Will EUR Suffer if Europe Adds to Russian Sanctions?

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Daily FX Market Roundup 07.21.14

Will EUR Suffer if Europe Imposes More Sanctions on Russia?

USD: All Eyes on CPI and Yield Curve

GBP Extends Losses After Lower House Prices

Big Week for New Zealand

AUD: Beware of Jawboning from RBA officials

CAD: Oil Prices Rise 1.7%

Potential Recovery in Yen Crosses

Will EUR Suffer if Europe Imposes More Sanctions on Russia?

For the past 3 trading days, there has been very little change in the value of the EUR/USD. The currency pair attempted to break through 1.35 but failed to extend far beyond that level. The outlook for the Eurozone economy is mixed –German producer prices stagnated but the IMF raised next year’s German growth forecasts from 1.6% to 1.7%. While the economy probably stagnated in the second quarter according to the Bundesbank, a recovery is expected in the coming months. However if European nations move forward with additional sanctions on Russia, it could stall the Eurozone’s recovery. In the same report, the Bundesbank specifically attributed the lack of growth to geopolitical tensions amongst other factors and according to the German industry’s Committee on Eastern European Economic Relations, the crisis could endanger 25k jobs. Eurozone nations in general has been reluctant to impose stronger economic sanctions on Russia but with the latest sanctions form the U.S. and the Malaysian Airlines crash, Europe is under significant pressure to step up their penalties. European ministers are meeting tomorrow to discuss further sanctions but chances are they will fall short of expectations. U.K. Prime Minister Cameron called for tougher sanctions that would limit Russia’s access to European markets and restrict business activity but officials close to the matter believe that the sanctions will be limited to asset freezes. Europe’s reliance on Russian oil also limits their willingness to squeeze Moscow too tightly. Nonetheless, the euro won’t be immune if fresh sanctions are imposed on Russia. At bare minimum we expect business confidence to weaken with a possible decline in manufacturing and service sector activity. This week’s German IFO and Eurozone PMI reports will most likely be affected by the ongoing tensions between Russia and the rest of the world.

USD: All Eyes on CPI and Yield Curve

Despite the decline in U.S. yields, the U.S. dollar traded higher against all of the major currencies today. The most important piece of economic data that the U.S. will release this week will be tomorrow’s consumer price report. We don’t expect it to be a big market mover for the dollar but some economists believe that it is a number worth watching given the recent uptick in price pressures. While we agree that inflation in the U.S. most likely bottomed, it is still not at a level that would accelerate Fed tightening. In fact, the Treasury yield curve is at its flattest level in 5 years, which means that investors do not expect the central bank to take action any time soon. The Wall Street Journal’s Jon Hilsenrath pointed out a few reasons why the world still loves U.S. Treasuries (http://blogs.wsj.com/economics/2014/07/21/grand-central-why-the-world-still-loves-u-s-treasury-debt/) that is worth a read. He basically says that in a period of uncertainty, investors are still hungry for safe assets like U.S. Treasuries. Foreign central banks also can’t seem to give up their addiction to Treasuries and the prospect of slow U.S. growth means that long-term rates will remain low for a longer period of time. Meanwhile volatility continues to subside after Thursday’s spike. Investors believe that the potential disruption in oil supply will be small and the international response will be weak.

GBP Extends Losses After Lower House Prices

The British pound traded slightly lower against the U.S. dollar following a decline in house prices. Online property portal Rightmove reported that house prices in the U.K. fell 0.8% in the month of July. This was the first decline in house prices in 7 months and they are likely to fall further according to Rightmove director Miles Shipside who said more houses are coming onto the market. They attribute the latest decline to everything from summer holidays, the World Cup, stricter rules on mortgage lending and suggestions from the Bank of England that rate rises could come sooner than previously expected. This last part is what investors are hoping for clarity on this week. The minutes from the most recent Bank of England meeting is scheduled for release on Wednesday and if there is more skepticism and reluctance to raise rates this year, sterling could test 1.70. Alternatively if most policymakers seem to be on board with the notion of earlier tightening, 1.72 could be tested. While sterling weakened today against the dollar despite a more significant decline in U.S. 10 year bond yields than Gilts, traders should keep an eye on the yield spread because it has been a big drive of GBP/USD flows.

Big Week for New Zealand

This is an extremely important week for the New Zealand dollar. Since the beginning of the year, NZD has been the best performing currency and this should come as no surprise considering that the Reserve Bank of New Zealand is the only major central bank raising interest rates. Back to back rate hikes in March, April and June along with the promise of further tightening in July drove NZD/USD to its strongest level in more than 2.5 years. Over the past week however, the rally New Zealand dollar lost momentum as weaker economic data raised concerns about whether the central bank would slow or pause its tightening cycle this week. Nearly all market participants are looking for the RBNZ to raise rates but with the trade surplus shrinking, dairy prices falling, credit card spending slowing, and consumer prices easing, there’s a very good chance that the RBNZ could pause after raising interest rates 4 meetings in a row. If they opt to do so, it could cause the New Zealand dollar to sell off even if rates are increased. The magnitude of the reaction will depend entirely on the central bank’s guidance but regardless of which way they lean, we expect a significant movement in NZD/USD. New Zealand was the only country to release economic data overnight and according to their reports, net migration increased but credit card spending growth slowed. No major economic reports are scheduled for release from Australia, Canada or New Zealand over the next 24 hours but RBA Governor Glenn Stevens is scheduled to speak tonight along with Deputy Governor DeBelle so watch out for more AUD jawboning. NZD/USD and USD/CAD ended the day unchanged while AUD/USD gave back part of Friday’s gains.

Potential Recovery in Yen Crosses

There was very little consistency in the performance of the Japanese Yen today, which was not surprising given that Japanese markets were closed for a holiday. The Yen traded slightly lower against the Canadian and New Zealand dollars, higher against the Australian dollar and Swiss Franc and virtually unchanged versus the U.S. dollar and euro. While we were a bit surprised by the Yen’s lack of strength in the face of early weakness in U.S. equities, by the end of the North American trading session, U.S. stocks bounced off their lows, justifying the muted reaction in currencies. Since we do not expect a pickup in overall volatility this week, demand for the Japanese Yen could ease, leading to a rally in the Yen crosses. There are a number of important Japanese economic reports on the calendar this week but as usual, data from Japan tends to have a limited impact on the currency. Tonight, the all industry activity index is scheduled for release along with supermarket sales, the leading and coincident index. Later in the week, we look forward to the trade balance, manufacturing PMI and consumer price reports. Firmer economic reports will give the Bank of Japan stronger reason to keep monetary policy steady.

Kathy Lien
Managing Director

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