The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The Forex Trading Week Ahead
07/29/2013 6:00 am EST
Kathleen Brooks and Chris Tedder, of Forex.com highlight the events and indicators likely to shape the forex markets this week.
FX Return Analysis
The dollar had another rough week as it continued to lose ground versus the G10. After being the strongest currency in the G10 since the start of this year, last week the euro, Swedish krone, and Danish krone all moved into positive territory vs. the US dollar for the year so far. One of the biggest questions for FX traders today is: has the strong dollar theme run its course?
The NZD was the strongest performer last week after the Reserve Bank of New Zealand (RBNZ) adopted a hawkish tone at its latest policy meeting. Although the RBNZ kept rates on hold, it kept a tightening bias in its statement as it tries to dampen house prices and avoid a property bubble. The contrasting monetary stance between the RBNZ and the Fed is helping to drive inflows into the kiwi.
The JPY is also a top performer over the past week as it has stalled the USD’s attempt to break above 100.00 in USD/JPY for the last few weeks. The JPY is being buoyed by some good news including further evidence that Japan is emerging from deflation and a strong win for current Prime Minister Abe in recent elections, which could bring some political stability to the country.
Interestingly, the dollar fell nearly 2% on a broad-based basis last week yet Treasury yields have climbed higher in recent days. Usually when yields are rising, this boosts the dollar. If yields can remain at this level, then we could see a recovery in the dollar in the coming days.
There has been a change in trend in the dollar, after having a strong first half of the year, it is rapidly giving back gains. In particular the USD is under-performing versus the Scandinavian currencies and the NZD. This is mostly down to relative monetary policies with the NZ, Swedish, and Norwegian central banks taking a more hawkish stance than the Fed in recent months.
In contrast, some uncertainty around the next move from the Bank of England has weighed on GBP although it managed to claw back some gains last week. Likewise, the yen remains weak as the Bank of Japan sticks to its economic stimulus plan.
The Battle for Fed Governor Hits the Dollar
The dollar nose-dived at the end of last week and this was partly attributed to the frenzy surrounding who will be the next Fed Chairman when Ben Bernanke is expected to leave his post in early 2014. Right now the front-running candidates include vice-chair at the Fed Janet Yellen and former Treasury Secretary and economist Larry Summers. So how do they stack up?
The dove’s choice: Janet Yellen. She is considered one of the most dovish members on the FOMC, which is dollar negative as it may throw the tapering of QE3 into some confusion were she to get the job. However, she is also known as a consensus builder, thus she may be able to meet some of the more hawkish members of the Fed in the middle rather than try to hammer through her own dovish agenda. Since the Fed tends to prefer to hire staff from inside the Bank, she is considered the front-runner. She would also be the first woman chairman, which could be a symbolic coup for the Obama Presidency.
The Pragmatist: Larry Summers. He is considered less dovish than Yellen after openly stating his concerns with quantitative easing as a monetary policy tool back in 2011. He also comes with a mixed reputation. He has been involved in plenty of controversy during his career as Treasurer and as the 27th President of Harvard, where he was forced to resign. However, he is well-respected globally and his political and economic pedigree cannot be disputed.
NEXT PAGE: Weak GDP vs. Strong Payrolls|pagebreak|
An official announcement on Friday said that the new Fed chairman will not be chosen until the autumn, so the race for a new chairman now is now well and truly started. However, there will also be other replacements at the Fed next year, as Elizabeth Duke and Jerome Powell are all scheduled to leave. Added to this, two further members may choose to end their terms early.
In 2014, we could be facing an interesting situation where the Obama administration has appointed every member of the FOMC. This could be perceived as dovish since the Democratic government is unlikely to want tighter monetary policy if it jeopardizes the economic recovery. Thus, doubts may start to creep in about the Fed’s long-term commitment to tapering, which could add further downward pressure on the USD in the coming weeks and months and also cap US bond yields.
Weak GDP vs. Strong Payrolls
There is a surge in US event risk this week: first up we have Q2 GDP, then the latest FOMC meeting and finally payrolls on Friday. Also thrown into the mix are ISM manufacturing and some consumer confidence data.
Q2 annualized GDP is expected to decline to 1% from 1.8% in the first three months of the year. The US has been plagued by mid-year slumps in recent years, so will this decline in growth hurt prospects for tapering QE3 later this year? We don’t think that it will do for a couple of reasons. Firstly, the slowdown in growth in Q2 may have been down to a fiscal squeeze as government spending slowed, thus it may be seen as a temporary blip. Secondly, this week’s data includes GDP revisions all the way back to the 1920’s, so it could be particularly hard to read. We could be in a situation where Q2 2013 growth is weak, yet growth in years gone by is revised higher.
The other anomaly in this week’s data could be weak GDP and strong job growth. The market expects a 185k increase in payrolls after a 195k increase in June. The market will be looking for something around the 200k ball park figure and the market could be sensitive to any slowdown in jobs growth. The risk is that US growth forecasts for 2013 as a whole are revised lower on the back of a weak Q2; however there are signs that the underlying rates of growth in the US remain robust. The final reading of July PMI was revised higher to its best level for 6 years and the ISM manufacturing report for July is expected to rise to 52.0 from 50.9, well into expansion territory.
