Meltdown in Equities Equals Losses for Currencies

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Daily FX Market Roundup 03-13-14

Meltdown in Equities Equals Losses for Currencies

Dollar: Stronger Spending and Claims Makes Fed Decision Easy

AUD: Expect More Short Covering after Jobs Data

NZD: Climbs to Fresh 11 Month Highs

CAD: Supported by Rise in House Prices

GBP: Relief Rally Versus Euro

JPY: Japan’s Vulnerability to Chinese Slowdown

Meltdown in Equities Equals Losses for Currencies

Early gains in currencies and equities faded with the turnaround in U.S. stocks. At the start of the North American trading session, the outlook for many of the major currency pairs including the EUR/USD and USD/JPY was bright especially after the stronger U.S. retail sales and jobless claims reports. However the initial enthusiasm in FX and stocks did not last for long as these instruments hit a wall of resistance. The Dow Jones Industrial Average opened for trading up more than 50 points and was down 230 points by the end of the day. After climbing to a fresh 2 month high against the greenback during the European trading session, the EUR/USD ended the day not far from its lows. There was no clear explanation for the reversal because Eurozone and U.S. data beat expectations but concerns about tapering and its impact on U.S. growth, along with the slowdown in China and uncertainty in the Ukraine contributed to the liquidation and profit taking. There is also no coincidence that the rally in stocks stalled near record highs and the rally in EUR/USD stopped at a very significant technical resistance level. As seen in the following chart, the rise in the EUR/USD stalled near the 50% Fibonacci retracement of the 2008 to 2010 sell-off that took the currency pair from above 1.60 to below 1.20. The initial optimism over stronger inflation in France and spending in Spain also faded with the rally in the currency. EUR/USD traders should keep an eye on the spread between U.S. and German yields. Yields for both countries are down sharply today adding to the risk aversion but if one outpaces the other, it will determine the next move for the euro. In the meantime, if the EUR/USD drops below 1.38, we could see a steeper slide down to 1.37.

Dollar: Stronger Spending and Claims Makes Fed Decision Easy

The 8bp drop in 10 year Treasury yields drove the U.S. dollar lower against most of the major currencies despite better than expected economic data. Like last week’s non-farm payrolls report, this morning’s retail sales and jobless claims numbers will harden the Federal Reserve’s commitment to tapering asset purchases but the sell-off in the dollar and decline in yields suggests that investors believe the Fed will reduce bond buying cautiously. Before today’s releases, central bank officials made it clear that a significant deterioration in the economic outlook would be needed to change the course the course of tapering. So unless retail sales fell by 1.5% or more, we can expect another $10 billion reduction in monthly bond purchases. Thankfully reducing stimulus won’t be a tough decision for Janet Yellen next week. For the first time since November, retail sales rose 0.3%. The dollar’s reaction to retail sales would have been stronger if there was a smaller downward revision to January data. However even though spending was revised lower the previous month, the fact that sales turned positive after two months of contraction is good news for the U.S. economy and should restore demand for U.S. dollars ahead of the FOMC rate decision. The rebound in sales tells us that spending is finally recovering after a brutal winter and will most likely improve further in March. The big surprise was in jobless claims, which dropped to its lowest level in 4 months. After last week’s improvement, economists were looking for weekly claims to snapback but instead they declined to 315k from 324k. With the 4-week moving average also falling to 330k from 336k, the Federal Reserve has every reason to believe that the labor market continued to improve this month. Combined with the 0.9% rise in import prices, the central bank will not only continue removing stimulus and drop the unemployment rate threshold but they should sound more optimistic about the outlook for the U.S. economy. Expectations for a continued normalization of monetary policy should limit losses for the greenback. Producer prices and the University of Michigan consumer sentiment survey is scheduled for release tomorrow and based on today’s economic reports, we expect slightly stronger numbers.

AUD: Expect More Short Covering after Jobs Data

Despite the meltdown in U.S. stocks and deterioration in risk appetite, commodity currencies managed to hold onto their gains, ending the day higher versus the greenback. Last night’s decision by the Reserve Bank of New Zealand to raise interest rates 25bp and upgrade their GDP and inflation forecasts drove NZD/USD to a fresh 11-month high. The RBNZ’s commitment to additional tightening should lead to further strength in the currency and there’s no near term resistance for the pair before the 2013 high of 0.8676. While the Australian dollar has yet to reach any milestones, it is quickly closing in on its 3 month high thanks to last night’s blow out labor market numbers. Australian companies added 47.3k jobs in the month of February. This was three times more than expected and the strongest pace of job growth since March 2012. All of the jobs gained were full time and excluding a 33.3k decline in part time employment, jobs increased more than 80k, the largest rise since August 1991. Although changes to their survey method contributed the outsized release, the data still shows underlying strength for the labor market and we finally have data that validates the central bank’s decision to drop their easing bias. With speculators still significantly short Australian dollars, we expect today’s report to trigger more short covering that could drive AUD/USD as high as 92 cents. A larger than expected rise in house prices also helped to lift the Canadian dollar higher.

GBP: Relief Rally Versus Euro

After rallying for the past 5 trading days, the British pound finally rebounded against the euro and U.S. dollar. The U.K. trade balance was supposed to be release on Wednesday, was delayed to Thursday and now pushed out until Friday for “quality checks.” This did not stop the pound from enjoying a minor relief rally. For the most part it has been a very quiet week for sterling and we do not expect any big moves in the currency pair until next Wednesday, when the minutes from the most recent Bank of England meeting and jobless claims report is released. The impact of the U.K. trade balance should be limited although based on the market’s expectations for a wider deficit, there’s a greater chance that the report will be negative than positive for sterling..

JPY: Japan’s Vulnerability to Chinese Slowdown

Not only did the sharp decline in U.S. yields today drive the dollar lower against Japanese Yen but it also dragged all of the Yen crosses into negative territory. Softer Chinese data and the subdued performance of the Nikkei contributed to the move. Consumer spending in China grew only 11.8% in the month of February, against a forecast of 13.5% while industrial production rose by 8.6% year over year compared to expectations for a 9.5% rise. While the Lunar New Year may have curtailed activity there is no question that China’s economy is slowing. As Japan’s largest trading partner, slower growth in China poses a risk to demand for Japanese exports, putting additional toll on the economy. Most of the recent Japanese economic reports confirm that Japan’s recovery lost momentum at the start of the year but last night, we learned that machine orders jumped 13.4% in January, erasing a large part of the previous month’s losses. The problem is that this report is extremely volatile on a month-to-month basis but the central bank is optimistic about capital expenditures. With March being the fiscal year end for Japan, it was not a surprise to see Japanese investors selling stocks and bonds in the week ending on March 7th.

Kathy Lien
Managing Director

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