4 Major Risks for Dollar in January

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Daily FX Market Roundup 01-04-13

4 Major Risks for Dollar in January
EUR: Finding Support at 1.30
GBP: UK Economic Challenges Begin to Surface
CAD: Another Blowout Employment Report
AUD: Surprise Contraction in Services Activity
NZD: Gold Drops to 4 Month Low
USD/JPY Up 10% Since Beginning of Q4

4 Major Risks for Dollar in January

It has been an exciting start to the year for the U.S. dollar. The Fiscal Cliff drama and the FOMC minutes increased the volatility for many currencies pairs, making trading far more exciting for those who have grown weary of quiet consolidations in the forex market. Even today’s non-farm payrolls report managed to trigger the usual knee jerk volatility in the EUR/USD followed by a small trend continuation in the hours that followed. We expect volatility to remain elevated in January with the dollar facing 4 major risks this month:

4 Major Risks for the U.S. Dollar

1. Shift in Monetary Policy Expectations
2. Earnings Season
3. Change in Treasury Secretary
4. Debt Ceiling Concerns

While the Federal Reserve is not expected to make a decision about ending QE3 for at least next 4 to 6 months, the fact that they are even considering terminating QE3 in 2013 is in our opinion, a game changer for the U.S. dollar. Investors will start to look at U.S. economic data differently. Previously, the general belief was that the Fed wasn’t going change monetary policy for the next 1 to 2 years but the FOMC minutes told a very different story – even before knowing the resolution to the U.S. Fiscal Cliff some Fed officials considered ending asset purchases in mid 2013. If economic data continues to improve, investors will start to consider this possibility more seriously. As a result, we expect U.S. economic reports to have an increased importance to the greenback, which means the potential for larger reactions in the US dollar.

The earnings season also kicks off on Tuesday and any big impact on stocks could trigger a reaction in currencies. The rally in equities has stalled and the next leg could be determined by the surprises and disappointments in Q4 earnings. If earnings are weak, equities and currencies could sell off and if they are strong, we could see a further improvement in risk appetite. Treasury Secretary Geithner is also expected to step down by the end of the month. Since the Treasury Secretary controls dollar policy, his replacement is important for the greenback but it has been a long time since the Treasury actively managed dollar policy. Instead, President Obama’s choice of Treasury Secretary will have a far more significant impact on fiscal policy, which is even more important considering that the debt ceiling is the most imminent risk facing the U.S. dollar. The U.S. officially reached its legal borrowing limit on Monday and the Treasury is currently reshuffling accounts in order to avoid defaulting on payments and these steps are expected to stave a default until February 28th. Congress will have to raise the debt ceiling soon but this will be a negotiation that will most likely rest on the shoulders of the new Treasury Secretary.

EUR: Finding Support at 1.30

The EUR/USD appears to be finding support at the psychologically significant 1.30 level ahead of next week’s European Central Bank monetary policy meeting. We expect the ECB to be relatively comfortable with the current level of monetary policy. Bond yields in Spain and Italy have fallen sharply as the sovereign stress in the region remains well contained. The Fiscal Cliff deal also removed a major near term risk for the Eurozone, which should alleviate some of the ECB’s concerns. As a result, we don’t expect comments from ECB President Draghi to add pressure on the euro. As reported by our colleague Boris Schlossberg, “On the economic front the PMI data from the region and German retail sales showed some stabilization and improvement. EU Final services PMI data printed at 47.8 but both Italian and Spanish services PMI reading improved to 44.3 from 42.7 and 45.6 to 45.1. Although the data remains well below the 50 boom/bust line, the latest readings from the region were second best monthly results in more than a year indicating that the service sector in the periphery economies is stabilizing and may be starting to recover. Meanwhile German Retail sales beat expectations rising by 1.2% versus 0.9% eyed. This was the second highest rise in more than a year and a good sign that the German consumer remains relatively confident about the economic conditions at home. Overall German retail sales fell in 2012 by approximately 0.1%-0.3% according to the statistics office.” Aside from the ECB meeting, Germany’s trade balance and industrial production are scheduled for release along with Eurozone confidence numbers next week.

GBP: UK Economic Challenges Begin to Surface

The British Pound traded lower against the U.S. dollar and euro following a surprise contraction in service sector activity. Markit Economics’ UK PMI report unexpectedly fell to 48.9 in December from 50.2 in November. It was the first time in 2 years that service sector activity contracted and this is terrible news for the U.K. economy, which is struggling to grow after rising out of recession in 2012. However this has helped drive EUR/GBP one of our favorite trades for 2013 higher. We expect the U.K.’s economic and fiscal challenges to become more apparent this year, leading to the underperformance of the GBP. Meanwhile UK stocks rallied after US data showed that employers hired more workers in December than expected and jobless rate remained unchanged. UK mortgage approvals met expectations as it rose 54.0K in November compared to 53.1K the previous month in a report released by the Bank of England. In a report yesterday, the BOE published a survey of lenders showing the availability of mortgages rose in the fourth quarter. The Credit Conditions Survey also showed that demand for home loans increased in the quarter and that spreads narrowed significantly. The BOE also says that availability of mortgages is expected to increase again this quarter as the data rose in the three months through December to the highest since the survey began in 2007. In a separate report by the BOE, it showed that the UK money supply fell 0.2% in November. M4 money supply measures the effectiveness of its asset purchases and had indicated a slowdown to 4.3% from 5.4% in December.

CAD: Another Blowout Employment Report

The Canadian, New Zealand and Australian dollars on the other hand traded higher against the greenback. While there were no major surprises in today’s U.S. non-farm payrolls report, labor market conditions in Canada blew out expectations once again. Economists were looking for zero job growth in December after very strong growth in November but Canadian companies added another 39.8k jobs, driving the unemployment rate down to 7.1%, its lowest level in 4 years. What made the release even more impressive was the fact that nearly all of the job growth was in full time work with strength seen in both the service and construction sectors. For the Bank of Canada, this solid employment report will validate their hawkish monetary policy stance and renew demand for the Canadian dollar. Of the 3 commodity currencies, the Australian dollar experienced the smallest gains because service sector activity contracted in the month of December. The country’s PMI services index dropped to 43.2 from 47.1, a development that could raise further concerns for the Reserve Bank of Australia. Canada’s IVEY PMI report is scheduled for release next week along with trade numbers from Australia, New Zealand and Canada.

USD/JPY Up 10% Since Beginning of Q4

The Japanese Yen weakened against all of the major currencies today. Japan’s newly appointed Prime Minister Shinzo Abe said on January 1st that the most urgent issue was to stop the yen from appreciating and deflation. So far he has been successful – the Yen is down 10% in Q4. Economic data has also taken a turn for the better. Markit Economics released a survey revealing Japan’s service sector expanding at a slightly faster pace. It also revealed that confidence among service providers hit its highest levels in five years. The activity index rose to 51.5 in December from 51.4 from the previous month indicating an expansion. There was a sharp reduction in manufacturing output. In November the composite output index gauge for both manufacturing and services activities fell from 49.9 to 49.3. The survey also found that business confidence in Japan’s service sector improved during December to the highest since November 2007.

Kathy Lien
Managing Director

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