This leaves a bit of a quandary for the Fed, whose meeting concludes on July 31. There is no press conference with out-going Chairman Ben Bernanke in August and a report in the Wall Street Journal last week said that the Fed would stick with QE3 through this meeting, which eradicated any hope that tapering could start early. This weighed on the dollar, which sunk against all G10 currencies last week (see the FX return analysis for more.) The Fed’s statement will be scrutinized, but we doubt it will go off message: 1, tapering does not mean tightening; 2, interest rates will remain low for a prolonged period and 3, the timing of tapering will be dependent on the economic data.
Overall, the dollar looks like it may have peaked for now. There is a risk of a further sell off after USD/JPY, GBP/USD, and EUR/USD all crossed some important dollar-negative thresholds last week. Interestingly, Treasury yields rose last week hitting a two-week high above 2.6%, yet this did not support a strong dollar. There may be some hesitation as we lead up to next week’s major event risks for USD. If the economic data disappoints then we could see yields fall back, weighing further on USD in the short term.
NEXT PAGE: Fundamental Wrap: UK and Europe|pagebreak|
Fundamental Wrap: UK and Europe
The Q2 GDP report for the UK was a rare bit of good economic news. Perhaps the most interesting part of the report was that all sectors of the economy: services, manufacturing and construction were higher. Although the UK economy still remains more than 3% smaller than its pre-recession peak, the good news is that the UK is not so reliant on the consumer and growth is becoming a little more balanced.
Ahead this week, we don’t expect any change from the Bank of England when it meets on Thursday. The Bank is likely to wait until the Inflation Report on August 7 before it announces any changes to policy like forward guidance. We think that QE is on the back burner for now as the economy has picked up and the latest July manufacturing PMI reading (also released on Thursday) is expected to remain at strong levels above 50.
If the BOE does release a statement with its policy decision this week and it mentions the term forward guidance then we could see the pound sell off. GBP/USD broke above a key resistance level at 1.5380 on Friday; the base of the daily cloud, the next level of resistance that could thwart the bulls is the cloud top at 1.5470. Overall, we think the pound could drift lower in the next couple of weeks as we wait for the BOE Governor Mark Carney’s first Inflation Report.
It’s a little over a year since ECB head Mario Draghi said he would do whatever it takes to save the euro. Since then borrowing costs have dropped for Europe’s peripheral economies and EUR/USD is up by about 10%. So can he manipulate the markets in the same way at the ECB meeting on Thursday?
The market expects no change from the ECB this week, and instead the focus may be on Draghi’s reaction to the pick-up in the July PMI survey data into expansion territory for the first time in 2 years. While we expect the Bank to welcome the improvement, there is still a lot to keep the ECB head awake at night. Its Q2 lending survey found an increase to lending to the consumer sector, but lending to businesses tightened further, particularly in the periphery. Thus, there are still problems with the ECB’s transmission mechanism not passing through to the real Eurozone economy, which supports further action from the ECB. Thus, we may see the ECB lay the ground work for a future rate cut if the lending data does not pick up, which could be EUR negative. In EUR/USD 1.3185—the daily cloud top—is a key support level in the lead up to the ECB meeting.
Also watch out for unemployment and inflation data, the unemployment rate is expected to rise to a fresh record high at 12.2%, even with the pick-up in Spanish employment, while inflation is expected to remain below the ECB’s target at 1.6% for July. Spanish retail sales for June are also expected to tank, so recent enthusiasm for the EUR could be curbed this week.
NEXT PAGE: Abenomics is Making Inroads|pagebreak|
Abenomics is Making Inroads into Ending Deflation in Japan
Abenomics has been given a big tick of approval by Japanese voters, with Shinzo’s Abe’s Liberal Democratic Party (LDP) winning a clear majority in the upper house elections last weekend. This has given Abe a green light to implement his so-called third arrow, structural economic reform. The first arrow came in the form of a massive monetary injection from the BoJ and the second was a massive stimulus package from the government, but the third may be the most important. The final arrow is the government’s way of addressing certain structural imbalances in Japan which are threatening long-term, sustainable growth, which has long-term implications for JPY assets.
Recent CPI data shows that the government is making headway into ending Japan’s deflation, with core consumer prices rising 0.4% y/y in June, beating estimates of a 0.3% rise. But the island nation isn’t out of the woods yet, in fact it is far from it. Core CPI excluding energy—Japan’s rejection of nuclear power means it has to import massive amounts of electricity—fell 0.2%, continuing more than four years of declines. While the deflationary trend may be changing in Japan, the BoJ’s 2% inflation target it wants to meet in 2 years is still looking ambitious.
