The Euro continued its dominance against the US Dollar for the third consecutive week of trading, closing above the psychologically significant $1.50 mark for the first time in 14 months. Unlike previous weeks, however, the single currency persevered against the safe-haven US Dollar despite relatively lackluster performance in the S&P 500 and other key risk sentiment barometers. Last week we argued that the high-flying EURUSD would increasingly need support from risky assets to continue its impressive rallies. Yet the S&P 500 finished the week 0.75 percent lower and yet the Euro traded higher. A surprisingly bullish streak for key European economic data seemingly made the difference, and fundamental forecasts for domestic growth remain quite bullish. Whether this is enough to propel the Euro to fresh highs is perhaps another matter, however, and a relatively important string of economic releases could force substantive shifts in Euro forecasts.
Impressive German IFO Business Confidence figures and Euro Zone Purchasing Manager Index numbers set the stage for respectable recovery across broad swaths of the regional economy. Indeed, sanguine growth forecasts have led traders to price in relatively substantial interest rate hikes from the European Central Bank. The lure of higher yields has undoubtedly played a part in Euro/US Dollar rallies, but the extent of Euro appreciation leaves it at clear risk of pullback. ECB watchers will keep a close eye on the coming week’s German and Euro Zone Consumer Price Index figures for important surprises. Current consensus forecasts call for yet another negative year-over-year change in Euro Zone Consumer Prices, but the rate of contraction is expected to narrow to a meager 0.1 percent. Suffice it to say, any material disappointments could make a considerable dent on ECB interest rate expectations. Wednesday’s German CPI figures could subsequently set the tone for near-term Euro/US dollar trading.
Traders will otherwise keep a close watch on global risky asset classes—especially as the Euro’s correlation to the S&P 500 trades near record highs. The US Dow Jones Industrial Average’s close below the psychologically significant 10,000 mark suggests that financial market risk appetite is not quite as robust as previously believed. Yet we would hardly call for a market top without a more substantive pullback across a broad swath of indicators. FX Options market volatility expectations have come down since last week’s peak, but it should be yet another week of eventful price action out of the Euro and US Dollar in the face of noteworthy event risk. - DR
Tuesday, October 27, 2009
Euro Top Remains Elusive, but ECB Rate Forecasts May Bring Reversal
Japanese Yen on Pace for Further Losses Against Euro, US Dollar
The Japanese Yen fell against major forex counterparts for the third week in a row, slipping further on outperformance across key risky asset classes. Yet the 20-day correlation between the US Dollar/Japanese Yen pair and S&P 500 actually turned negative for only the second time in two years—emphasizing ongoing shifts in FX market dynamics. The Yen has long been the go-to currency during times of market stress and, by extension, the first to fall through financial market booms. As the lowest-yielding currency in the industrialized world, investors aggressively borrowed JPY to fund investments in sources of higher income. More recently however, the US Dollar has taken the dubious honor of the cheapest currency to borrow across global financial markets. The surprising shift goes a long way in explaining the USDJPY pair’s inverse correlation to key risky assets, and it will likely remain a major factor for the Japanese Yen through the foreseeable future. Week in and week out, we have repeated that financial market risk sentiment and the trajectory of the S&P 500 would be the major determinant of USDJPY price action. Of course, the substantive shift in risk correlations would suggest USDJPY moves may depend on other fundamental factors. Against other counterparts, the Yen’s continued losses show little investor interest in buying and holding the low-yielding currency. Given its extraordinarily low yield, holding Japanese Yen is an expensive proposition; the trader must pay higher interest rates to receive paltry JPY yields.
A cursory look at a Yen chart will show you that the currency will tend to lose more often than it gains—except to note that its rallies are far sharper than its declines. That is to say, FX traders avoid buying Yen unless they absolutely have to. And when they are forced to cover JPY short positions, they typically do so in a hurry. Given these JPY trading dynamics, we believe that the Japanese Yen is likely to continue drifting lower against the Euro, British Pound, Australian Dollar, and New Zealand Dollar. The wildcard remains whether we can expect a noteworthy correction in broader financial market risk sentiment.
