AUD: What to Expect from the RBA

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Daily FX Market Roundup 02-04-13

AUD: What to Expect from the RBA
NZD: Backs Off 11 Month High
USD/CAD Struggles to Recover
GBP: Recovers Sharply Against the EUR
Beware of a Steeper EUR/USD Correction
USD: Mixed Day, Quiet Week
JPY: Hits Fresh Lows Before Rebounding

AUD: What to Expect from the RBA

The Australian dollar traded higher against the U.S. dollar ahead of the Reserve Bank of Australia’s monetary policy announcement. The RBA is widely expected to leave interest rates unchanged at 3%, but a small amount of economists and investors are looking for a back-to-back interest rate cut from the central bank. Over the past 2 weeks, softer economic data drove the Australian dollar sharply lower against the greenback as investors start to wonder how long the RBA will wait before cutting interest rates again. Since the last monetary policy meeting in December, where the RBA reduced rates by 25bp, we have seen both improvements and deterioration in the economy.

Manufacturing and service sector activity slowed significantly while retail sales and consumer confidence weakened. As core measures of Australian economic activity, deterioration in these reports is a big warning sign for Australia’s economy. Inflationary pressures are also muted and will most likely fall short of the RBA’s forecasts. For these reasons, the RBA should keep monetary policy easy and considering cutting rates again. However businesses have also grown more optimistic and according to a survey conducted by Deloitte Access Economics, mining investment expanded rapidly in the fourth quarter and should have provided underlying support for Australia’s economy. Labor market conditions also held steady while financial markets improved. More importantly, the government’s decision to abandon their plans for a budget surplus in June will ease the pressure on businesses and consumers. Signs of stability in China’s economy will also reduce some of the central bank’s concerns. So while there are troubles spots in the domestic economy, improvements elsewhere should deter the RBA from cutting interest rates again.

If the RBA leaves rates unchanged and their monetary policy statement is neutral, 1.04 could become a near term bottom for the AUD/USD. However if the central bank expresses any desire to continue easing, it could be just what the AUD/USD needs to close below 1.0350. We believe that the RBA will leave the door open to additional easing and therefore the risk for the AUD/USD is to the downside. While the RBA rate announcement is the main focus for Australia this evening, service sector PMI and the trade balance are also scheduled for release and may provide their own source of volatility for the AUD/USD.

Beware of Steeper EUR/USD Correction

The euro weakened against the U.S. dollar for the first time in 10 trading days. While the sell-off in the EUR/USD was caused by political uncertainty in Spain, even without the calls for Spanish Prime Minister Rajoy to resign, the currency pair was due for a correction. The European Central Bank has a monetary policy meeting this week and while their message is not expected to change, it will be difficult for Mario Draghi to avoid talking about the currency. Over the past 2 months, the EUR/USD has risen nearly 7% and while we know that the central bank is comfortable with the EUR/USD between 1.34 and 1.36, the question is whether the recent rally has happened too quickly and if the central bank is worried about a 1.38 to 1.40 currency value. The EUR/USD is currently near its long term average, so we do not expect Draghi to call the move “brutal,” a term used by Trichet in 2004 and 2007 to cap the gains in the currency. At the time, investors interpreted brutal to mean that the central bank was ready and willing to intervene in its currency. Draghi has 3 choices this week – he can brush off the currency’s recent move and say they are not worried, which would be extremely positive for the euro. He can also say, “excessive exchange rate moves are undesirable,” which is not as powerful as calling the move brutal but would send a clear message to the market that the ECB is not satisfied with the recent move in the currency. Trichet used some version of the “excessive exchange rate” comment in 2008, 2010 and 2011 but unfortunately it did not curtail the gains in the EUR/USD nearly as well as the word brutal. The best answer that Draghi can give is to “no comment” on currency questions but the market would probably interpret that to mean continued comfort with the current EUR/USD level. The head of the European Central Bank probably won’t discuss the currency in his prepared commentary but reporters will jump at the opportunity to ask him about the euro. As a result, traders should beware of a deeper correction in the EUR/USD this week ahead of Thursday’s central bank meeting.
European stocks and bonds also fell sharply today. The steepest losses were seen in the Spanish markets with the IBEX down more than 2% and 10-year bond yields up nearly 20bp. Spanish Prime Minister Rajoy is embroiled in an alleged illegal cash payment scandal that has led to widespread calls for his resignation. With the Eurozone’s recovery still in its infancy, political uncertainty isn’t good for the currency.

GBP: Recovers Sharply Against the EUR

The British pound traded sharply higher against the euro and modestly higher against the U.S. dollar. On Friday, EUR/GBP experienced its strongest one-day slide against the EUR since September 2009 and today it recovered all of its losses. U.K. economic data continued to disappoint with construction sector activity failing to improve like economists had anticipated. The country’s PMI construction index held steady at 48.7 while house prices remained flat. There has been very little improvement in the U.K. housing market since the beginning of the year and this lack of momentum will worry monetary policy members who meet later this week. Yet the disappointment in U.K. data did not prevent the GBP from rallying. The Wall Street Journal carried an article today that quoted some experts as saying that the sell-off in sterling may be overdone. With Eurozone concerns returning, demand for the pound is recovering but the outlook for the U.K. is grim. The article cites this month’s Italian elections on February 24th and 25th as reasons for concern along with the scandal around the Spanish Prime Minister and we believe there could be some merit to this argument. U.K. service sector PMI is due for release tomorrow. The sharp decline in manufacturing activity points to slower service sector activity but a rise in consumer confidence suggests that service sector activity may not have slowed as much as investors fear.

USD: Mixed Day, Quiet Week

With Europe back in the headlines, investors are getting nervous and this has translated into losses for the equity market and a rally in the Japanese Yen. However the U.S. dollar, which is also a safe haven currency did not rise against all currencies. The greenback traded higher versus the euro and Canadian dollar but lost value against the Japanese Yen, British pound, Australian and New Zealand dollars. Part of the reason for the inconsistent performance is the lack of meaningful economic data. Last week we had the FOMC meeting and non-farm payrolls and even these 2 big headline events failed to have a big impact on the dollar. The Federal Reserve is comfortably on hold and there’s nothing on the calendar this week that will change this view. Factory orders were the only piece of U.S. data released today and orders rose 1.8% in December, which was less than anticipated but a significant rebound from the 0.3% contraction seen in November. Between the 0.5% miss and the downward revision to the prior month’s report, manufacturing activity fell short of expectations at the end of the year. Non-manufacturing ISM is due for release tomorrow. Service sector ISM is a closely watched report because it is a leading indicator for non-farm payrolls. Since NFPs were released before the ISM this month, we don’t expect the forex market to have a major reaction tomorrow. Nonetheless, if service sector activity recovers along side manufacturing activity, it would be good news for the U.S. economy and USD/JPY.

JPY: Hits Fresh Lows Before Rebounding

After rising to a fresh multi-year high at the start of the European trading session, Japanese Yen crosses ended the day in negative territory on the back of the sell-off in European and U.S. equities. Over the weekend, Finance Minister Aso said it could take a few years before the economy recovers which is an honest assessment that recognizes the uphill battle that Japanese policymakers have to revive the economy. Japan’s government will need to rely on a combination of fiscal and monetary policy to achieve their goals. Later this week, the government is expected to outline its criteria for the next BoJ governor. The expectation that the DPJ will bring in someone that supports ultra-easy monetary policy should keep the Yen weak. No major Japanese economic reports are due for release this evening but more Chinese data on the calendar. If there are any surprises in the HSBC’s non-manufacturing report, Asian currencies including the Yen could be affected.

Kathy Lien
Managing Director

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