BoJ Governor Kuroda is speaking today at the Research Institute of Japan, where he is expected to reiterate his commitment to achieving 2% inflation at all costs. Also, we expect the governor to point towards June’s CPI data as evidence that the bank and the government are making headway towards the BoJ’s inflation target. The market will be on the lookout for possible guidance from Kuroda on what can be expected from the BoJ at its policy meeting in early August. However, we aren’t expecting him to stray very far from the official line that the bank will do whatever it can to end deflation, but specific details are unlikely at this stage.
The yen has spent most of this month consolidating around 100 against the US dollar. From here, we are looking for a break of this consolidation pattern (see chart). In the near-term, Japan’s stronger than expected CPI data may underpin yen strength. But this may be weighed against possible USD movement in the lead-up to US NFP data and a policy meeting at the Fed this week.
Australian CPI Data Leaves the Door Open for Further Interest-Rate Cuts
Australian consumer prices rose 0.4% in the June quarter and 2.4% from a year earlier, a little shy of analysts’ estimates of 0.5% and 2.5% gains, respectively. However, underlying inflation was a little higher than expected, with trimmed mean and weighted median CPI increasing 2.2% y/y (expected 2.1%) and 2.6% y/y (expected 2.4%) respectively. The latter two measures of CPI are watched closely by the RBA, is you average them you will see there has been little change in inflation between Q1 and Q2. .
The RBA’s target range for inflation is 2-3%, thus current levels shouldn’t be enough to stop the bank from cutting interest rates if it deems it necessary to support demand. Breaking the CPI data down, non-tradable inflation jumped 4.3% from a year earlier, though it’s decelerating rapidly quarter by quarter and may continue to slow in coming quarters. Furthermore, once the effects of the carbon tax are taken out, which was introduced a year ago and resulted in a temporary jump in prices, underlying inflation is slightly lower. Overall, we think price pressures are well contained and shouldn’t hinder the RBA from lowering interest rates by another 25 bps at its next meeting if the bank sees a need to stimulate demand.
NEXT PAGE: Is the RBNZ Trying to Calm the Housing Market?|pagebreak|
Since the RBA last met the unemployment rate jumped to 5.7% from 5.5%, and both business and consumer confidence has taken a dive. Some of the rise in the unemployment rate can be attributed to an increase in the participation rate as people come back into the workforce but they are failing to find full-time employment. Instead, we are seeing an increase in part-time employment which isn’t indicative of a healthy labor market. Furthermore, consumer confidence appears to be trending lower—it fell another 0.1% in July according to Westpac—and business conditions indicators remain abysmal.
Retail sales and building approval indicators are yet to be released before the RBA meets on August 6. The housing market appears to be strong but consumers are yet to fully respond the RBA’s previous rate cuts. Retail sales are expected to have been fairly lackluster during June. On balance, we think the data will support the case for another rate cut from the RBA, but it’s going to be a very close call. The bank may choose to keep its cards close to its chest as it waits for more economic data over the coming months/weeks.
If this week’s building approvals data (expected 2.5% m/m for June) significantly disappoints the market, then we may see a sharp sell-off in the Australian dollar as bets of a rate cut from the RBA in August increase, especially considering Australia’s housing market is one of the few bright spots in the economy. In which case, a drop below 0.9000 for AUD/USD cannot be ruled out.
Is the RBNZ Trying to Calm the Housing Market?
At its July meeting the Reserve Bank of New Zealand (RBNZ) elected to keep the official cash rate at 2.5%, as expected, but Governor Wheeler stated that the RBNZ may need to remove monetary stimulus to counteract a rapid increase in house prices in some of NZ’s major cities. The bank is already in the process of introducing certain measures to cool the property market, including increasing deposit amounts and bank reserve ratios. But it may only be a short-term solution given the strength of property prices in NZ. A rate hike from the bank is becoming more likely in the coming months. It is more a question of when the bank will elect to tighten policy.
The NZ dollar remains a point of concern for the RBNZ. In fact, the dollar is one of the main reasons why we don’t expect the bank to raise interest rates until next year. With rather begin inflation; the RBNZ has the luxury of waiting to raise interest rates.
This week sees the release of NZ business confidence data, which isn’t expected to have changed much over the month, thus the immediate impact on the NZ dollar may be limited. However, an expected divergence of policy between the RBA and the RBNZ, with the latter becoming more hawkish as the former becomes more dovish, is weighing on AUD/NZD.
There has been a broad move away from the Australian dollar on the back of mixed domestic inflation data and weak Chinese manufacturing PMI figures, and a flood towards the kiwi after a slightly hawkish RBNZ policy statement last week. Furthermore, NZD/USD failed to breach a support zone around 0.7910 prior to the RBNZ policy meeting. Overall, this sent AUD/NZD to a 55-month low.
While we still retain our overall bearish bias towards this pair, underpinned by a divergence of monetary policy between Australia and New Zealand, there is the possibility of a retracement in the short-term. A pull-back may be considered a natural correction given how oversold this pair looks. However, a break of these support levels may see the pair sink even lower, as the bears still appear to be in overall control of price action. In the event of a push higher, 1.1650 is a key resistance level for the pair.
By Kathleen Brooks and Chris Tedder of Forex.com
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