How ECB Could Prepare Investors for More Easing

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Daily FX Market Roundup 08.29.14

How ECB Could Prepare Investors for More Easing

Great Month for the Dollar

Why Sterling Could Rally Next Week

CAD Supported by Stronger GDP Growth

NZD: Major Downside Risk for Terms of Trade

AUD: Australian and Chinese Manufacturing PMI Next

JPY: Depressing Data Increases Pressure on BoJ to Ease

How ECB Could Prepare Investors for More Easing

There are 5 central bank meetings next week but the European Central Bank’s monetary policy announcement will be the most important. In fact the ECB meeting could even trump the U.S. non-farm payrolls report in terms of its impact on the EUR/USD. In no way shape or form is the ECB ready to roll out Quantitative Easing but given recent economic reports, particularly from Germany, the case for additional stimulus is growing. Although core Eurozone CPI growth ticked up in the month of August, the steep decline in German retail sales, increase in unemployment, deterioration in consumer, business and investor confidence all point to a loss of momentum in the Eurozone’s largest economy. While it would be easy to blame all of this on the Russian/Ukraine conflict, Russian exports represent only 1% of German GDP. The problem for Germany and many other countries in the region is restrictive fiscal policy. Low inflation is still a big problem but today’s increase in core CPI growth could make Mario Draghi more comfortable with leaving monetary policy unchanged next week. With the first TLTRO program expected in September, the central bank may opt to wait and see how the uptake is before increasing stimulus. Yet we do not expect the central bank to stand aside and do absolutely nothing next week. The course for the ECB is clear and the only question is how quickly and in what form will they will ease again. There are many ways that the central bank could prepare the market for more stimulus without actually making any immediate changes to monetary policy. The easiest way would be to significantly lower their GDP and inflation forecasts – don’t forget that their staff forecasts will be released next week. They could also pre-announce ABS purchases with details to follow. The latter would obviously have a more significant impact on the euro than the former. Some economists are also calling for a 10bp deposit rate cut which would constitute easing but we think the central bank will postpone this move to September. Unless the ECB does nothing at all or makes only a small change to their staff forecasts, the ECB meeting should accelerate the losses in the EUR/USD.

Great Month for the Dollar

August was a great month to be long U.S. dollars and while there was only a small amount extension in the dollar’s rally this past week, the currency held onto its gains against most of the major currencies. Investors continued to buy dollars in the face of stronger and weaker economic reports. On Friday for example, the greenback traded higher against all of the major currencies with the exception of CAD despite mostly softer data. Personal income growth slowed to 0.2% while personal spending dropped -0.1%, the first decline in 6 months. Manufacturing activity in the Chicago region accelerated significantly and consumer confidence as measured by the University of Michigan consumer sentiment survey was revised higher. As we noted all week, the voracious demand for dollars stems not from the impressiveness of the U.S. economy but from the lack of better alternatives. At bare minimum, the U.S. economy is moving in the right direction with a central bank that is in the process of unwinding and not boosting stimulus. The big question now is how quickly the Federal Reserve will raise rates. Janet Yellen provided zero insight at Jackson Hole but next week’s economic reports and speeches from Fed Presidents could shed light on the central bank’s plans. The Non-farm payrolls report is hands down the most important piece of data on the U.S. calendar and by all counts, job growth is expected to accelerate. Weekly jobless claims printed below 300k three out of the last four weeks with the 4-week moving average of claims consistent with +200k job growth. Manufacturing and non-manufacturing ISM numbers are also scheduled for release along with the Beige Book.

Why Sterling Could Rally Next Week

We are looking for a stronger rebound in sterling next week based on the prospect of positive economic data. Although there was not much in the way of U.K. data released this past week, nearly all of the second tier economic reports fueled expectations for a stronger recovery. This morning for example, Nationwide reported a 0.8% increase in house prices, exceeding the market’s 0.3% forecast. Last night, GfK reported a rebound in consumer confidence with more respondents to their survey looking for an improvement in the economy. This follows a sharp rise in the CBI retail sales report and the British Chambers of Commerce’s decision to upgrade their 2014 GDP forecasts. We are looking for this strength to carry through into next week’s PMI reports. If the PMI manufacturing and service indexes show acceleration in growth during the month of August, it could be just what sterling needs to stage a stronger recovery. The Bank of England also has a monetary policy announcement but no changes are expected which means it will be a nonevent for the currency. GBP/USD consolidated for the past week between 1.6518 and 1.6614. It failed to close above 1.66 on every occasion but its persistence in testing this level signals the market’s desire for an upside break.

CAD Supported by Stronger GDP Growth

The Canadian dollar traded ended the day unchanged versus the U.S. despite stronger than expected GDP numbers. Canada’s economy expanded by 3.1% in the second quarter, the strongest pace of growth since Q3 of 2011. Improvements in demand at home and abroad fueled the pick up in economic activity with exports rising 17.8%. According to Statistics Canada “the quarterly growth was a result of increased economic activity in all sectors of the economy except non-profit institutions serving households.” While USD/CAD extended its decline only slightly after the GDP report, the improvement in growth along with the uptick in retail sales and employment should make the Bank of Canada slightly less dovish. The BoC is not expected to change monetary policy next week but a more optimistic view could encourage further gains in the loonie. Aside from the rate decision, the country’s trade balance, employment and IVEY PMI reports are also scheduled for release. Meanwhile the Australian and New Zealand dollars traded lower. Sunday night will be a busy one for both countries with New Zealand’s terms of trade scheduled for release followed by Australian and Chinese manufacturing PMI numbers.

JPY: Depressing Data Increases Pressure on BoJ to Ease

The Japanese Yen traded lower against all of the major currencies today following a series of disappointing economic reports. The jobless rate increased, overall household spending fell more than expected, CPI growth eased, retail sales declined, housing starts plunged and industrial production growth slowed. In fact there was not one piece of good news in last night’s economic reports and unfortunately this means the economy is still struggling to recover from the retail sales tax hike. Policymakers have been looking for a recovery in the third quarter but based upon these reports, they should be growing more worried about loss of momentum. Spending continues to fall even as the initial shock of the tax hike fades and most importantly, industrial production growth failed to pick up. IP increased a mere 0.2% in July versus a forecast of 1%. While no changes in monetary policy are expected from the Bank of Japan next week, the case for further easing strengthened, making the Yen a more attractive funding currency.

Kathy Lien
Managing Director

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