Impressive performance and fresh highs across key barometers leaves markets at prime risk of pullback. Yet too many traders have gone bust in trying to time a market top. Until we see plausible signs of market turnaround, we have little reason to believe that the Japanese Yen may recover against higher-yielders. The admittedly unpredictable dynamics between the US Dollar and Japanese Yen make the USDJPY an especially challenging pair to trade. If nothing else, however, its recently bullish momentum is likely to keep it aloft through the coming week of trade
British Pound Decline Could Continue on Falling BOE Rate Forecasts
The British pound racked up heavy losses on Friday, tumbling 1 percent against the Japanese yen and nearly 2 percent against the US dollar, after UK GDP unexpectedly showed that the nation did not emerge from recession during Q3, and instead, the economy contracted for the sixth straight quarter at a rate of -0.4 percent. Likewise, the annual rate of growth edged up to -5.2 percent from -5.5 percent, falling short of expectations for a move to -4.6 percent. A breakdown of the GDP report showed that nearly every UK business sector remained in recession, as the services industry component fell by 0.2 percent while the production industry component tumbled 0.7 percent. Going forward, it’s worthwhile to note that GDP is a lagging indicator and the release’s impact on interest rate expectations is the most important part. Indeed, the British pound fell sharply because Credit Suisse overnight index swaps shifted to price in a 10 percent chance of a 25 basis point cut by the BOE during their next meeting. Furthermore, expectations for rate increases over the next 12 months fell to 88.1 basis points from 93.4 basis points. While the BOE hasn’t really given any indication of their collective stand on quantitative easing (QE) at this juncture, we do know that the Monetary Policy Committee (MPC) is looking for reasons to justify either winding down or expanding their target level of asset purchases. The minutes from their October policy meeting showed that the "forecast round ahead of the November Inflation Report would provide an opportunity to assess more fully how the medium-term outlook for activity and inflation had evolved since August," and if the latest economic data has any bearing on the MPC’s bias, it looks there is still some bearish potential for the British pound.
Looking ahead to the next week, UK data shouldn’t have too much of an impact on rate expectations, but there is always the lingering risk that BOE MPC members will make comments that could impact trade. Thursday is really the only day with scheduled indicators on hand. Net consumer credit in the UK is anticipated to remain negative for the third straight month at -0.2 billion pounds, but on the other hand, UK mortgage approvals are projected to hit a more than one-year high of 53,600, suggesting that lending levels remain low but housing demand is growing. Meanwhile, GfK consumer confidence is forecasted to climb to a nearly two-year high of -14 from -16, indicating that sentiment is still pessimistic but improving, albeit at a slow pace. All told, where GBPUSD goes in the coming week will likely have more to do with US dollar trends than UK fundamental forces, but a break below the 50 SMA at 1.6265 opens the door to much steeper declines. – TB
Swiss Franc Looks To Test Parity, Will SNB Intervene?
Two significant fundamental releases are on this week’s economic docket with the UBS consumption indicator and the KoF leading indicator on tap. Rising unemployment has weighed on domestic demand and although the economy has shown signs of emerging from its recession, the labor market remains weak as declining orders keep companies in cost cutting mode. Nevertheless, the outlook for the next six months is forecasted to rise to 1.10 from 0.85 on the back of an improving global economy. Regardless, traders should take their cue from risk sentiment with a week full of earnings reports ahead and the U.S. growth numbers. A test of parity is a possibility this week if risk appetite returns, but reversals can often follow tests of significant psychological levels. Also, traders must beware of possible intervention from the Swiss National Bank as they continue to fight against Franc appreciation and its negative implications for the economy. - JR
The Swiss Franc trended higher against the dollar over the past week as risk sentiment continued to drive price direction. Strong corporate earnings from Apple, JP Morgan and DuPont sparked risk appetite to start the week but concerns over valuations led to diminishing returns for bullish investors as equities struggled to hold onto gains. A disappointing U.K.3Q GDP reading, -0.4% versus 0.2%, has raised concerns that other G-7 nations will follow with dour growth results. The U.S. GDP report will cross the wires next week and a similar result could lead to support for the pair. Although Swiss fundamentals have little sway over Franc direction, the 2.3% drop in exports and 3.1% gain in imports during September were negative signs for the economy. Swiss Franc strength has been a concern for the SNB as it continues to deter foreign demand and foster deflation.
Canadian Dollar May Come Under Pressure Ahead of BOC Decision
The Canadian dollar eased back on Friday after the release of the nation’s consumer price index (CPI) fell for the fourth straight month in September, the longest series since 1953. Indeed, the annual CPI rate fell to -0.9 percent, but on the other hand, the annual rate of the Bank of Canada’s core CPI eased back less than expected to 1.5 percent from 1.6 percent, highlighting the impact of volatile commodity prices on inflation reports in the nation. Furthermore, the data sets the stage for the Canadian dollar’s main source of event risk this coming week: the Bank of Canada’s rate decision. The BOC is expected to leave rates unchanged at 0.25 percent once again. After the Bank left rates unchanged on September 10, they said that they would maintain a neutral stance through June 2010, and the rest of the statement was relatively optimistic as they said “GDP growth in the second half of 2009 could be stronger than…projected in July.” However, they also indicated that the Canadian dollar’s strength remained a threat to not only growth, but the return of inflation back to target. Overall, indications that the Bank still sees downside risks for inflation could weigh on the Canadian dollar, but as we’ve seen in the past, the currency is more responsive to changes in the economic outlook.
