Forex: Beware of More Trouble from Russia and China

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Daily FX Market Roundup 03-20-14

Forex: Beware of More Trouble from Russia and China

Behind the Sell-off in Euro

GBP: Extends Losses Versus Dollar for Third Straight Day

CAD: Retail Sales a Risk to USD/CAD Rally

NZD: GDP Growth Slows in Q4 but Underlying Strength Persists

AUD: Supported by Rebound in Gold

JPY: Foreign Investors Dump Japanese Stocks

Forex: Beware of More Trouble from Russia and China

The rebound in U.S. equities and rally in the dollar tell us that investors are satisfied with today’s U.S. economic reports. Healthy labor and manufacturing data made investors hopeful that growth would not be curtailed by the central bank’s efforts to reduce stimulus. With yields at extremely low levels, there’s a reasonable chance that growth will continue as long as the Federal Reserve normalizes monetary policy in a slow and gradual manner. Investors continue to adjust their positions for a potentially earlier increase in interest rates. By saying that tightening will begin 6 months after QE ends, Janet Yellen has given investors a targeted timeline to base their positions. Today’s better than expected U.S. economic reports also reinforce the Fed Chairman’s upbeat assessment of the economy.

With weather disruptions behind us, manufacturing activity is beginning to improve. The Philadelphia Fed manufacturing index surged to 9.0 in March from -6.3 in February and leading indicators rose 0.5% last month compared to a forecast for only a 0.2% rise. The outlook for labor market remains positive with jobless claims rising less than expected from 315k to 320k. Claims have been hovering near 4-month lows for the past 2 weeks, which is consistent with a continued recovery in the labor market. Although continuing claims increased more than expected, it had little impact on the dollar because it doesn’t affect the central bank’s plans to taper. Existing home sales declined slightly but the 0.4% pullback was right in line with expectations. These stronger U.S. economic reports will lend continued support to the dollar.

Meanwhile in response to the sanctions from the U.S., Russia banned 9 American officials from entering the country including Speaker John A. Boehner, Senate Democratic Leader Harry Reid and Senator John McCain. So far the sanctions by both sides have been mild but President Obama plans to clamp down on Russia’s industrial sectors, which would have a more direct impact on the economy and could elicit a bolder response from Putin. Ukraine is starting to accept that Crimea belongs to Russia now but the crisis is far from over and poses a continued risk to the financial markets.

Defaults in China are also becoming a bigger problem for financial market stability. Earlier this week the country’s largest steel maker defaulted on CNY 3 billion in debt and Shanghai based Chaori Solar Energy said it will not be able to meet its bond payments. Today we learned that a major Chinese real estate developer is on the brink of bankruptcy. In the past, the Chinese government would step in with bailouts or extensions but these days we have seen more companies bite the dust with no government intervention. According to Chinese Premier Li Keqiang, more defaults are unavoidable. While allowing unhealthy companies to fail will make China’s economy stronger in the long run, in the short term it could cause its currency and equities to fall further, posing a risk to other markets around the world. So while stocks are doing well today, there are serious external risks worth monitoring.

Behind the Sell-off in Euro

The euro was one of the currencies hit the hardest today by the market’s demand for dollars. Weaker German producer prices add to the central bank’s concerns about inflation and widen the gap between U.S. and Eurozone monetary policies. After rising a mere 0.1% in January, PPI stagnated in the month of February. This marked the seventh straight month of negative annualized PPI growth for the Eurozone’s largest economy. Low inflation has been a persistent concern for the ECB and unfortunately it does not look like price pressures improved significantly last month. Meanwhile tensions between Europe and Russia remain high with Germany warning about additional sanctions if they fail to ease the crisis in Crimea. However with Ukraine waving the white flag and preparing to pull its military out of Crimea, the Ukraine government could be talking its own steps to ease the standoff in the region. The Swiss Franc held steady against the euro after the Swiss National Bank left monetary policy unchanged. EUR/CHF had very little reaction to the rate decision because there was nothing new in their forecasts or monetary policy statement. The SNB reiterated their pledge to defend the 1.20 EUR/CHF floor and lower their inflation forecast for 2014 and 2015 by 0.2%. Eurozone current account numbers are scheduled for release on Friday and the deterioration in Germany and France points to a slightly softer release that could add pressure on the euro.

