The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The Forex Trading Week Ahead
04/15/2013 6:00 am EST
Kathleen Brooks and Eric Viloria, CMT, of Forex.com highlight the events and indicators likely to shape the forex markets this week.
Cyprus, Eurozone Finance Ministers and the Gold Price
The meeting of EU finance ministers at the end of last week was not meant to focus on Cyprus; in fact the Irish finance minister (and host of the meeting) said that the Cyprus issue was resolved. However, the tiny nation kept creeping up in headlines on Friday, suggesting that a lot of time was spent discussing Cyprus' funding needs.
Firstly, the bailout has been extended to EUR 23 billion from EUR 17 billion; however the Troika’s contribution will remain unchanged at EUR 10 billion, meaning that Cyprus has to find EUR 13 billion to fund its rescue. Deeper haircuts on deposit holders above EUR 100K in Laiki bank seem highly probable. Some have suggested this could be as high as 80%. Added to that, the focus has been on a potential sale of Cyprus’ gold reserves. It looks like Cyprus will need to sell the majority of its gold reserves (10 of its 13.9 tonnes) to pay back the ECB for the losses it will incur on its emergency loans to Laiki bank in the lead up to the Cypriot crisis. This is the equivalent of about EUR 400 million of gold sales, a mere drop in the ocean of the commodities market. However, Cyprus’s gold sale is deeply symbolic. Investors are pricing in the possibility that other troubled Eurozone countries—like Italy and Spain—may need to dispose of their much larger gold holdings (2,450 and 300 tonnes, respectively), which could have a very disruptive influence on the market for the yellow metal.
Overall, the big development from this meeting—that Ireland and Portugal have had a seven-year extension to their bailout loan maturities and that Cyprus will get its bailout funds as soon as possible—have been mostly lost in the headlines about Cyprus’s gold reserves. The fascination with Cyprus’s self-funded bail—out is fascinating markets and media alike because it further highlights the new direction of the sovereign crisis. No more will Germany and co. in the North fund limitless bailouts; we have entered the era of the bail-in.
These meetings didn’t see many developments on two crucial pieces of the sovereign crisis jigsaw: banking union and a growth strategy. On that point, data last week was incredibly weak. Spain’s industrial production data fell 6.5% annually in February, Italian industrial data fell 3.8%, and overall in the Eurozone the pace of annual contraction was 3.1%. This does not bode well for Q1 GDP for the currency bloc, which enhances the chance of a EUR sell off. EUR has been supported in the last few weeks on the back of an overall risk rally post the BOJ stimulus. EUR/USD rose to 1.3140 last week, which will do nothing to help the competitiveness of European exports. Thus, the more the euro rallies, the more likely the chances are that the ECB may try to talk down the single currency. Support lies at 1.2980 in the near term, while 1.3200—base of the daily Ichimoku cloud—is near term resistance.
Figure 1: Gold price in USD. It fell to its lowest level since 2011 on Friday, after the news of potential gold sales by Cyprus. Key support lies at $1,450.
NEXT PAGE: Could the UK Still Have a Triple-Dip?|pagebreak|
Could the UK Still Have a Triple-Dip?
There have been some pockets of strength in the UK economic data of late, including retail sales, however, the expected rebound in the construction sector has, so far, not materialized. The latest data on construction output reminded us how perilous a condition this sector is still in, it declined at a 7% annual rate in February, more than the 5.5% decline in January. Add to that, the snowy weather in March and the prospects for construction in Q1 are not that rosy.
In contrast to the weak construction data, the retail consumer could help to at least limit the blow to GDP in Q1. The latest BRC retail sales survey showed the fifth successive month of expansion, taking the average monthly rate of growth to 2.2%—the biggest gain since the end of 2009. The official measure of retail sales are released next week, however they are expected to diverge with the BRC measure and show a 0.6% monthly fall, bringing the annual rate of growth down to 0.9%. Thus, a weak end to the quarter could dampen the impact of consumption on Q1 GDP. Added to this, labor market data also released next week is expected to show a marked slowdown in job creation in the three months to February, falling to 60k from 131k. Average weekly earnings growth is also expected to be a measly 1.3%, which, when adjusted for inflation, shows that wage packets are shrinking on an annual basis. Thus, we can’t rely too heavily on the consumer either.
So what impact could a negative Q1 GDP reading have on the pound? The Q1 data could be harder to read due to weather-related effects, which may suggest that the underlying rate of growth is stronger than the headline number suggests. However, a weak quarter could also boost the chance of more QE from the BOE, which should be pound negative.
The minutes of the Bank of England meeting from April will be released on Wednesday. These are expected to show another 6-3 split, with three members, including Governor King, voting for more QE. We believe the minutes will show that that ongoing debate about the effectiveness of QE continues to rage on at the BOE. However, we tend to think that the data up until the April meeting was not bad enough to justify more stimulus. If the economy slips back into recession in Q1, that could be the trigger for a more accommodative BOE going forward. Also, we believe that the BOE under Carney, who takes up the post of Governor in July, will advocate further QE expansion and a very dovish stance. Thus, in the medium-term we remain GBP bears. GBP/USD reached a high of 1.5410 last week, which is now key resistance. We think this cross is a sell on rallies, and it will only continue to appreciate if the external risk environment remains supportive. Dovish minutes, or weak labor market or retail sales data, could hurt this cross. Key support lies at 1.5220—the base of the daily Ichimoku cloud, while resistance above 1.5410 lies at 1.5430 then 1.5495 in the short term. We think any moves to these levels will be met with a wave of sterling selling.