Other potential source of volatility for the Canadian dollar in the coming week comes from oil prices, which DailyFX Strategist John Kicklighter noted is showing signs of reversal, retail sales – which are forecasted to rise by a slight 0.1 percent – and the BOC’s Monetary Policy Report. However, it is that policy report that should draw the most attention as the BOC is likely to include updated outlooks on growth and inflation. That said, the key to price action will be revisions, as upward changes to GDP will lead the markets to aggressively price in rate increases in 2010. From a technical perspective, daily USDCAD charts show that RSI rose from oversold levels, which has typically yielded at least a few days worth of gains since the start of 2009. - TB
Australian Dollar Outlook Remains Bullish on Interest Rate Expectations
The Australian dollar rose to a fresh yearly high of 0.9326 against the greenback and the higher-yielding currency may continue to appreciate going into the following month as investors speculate the Reserve Bank of Australia to tighten policy throughout the second-half of the year. Credit Suisse overnight index swaps shows market participants are pricing a 131% chance for a 25bp rate hike in November and expect the central bank to raise borrowing costs by more than 200bp over the next 12-months, and the Aussie may continue to retrace the sell-off from the previous year as policy makers hold and improved outlook for the economy. The Reserve Bank of Australia Minutes said that the “very expansionary setting of policy was no longer necessary” as the $1T economy skirts the global recession, and went onto say that it may be “imprudent” for the central bank to hold the interest rate at the 49-year low as policy makers maintain their dual mandate to ensure price stability while fostering full-employment. Moreover, the central bank held a hawkish tone and said keeping borrowing costs at “very low levels” could raise the risks for inflation, and said that the “trough in inflation was significantly higher than earlier thought.” Moreover, RBA Assistant Governor Philip Lowe stated that the rebound in economic activity would “gradually lead to a normalization of interest rates,” and said that the country is likely to have “a higher average exchange rate than we’ve had over the past couple of decades.” However, the central bank expects the marked appreciation in the Australian dollar to temper the risks for inflation, and the central bank may adopt a wait-and-see approach over the remainder of the year as the outlook for global growth remains uncertain.
Nevertheless, the economic docket for the following week is likely to spark increased volatility for the Australian dollar and may drag on the exchange rate as market participants anticipate price pressures to weaken further in the second-half of the year. Economists forecast consumer prices to grow at an annual pace of 1.2% in the third quarter after rising 1.5% during the three-months through June, while producer prices are project to fall to an annualized rate of 0.5% from 2.1% in the second-quarter. At the same time, private-sector credit is anticipated to increase 0.2% in September following the 0.1% rise in the previous month, while bank lending is expected to grow at an annualized pace of 2.0% from the previous year. As a result, the slew of mixed data may leave the AUD/USD confined in a narrow range as investors weigh the outlook for future policy but nevertheless, as risk trends continue to dictate price action in the currency market, a rise in risk appetite may lead the high-yielding currency to hold above 0.9300 over the following week. - DS
New Zealand Dollar Rally May Stall as RBNZ Disappoints on Rates
The interest rate announcement tops the data docket, with economists calling for the Reserve Bank of New Zealand to hold rates at the record-low 2.5%. The markets seem to be in agreement, with a Credit Suisse index of priced-in expectations showing traders see no chance of a hike this time around. To that effect, all eyes will be focused on the statement accompanying the release, with investors looking to gauge whether the timetable for the withdrawal of monetary stimulus has been accelerated from the previously given “latter part of 2010” estimate after consumer prices unexpectedly surged in the third quarter. The hawks may be in for a disappointment however considering policymakers will be wary of acting on rates to protect the still very fragile export sector. Indeed, both the central bank and government have been very vocal about the detrimental effects of a higher Kiwi dollar in driving away foreign demand. Overseas sales make up over 30% of the economy’s total output, so any policies that stand to hurt firms catering to foreign markets will likely stunt the fledgling economic recovery of recent months. Appropriately enough, September’s Trade Balance figures are set to be released less than two hours after the central bank announcement crosses the wires, with exports expected to match the 23-year record drop recorded in the previous month even as the overall deficit narrows on lackluster import demand. In fact, the RBNZ may have already embarked on a somewhat covert tightening campaign aimed at checking inflationary pressure while minimizing the impact on the NZD exchange rate. The central bank “leaked” an announcement that it would end some of its emergency lending programs enacted amid the credit crunch in November, a fact that it did not officially confirm via an official news release until about a day later. This move will gradually slow the flow of liquidity into the economy, reducing the pace of money supply growth and acting against inflation. Policymakers’ approach to the announcement suggests they were consciously trying to avoid a snow-ball effect that would send the New Zealand Dollar steeply higher. It also hints that perhaps this approach to tightening will be seen as sufficient to stick with rates at current levels until the second half of next year as scheduled. Looking beyond the economic calendar, the outlook for risk sentiment is likely to remain a key catalyst for price action. Indeed, a trade weighted average of the New Zealand Dollar’s value remains over 95% correlated with the MSCI World Stock Index as traders’ appetite for returns boosts stocks, commodities and high-yielding currencies alike. To that effect, traders will keep a keen eye on a handful of high profile third-quarter earnings reports including those from consumer goods giant Procter & Gamble, big oil names including Exxon Mobil and Chevron, and US Steel.
