Bank of Japan Rate Decision – 3 FX Trading Scenarios

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Daily FX Market Roundup 04-02-13

Bank of Japan Rate Decision – 3 FX Trading Scenarios
EUR: What to Expect from the ECB
Dollar Slips on Potential for NFP Miss
GBP – Don’t Expect Much from BoE
AUD – Another Night of Busy Data
NZD – China Reports Stronger Service Sector Activity
CAD – Oil Down 2.75%

Bank of Japan Rate Decision – 3 FX Trading Scenarios

The time has finally come for the Bank of Japan to deliver. After preparing the market for aggressive monetary easing over the past few months, investors will be looking for the central bank to follow through with their promise this evening. Tonight’s meeting will be a first for BoJ Governor Kuroda and based on last week’s comments, he doesn’t plan to keep the BoJ sitting on the their hands for another month. While most investors also expect Japan’s central bank to announce new easing measures, the recent rally in the Yen suggests most expect the BoJ to underwhelm. Kuroda’s team has many options at their disposal and the final announcement can take many forms but here are 3 basic scenarios that traders should be watching for at this upcoming meeting:

Scenario #1 – BoJ Pull Forward Open Ended APP Program > Bullish for USD/JPY

The most aggressive announcement that the BoJ can make would be to pull forward their open ended Asset Purchase Program from 2014 to May 2013 or better yet, immediately. By shifting to unlimited QE, the central bank would prove to the market their level of commitment. This should come hand in hand with an extension of the duration of JGB purchases – the further out, the better. If they also increase the amount of risk assets bought beyond JGBs, it would be a perfectly wrapped gift to the economy and the market. Forex traders would most likely respond extremely well, taking USD/JPY up to 94 and possibly even 95.

Scenario #2 – Increase Scope and Maturity of their APP Program > Potential for Disappointment

While we would like to think the best of the BoJ, the second and most likely scenario is a contained expansion in monetary policy that would allow them to reevaluate the market’s reaction and increase stimulus further at the end of the month. Currently the BoJ is buying JGBs up to 3 years, if they extend their purchases to 5 years and leave it at that, it would probably be interpreted as a disappointment. If they expand purchases to 10 years, it would be neutral to slightly bearish for USD/JPY but if they expand the maturity of bonds purchased to 30 years, it could lift USD/JPY but the gains would be nominal. Aside from the size and scope of asset purchases, the BoJ is also widely expected to form a new Asset Purchase fund by merging current JGB purchases with Rinban operations. They are also expected to abolish the banknote rule, which limits their long term JGB purchases to the amount of banknotes in circulation.

Scenario #3 – No Major Changes to APP Program > Bearish for USD/JPY

The third scenario would be the most disastrous for USD/JPY, which would be no major changes to the BoJ’s asset purchase program. This is the least likely scenario because to forgo any major action would be a sign of weakness for the new central bank governor and raise the question of whether they will be able to make do on their promises at all. In this scenario, they would still probably abolish the banknote rule and merge JGB and Rinban purchases but that won’t be enough.

Given the high level of expectations that the Japanese government has set, hopefully they haven’t set themselves up for disappointment. According to the CFTC’s IMM report, many speculators are short Yen already so in order for the rally in USD/JPY to regain momentum, the BoJ will need to over deliver. Therefore anything short of open ended QE and a major expansion in the scope and duration of asset purchases may not be enough. Expect some big moves in USD/JPY tonight.

EUR: What to Expect from the ECB

The euro traded slightly higher against the U.S. dollar ahead of the European Central Bank’s monetary policy announcement. The ECB is widely expected to leave interest rates unchanged but given the recent weakness in German economic data and problems in Cyprus, there’s speculation that the ECB could lay the foundation for a rate cut. If that were the case, it would be signaled in Mario Draghi’s post monetary policy meeting press conference. There are plenty of reasons for why the ECB may be warming to the idea of more stimulus but German stocks have recently climbed to 5 year highs and the EUR has fallen – two factors that help to support the region’s economy. That may not be enough to wash away the ECB’s concerns but it’s a factor in this week’s central bank meeting. Either way, we don’t expect any optimism from the ECB and pessimism alone could sink the EUR if Draghi even hints that a rate cut is possible. The cracks are beginning to show in Germany and Cyprus could be the first of many weaker southern European nations such as Slovenia to seek emergency funding from the ECB. To preempt some of these difficulties, Draghi may want to ease. When the ECB plans to change monetary policy, they usually like to prepare the market for the move by dropping hints early. However if we are wrong and Draghi sounds calm and unconcerned about the recent deterioration in economic data and the problems in Cyprus and Italy, it would be just what the EUR/USD needs to stage a stronger recovery towards 1.30.

Dollar Slips on Potential for NFP Miss

The U.S. dollar is trading lower against all of the major currencies this morning on the back of weaker than expected labor market numbers. With less than 72 hours to go before the non-farm payrolls report, today’s data will help shape expectations for Friday’s big release. Based on the numbers received so far, we’re looking at the potential for a disappointment this month. Economists expect payrolls to rise by 198K in March compared to 236K in February. According to private payroll provider ADP, U.S. companies added only 158K jobs last month, down from an upwardly revised 237K. While the revision to last month’s report makes it seem like ADP does a very good job of forecasting NFP, their original estimate was 198K. Nonetheless, it can be relied on as a directional gage for the labor market. Non-manufacturing ISM also dropped to 54.5 from 56, signaling weaker growth in the service sector. Not only was this the largest disappointment in a year but the employment component dropped to a 4 month low of 53.3 from 57.2. Taken together, this is terrible for Friday’s payrolls report and signals the potential for a sizeable disappointment along with further dollar weakness. Weekly jobless claims and the Challenger Job Cuts reports are scheduled for release tomorrow.

GBP – Don’t Expect Much from BoE

The British pound rebounded against the U.S. dollar today despite weaker than expected economic data. While construction activity contracted at a slower pace in March compared to February, the improvement was less than economists had anticipated and still left the sector in contractionary territory for the fifth straight month. At the end of March, there were some improvements in the U.K. economy but since then we have seen more mixed reports. For the BoE, there has not been enough deterioration or improvement to warrant any changes in monetary policy. As a result, the meeting will most likely be a nonevent for the GBP/USD. If anything, the minutes from tomorrow’s meeting will most likely show continued caution, particularly since the borrowing under their Funding for Lending Scheme declined. PMI services should have a more significant impact on the GBP/USD tomorrow than the BoE meeting – economists are looking for service sector growth to slow.

AUD – Lifted by Stronger Australian and Chinese Data

The Australian, New Zealand and Canadian dollars gave up earlier gains to end the day virtually unchanged against the greenback. While Australia reported very strong economic data overnight, the sell-off in U.S. equities dragged all of the commodity currencies lower. Thanks to a rebound in commodity prices in February and acceleration in manufacturing activity that month, the country’s trade deficit shrank to -178M from -1215M. This was the country’s smallest trade deficit in 14 months. Combined with stronger Chinese service sector activity, the AUD/USD made a run for 1.05 and failed. Tonight’s PMI services, building approvals and retail sales reports will give the AUD/USD another stab at that key level but it will take very good numbers for the currency pair to break it. No major economic reports were released from New Zealand and Canada but the 2.75% drop in oil prices weighed on the loonie. Nothing is expected from either country over the next 24 hours.

Kathy Lien
Managing Director

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