Figure 2: GBP/USD daily
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US Economy Off to a Slow Start to Q2
Economic data releases for US indicators in March show that the economy got off to a rough start in Q2. The March employment report was very disappointing with a below 100K print. The slowdown in employment growth and wage growth was reflected in the retail sales figures, which unexpectedly fell by -0.4% in March on both the headline reading and on sales excluding autos. With personal consumption making up a large portion of the US economy, recent data does not bode well for Q2 growth. While employment figures in March were seemingly unaffected by government spending cuts (only a net -7K jobs from the public sector), if the sequestration remains in place, the impact is likely to be felt in the coming months. Consumer confidence as measured by the University of Michigan dropped to the lowest level in nine-months as pessimism grew amid fiscal consolidation. Budget talks in Washington are ongoing and until a credible plan is in place, the economic recovery may be restrained.
In the week ahead, industrial production and regional manufacturing reports will be released including the Philadelphia Fed index and Empire manufacturing. Consumer prices are also scheduled next week, and if producer prices are any indication of the outlook for CPI, the risk is to the downside (PPI fell by the most since May 2012). Softness in inflation is likely to reinforce current Fed stimulus and may weigh on the USD. Housing data is also scheduled with homebuilders’ confidence, housing starts, and building permits for March due. We expect economic data to continue to be on the soft side as the economic recovery moderates from Q1.
The impact on currency markets may not be so clear. Weakness in US economic data suggests continued Fed purchases, which is viewed as a negative for the buck, while risk aversion tends to benefit the dollar. What we have seen in the past is that with no imminent adjustments expected to Fed policy, the dollar tends to respond more to the broader risk environment. On the other hand, when the monetary policy discussion intensifies, the USD responds more to Fed expectations. For now, the Fed is likely to stay the course and maintain policy so risk sentiment may be more of a factor driving the USD. As this is a dynamic relationship, we will continue to monitor developments.
BOC to Hold Steady
The Bank of Canada (BOC) will meet to announce interest rates next week and we expect that the bank will keep rates steady at 1.00%. Though the BOC benchmark rate has been unchanged since 2010, the policy meeting continues to impact markets with the Bank’s assessment of the economic outlook and interest rate rhetoric as the key drivers. Therefore with the likelihood that rates remain on hold, the focus as usual will be on the tone of the statement and outlook for interest rates.
Since the March meeting, economic indicators show that inflation picked up and the housing market remains strong. Labor developments were mixed with the most recent employment report being very disappointing. The unemployment jumped to 7.2% in March from 7.0% after a loss of -54.5K jobs which more than reversed the 50.7K gain in the prior month. Moreover, of the decline of -54.5K, -54K came from a drop in full time employment. Housing starts remained strong with 184K in March and building permits continued to rise. Consumer prices were much stronger, growing at 1.2% on yearly basis in February (prior 0.5%). This is significant because the BOC’s main focus is to keep inflation in the 1-3% target range with the Bank’s monetary policy aimed at keeping inflation at the 2% target midpoint.
NEXT PAGE: USD/JPY Backs Off from 100|pagebreak|
At the most recent meeting, the BOC indicated that “the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be require, consistent with achieving the 2% inflation target”. The rise in inflation therefore may allow the Bank to maintain the language regarding the withdrawal of stimulus, however that inflation is still towards the low end of the Bank’s range, we expect that there is no urgency to indicate a hike in rates.
Technically, USD/CAD has been trending lower since peaking on March 1 ahead of the 1.0350 level and the pair has since been drifting towards parity. There is notable support around 1.0080, which is the 50% retracement of the entire 2013 range and the base of the daily Ichimoku cloud. A break below here would likely see towards parity while the top of the channel converges around the 21-day SMA as the key upside pivot.
Figure 3: USD/CAD 4-hour Candlestick Chart
USD/JPY Backs Off from 100
Bank of Japan Governor Kuroda will be speaking next week. He recently said that steps taken are sufficient to achieve the 2% inflation target and that the BOJ will carefully monitor market reactions of its operations. Kuroda said that “we will monitor closely what happens with the currency rate and how it affects the economy.” He also noted that the exchange rate won’t dictate Japan monetary policy and added that monetary policy is not aimed at affecting yen rate. USD/JPY has risen sharply since Kuroda took over at the BOJ, and this week the pair came within pips of the major psychological 100.00 level, which is also where the top of the current bullish channel comes in. It appears to be correcting lower within its longer-term upwards trend as traders book profits on yen shorts.
It seems that the BOJ is content with current policy as the Bank indicated that it has done what’s necessary and possible for now. Officials and market participants have voiced their doubts about how effective the policy response will be in achieving the 2% inflation goal within the two-year time frame. Japanese Finance Minister Aso recently said that it is not easy to achieve 2% inflation in two years and former BOJ deputy Kazumasa Iwata said that it is “impossible to achieve 2% inflation in two years” adding that it “won’t be easy even in five years”. We think that the JPY is likely to remain weak for now, but in the absence of fresh stimulus and as market doubts rise, the currency is vulnerable to corrective moves.
It is also of note that JPY weakness may have a negative impact on economic growth Japan as noted by Abe’s economic advisor. He said that USD/JPY at 100 is no problem, but that 110 would be detrimental with regards to high import prices. Therefore, it is likely that JPY downside may be limited if the costs of having a weaker currency outweigh the benefits. It will take time for the policy response and changes in the exchange rate to filter through to the real economy however and we will be monitoring the effects on growth and prices.
By Kathleen Brooks and Eric Viloria, CMT, of Forex.com
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