deep-seated structural economic problems. Hollande has campaigned for a 75% tax rate for those earning more than EUR 1 million per year, which could cause a drain of talent to leave France.
However, Sarkozy is calling to end an employment tax credit that could hurt job creation in the future. Added to that, neither has concrete plans to reign in France’s public sector spending, which has accelerated in recent years, or enact structural reform to help boost growth. Due to this, we think that in the long-term the spread between French and German ten-year debt, which is currently just below 140 basis points, is likely to continue to widen as fiscal health and economic growth rates continue to diverge in the two nations.
Italy and Spain Turn Attention to Fiscal Targets
As Germany continues to show strong signs of growth, the weaker peripheral economies are increasingly turning hostile to Germany’s strict fiscal targets included in the EU’s Fiscal Pact.
Spain was the first country to revise its budget deficit target higher for this year, and last week, Italy followed suit. Prime Minister Monti said that the government would delay by a year its plan to balance the budget in 2013 due to the weakening economic outlook. It will instead revert to the original 2014 plan (former PM Berlusconi pushed it forward a year) as the economy contracts.
The market reaction to the news from Italy was fairly muted, in contrast to Spain. When Madrid announced it was changing its fiscal target, it triggered a wave of selling in Spanish bond markets and a sharp move higher in yields.
The difference between Spain and Italy is that Italy’s budget deficit is much smaller than Spain’s at 3.8% of GDP at the end of last year vs. 9.3% for Spain. Thus, the markets are more likely to allow Italy a little more slippage than Spain. However, Italy still needs to show its commitment to fiscal consolidation, as its public debt burden is enormous, and added to that, its bond yields have also moved higher, albeit at a slower pace than Spain’s, and are currently around 5.6%.
Bank of Japan to Back up Rhetoric with Action
On Friday, April 27, the Bank of Japan (BOJ) will announce its policy decision, and markets are expecting the Bank to maintain rates at 0-0.10% and take steps to further ease monetary policy. Members of the Bank of Japan have reiterated their commitment to pursue powerful easing in order to fight deflation, and government officials have been increasing pressure on the bank to act.
Economy and Fiscal Policy Minister Furukawa has been quite vocal of late, saying that he hopes the BOJ will consider its price target. He suggested that the Bank buy longer-maturity debt as an option to ease and reaffirmed that overcoming deflation is the top priority for both the government and the central bank.
With the stated inflation target of 1%, price data will be a key focus. CPI figures will be released on Thursday, and March national CPI (excluding fresh food) is forecast to remain on hold at +0.1% yearly growth, a level well below the 1.0% target.
Furthermore, the timelier Tokyo CPI (excluding fresh food) is anticipated to show continued deflation with a yearly decline of -0.3%. Continued weakness in CPI growth and indications of deflation are likely to prompt the BOJ to be more aggressive and ease with the option to increase asset purchases by five to ten trillion yen, buy longer-maturity debt, or raise its target level of inflation.
We expect the Bank to take additional measures at this week’s meeting to move inflation closer to the 1% target. Further easing would have a weakening impact on the yen and could see JPY crosses move higher as a result.
Movement in the JPY is likely to be dictated by the extent of measures taken by the Bank, and as we saw earlier this month, the Bank tends to take a more cautious approach despite calls for aggressive action. We would note that prices currently reflect some degree of easing, however, there is scope for further yen weakness if the Bank is more aggressive.
In USD/JPY, the 21-day simple moving average (SMA) is the key upside pivot in the short term, ahead of the prior highs above the 84.00 level. To the downside, the 80.00 level is key support, and below that sees the weekly cloud base just above the 78.00 figure.
Movement in the JPY is likely to be dictated by the extent of measures taken by the Bank, and as we saw earlier this month, the Bank tends to take a more cautious approach despite calls for aggressive action.
Australian CPI May Open Door for RBA Rate Cut
The RBA has had a dovish tone at recent meetings but said that it would be prudent to wait for inflation data before cutting rates. Therefore, this week’s 1Q CPI (which is expected to fall to 2.2% from 3.1%) will be crucial to the outlook for the RBA’s policy rate. Our main view is for softer CPI to reinforce a reduction in rates at the May meeting with the risk for an upwards surprise in CPI, which could push back rate cut expectations and support the AUD.
FOMC Still in "Wait and See" Mode
The FOMC will meet this week on April 24-25 and is likely to keep policy on hold as it continues to assess the economy. We expect that the Fed will keep all options on the table, as there is still a large amount of uncertainty with regards to the health of the US labor market.
The four-week moving average in weekly initial jobless claims has ticked higher over the past couple readings, and the March employment report was disappointing. One month’s worth of disappointing data is not enough to prompt action by the Fed, and therefore, we expect the central bank to maintain its current stance.
With a two-day FOMC meeting this week, the focus will be on chairman Ben Bernanke’s press conference and the Bank’s updated interest rate projections.
We have seen a variety of viewpoints from various Fed officials, and the projections will help to clarify the Bank’s view and manage expectations. A shift in the timing of the next probable rate increase would impact markets broadly, and any sign of tightening sooner than previously expected could have a positive impact on US yields and the dollar with the possibility for a knee-jerk reaction lower in risk sentiment, while prolonged low rates would have the opposite effect.
The markets ended last week on a high after some stronger German and UK economic data combined with some positive earnings releases in the US helped to boost risk appetite. The news from the IMF/G20 meetings was also positive.
It appears that the IMF has managed to secure an extra $400 billion for its financial stability fund, which could help struggling Eurozone countries. Markets love liquidity, so this added fuel to the rally.
The British pound was the top performer in the G10 sphere last week (see UK section for macro analysis). GBP/USD and EUR/GBP ended the European session on Friday at some key levels: EUR/GBP was below -0.82 (the low from 2010), and GBP/USD was above 1.61.
We expect some volatility and range trading as we lead up to the Q1 GDP figure, but if there is an upside surprise, then we expect these sterling crosses to move higher. We also think a long GBP/JPY position may perform well this week due to the contrasting central bank stances of the BOE and BOJ.
The BOE is not expected to add more stimulus to the economy, while the BOJ is expected to increase its asset-purchase program when it meets this week. Thus, we would target the 133.50 high from late March (and also a triple top) in the near term.
The euro is moving with overall risk appetite; however, we continue to think that the rally is vulnerable as election risks in France and Greece dampen investor sentiment towards the single currency. We expect the euro to be jittery ahead of some key economic data releases from Spain, including the unemployment rate for the first quarter on April 27, and, of course, the results of the French elections.
We believe that the euro could be sold if we rally towards 1.3250. The 1.3200 level and then 1.3130 are key near-term supports. Above 1.3280 opens the way for a more sustained rally towards 1.35 in the medium term, and that could be driven by a continued strong tone to German economic data.
By the Staff at FOREX.com
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