AUD: Why RBA May Want to Maintain its Neutral Bias

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Daily FX Market Roundup 06-02-14

AUD: Why RBA May Want to Maintain its Neutral Bias

NZD: Extends Losses Despite China’s Report of Stronger Manufacturing Activity

CAD Weakens on Lower Oil Prices

Euro Resumes Losses as Weak Data Validates Need to Ease

GBP: Shakes Off Weaker Data

USD/JPY Supported by Higher Nikkei and US Yields

AUD: Why RBA May Want to Maintain its Neutral Bias

With a monetary policy announcement, retail sales, PMIs, GDP and the trade balance scheduled for release this week, the Australian dollar could see quite a bit of volatility. For the past 2 months, the currency pair spent most of its time trading within a narrow 200-pip range and many investors are now hoping for a breakout that could trigger a new trend in AUD/USD. Based on today’s steep decline in the Australian dollar, it certainly looks like investors are positioning for weaker data and less optimism from the central bank. AUD/USD was the day’s worst performer and a surprisingly large drop in building approvals and continued decline in iron ore prices drove the sell-off. Yet there was also good news out of Australia and China with manufacturing activity improving in both countries. In fact, it is this improvement abroad that could lead the Reserve Bank to look beyond the weakness in domestic demand. As shown in the following table, outside of retail sales and consumer confidence, there’s been just as much improvement as deterioration in Australia’s economy since the last monetary policy meeting and the same is true of the country’s largest trading partner, China. Business confidence increased in the month of April, inflationary conditions improved and the unemployment rate held steady. These are all reasons for why the central bank could maintain its neutral monetary policy bias, which would catch many AUD/USD traders by surprise and lead to a relief rally in the currency. However it may be difficult for the RBA to ignore the 10% fall in iron ore prices since the last monetary policy meeting and the recent austerity measures, which have already put a dent into consumer confidence and risks damaging the recovery. So while the RBA has legitimate reasons for maintaining a neutral monetary policy bias, investors also have valid reasons to believe that the central bank will be less optimistic. This ambiguity could translate into a sharp reaction in the AUD/USD to tonight’s RBA rate decision. The levels in AUD/USD are well defined. If the RBA is dovish, AUD/USD should break 92 cents and begin a move that could take it as low as 90 cents but if the central bank maintains a neutral bias, AUD/USD could rise back above 93 cents at which point the next stop could be 0.9425.

Dollar Soars on Epic Fail from ISM

Thanks to data errors from the Institute for Supply Management, it has been a very interesting North American trading session. The dollar ended the day higher against all of the major currencies but not before some early volatility. The main piece of U.S data that was scheduled for release today was the ISM manufacturing report. At 10am ET, ISM reported that the manufacturing index dropped to 53.2 from 54.9 in the month of May, causing USD/JPY to tumble from 102.26 to 102.02. About 90 minutes later they said the wrong seasonal factor was applied and the index actually rose 56 from 54.9 and this announcement triggered a quick recovery in USD/JPY. However the drama did not end there – another hour later, they revised the number for a second time to 55.4. Even though this was a lower estimate, investors were relieved that manufacturing activity accelerated last month and expressed their satisfaction by driving USD/JPY to a one month high. This major failure by ISM will increase the credibility of a similar report published by Markit Economics. While Markit’s releases have significant legitimacy abroad, they only recently released surveys of North American economic activity and these reports are slowly having a greater impact on the markets. Over a week ago, Markit reported a slight uptick in manufacturing activity and earlier this morning before the ISM report was released, they revised the index from 56.2 to 56.4. In response to the healthier manufacturing report, U.S. yields rose above 2.5%. With U.S. stocks climbing to a fresh record high and U.S. yields rebounding, the dollar is back in demand. Tuesday’s factory orders and IBD/TIPP Economic Optimism reports are not expected to have a significant impact on the dollar so as long as yields continue to recover, the dollar will remain bid.

Euro Resumes Losses as Weak Data Validates Need to Ease

The euro extended its losses against the U.S. dollar today on the back of weaker economic data. With only a few more days to go before the European Central Bank’s highly anticipated monetary policy announcement, incoming data validates the central bank’s plans to increase stimulus. According to the latest reports, manufacturing activity in the Eurozone grew at a slower pace while German consumer prices declined for the second month in a row. Low inflation was the main reason why the central bank cut interest rates back in November and the lack of improvement only makes easing more necessary. According to ECB member Nowotny, inflation is clearly below target and a negative deposit rate is being discussed as a possible option for Thursday’s meeting. Given comments from other European policymakers, we believe that negative rates are a done deal. In fact if the central bank fails to lower the deposit rate, they could end up driving EUR/USD higher since investors already discounted the move. We know that even after a 2% decline in EUR/USD since early May, the ECB is not happy with the level of the euro. In fact just this morning ECB member Linde said the strength of the euro is damaging and he expects the dollar to appreciate eventually, helping to ease the upside pressure in the currency. We continue to look for EUR/USD to drift lower ahead of Thursday’s announcement with the Eurozone’s unemployment rate and CPI estimate for the month of May potentially accelerating losses over the next 24 hours.

GBP: Shakes Off Weaker Data

The resilience of the British pound has been nothing short of impressive. The currency ended the day unchanged against the U.S. dollar despite a rise in U.S. yields and weaker U.K. data. Manufacturing activity slowed in the month of April and while it can be argued that the index remains at elevated levels, it should not have provided any support to sterling on a day when mortgage approvals dropped from 66.5k to 62.9k. With today’s report, over the past 3 months we have seen approvals fall a total of 17%, a clear sign that the housing market is losing momentum. Last week, there were a number of reports of slower house price growth and today in addition to the drop in approvals, net consumer credit and lending also slowed. These releases will only harden the central bank’s conviction to leave monetary policy easy. The Financial Policy Committee could still take action to cool the market if house prices do not fall further but investors should not expect any action from the BoE. Nonetheless tomorrow’s Nationwide House Price and UK PMI Construction sector reports should show a further slowdown in the overheated sector.

USD/JPY Supported by Higher Nikkei and US Yields

Between the sharp rise in the Nikkei overnight and the rebound in U.S. yields, it is no surprise to see a nice recovery in USD/JPY. In fact almost all of the yen crosses ended the day in positive territory. Compared to other major economies, Japan’s calendar this week is light which means the Yen will most likely trade on the market’s appetite for risk and the U.S. dollar. Last night’s capital spending report adds to the evidence that strong corporate investment could provide a nice offset to weaker consumer spending. According to the latest report, capital spending rose 7.4% year over year in the first quarter, up from 4% in Q4. This was substantially stronger than the market’s 5.8% forecast. The manufacturing PMI index was also confirmed at 49.9, up from 49.4 the previous month. Labor cash earnings are scheduled for release this evening but the report is not expected to have much impact on the Yen. 103 continues to be the key resistance level for USD/JPY.

Kathy Lien
Managing Director

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