GBP: Extends Losses Versus Dollar for Third Straight Day

The British pound continued to recover against the euro but extended its losses against the U.S. dollar for the third consecutive trading day. The Confederation of British Industry’s Industrial Trend Survey was the only piece of U.K. data released today and according to the report, orders are rising but prices are falling. This is consistent with the Bank of England’s view that the economy is improving but price pressures remain very low. The CBI index is a measure of manufacturing activity and the improvement bodes well for next month’s PMI index. According to BoE policymaker Martin Weale, slack in the economy could be used up in the next 2 to 3 years, which is faster than the central bank’s official forecasts. Nonetheless until the slack is used up, he expects rates to remain low. Public finances are scheduled for release tomorrow and while an improvement is expected, finances in general are pretty terrible with borrowing at dangerously high levels. The 1.65 to 1.6475 region serves as key support levels for GBP/USD. The currency pair first tested these levels during the early North American trading session and appears to poised to break through them in the coming days but the sell-off should be a function of dollar strength and not sterling weakness.

CAD: Retail Sales a Risk to USD/CAD Rally

After yesterday’s sharp decline, the commodity currencies ended the day unchanged against the greenback but not before USD/CAD rose to a fresh 4 year high. The turnaround in U.S. stocks helped to bolster risk appetite leading to a recovery in some risk currencies. The uptrend in USD/CAD remains intact but tomorrow’s retail sales report could lead to a steeper correction. Based on the rebound in wholesale sales, retail sales are expected to recover after falling 1.8% the previous month. Although Canada experienced job losses in February, the consumer spending report is for the month of January when job growth hit its strongest level in 5 months. Consumer prices are also expected to rebound but remain low on an annualized basis. Earlier this week Bank of Canada Governor Poloz said they may have to consider additional rate cuts if inflation or inflation expectations continue to fall. No major economic reports were released from Australian but New Zealand had Q4 GDP numbers. According to the latest report, GDP growth slowed to 0.9% from 1.2% in the last 3 months of the year, which was in line with expectations. Manufacturing activity grew at its strongest pace in 8 years and with domestic demand expected to rise further, the outlook is bright for New Zealand. Tonight, New Zealand job advertisements, consumer confidence and credit card spending numbers are scheduled for release. We continue to expect positive economic surprises. The recent increase in milk, cattle and beef prices will contribute to stronger farming incomes, higher wages and greater inflationary pressures. The market is currently pricing in more than 100bp of tightening by the RBNZ this year. Australia will release leading indicators, which is not expected to be a big market mover for the currency. Instead, traders should keep an eye on risk appetite, the market’s demand for U.S. dollars and China.

JPY: Foreign Investors Dump Japanese Stocks

With the muted increase in U.S. yields and the steep slide in the Nikkei overnight, the Japanese Yen traded higher against most of the major currencies. The sell-off in the Nikkei was largely attributed to the weakness in U.S. stocks on Wednesday but news that foreign investors dumped Japanese equities in size during the week ending March 14 also contributed to the weakness. The 1.1 trillion yen liquidation of Japanese stocks marked the largest one-week sale ever. One month certainly does not make a trend but such significant selling cannot be ignored. With the consumption tax poised to increase in just a few weeks, investors could be bailing in anticipation of weaker economic activity. Of course the Japanese government is confident that the economy will be able to withstand the tax increase and bounce back strongly. Given the rise in convenience store sales last month they could right. The Japanese on the other hand were net buyers of foreign bonds but sellers of foreign stocks. Although BoJ Governor Kuroda said on Wednesday that the hurdle for additional easing is high, today he indicated that the central bank will continue easing until 2% inflation is stable and would adjust policy without hesitation if needed.

Kathy Lien
Managing Director

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