Déjà vu in the Dollar and Stocks

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Daily FX Market Roundup 09-18-12

Déjà vu in the Dollar and Stocks
EUR – Watch Out for Portugal
GBP: BoE Minutes Will be Important
AUD: Neutral RBA Minutes
CAD: Oil Prices Continue to Fall
NZD: Current Account Numbers on Tap
JPY: Will the BoJ Ease Again?

Déjà vu in the Dollar and Stocks

The U.S. dollar ended the North American trading session unchanged or stronger against all of the major currencies. The lack of follow through in the sell-off seen last week mirrors the lack of extension in equities. In the past, it has taken some time for currencies and equities to react to Quantitative Easing. This morning we talked about how the dollar reacted to QE1 and QE2 and while stocks also rallied on the day QE2 was announced, equities moved lower and consolidated for the next 3 weeks before powering to a 2.5 year high. So while the recent price action in the dollar and stocks may be confusing on the surface given the significance of the Federal Reserve’s announcement last week, it is not unusual when compared to their response to two earlier rounds of Quantitative Easing. This morning we attributed this to a buy the rumor sell the news mentality but if we explore this concent further, the price action makes even more sense. Before the Federal Reserve made their announcement, economists around the world were talking about the possibility of QE3, giving investors the opportunity to position for what appeared to be an inevitable decision. When the announcement was made, investors rejoiced, taking the dollar lower and equities sharply higher but now that the decision has come to pass, there could be a period of consolidation before the risk rally resumes. Once the positive effect of the stimulus starts to be evident in U.S. data, the good news could be what reinvigorates the risk rally.

Meanwhile better than expected U.S. economic data offset dovish comments from Federal Reserve President Dudley. As one of the more dovish voting members of the FOMC, Dudley said, “easing was needed” because of “unacceptably slow growth” and “unacceptably high” unemployment. He found the performance of the economy disappointing and the near term outlook for the business sector “worrisome.” He made it clear that the Fed has not run out of ammunition and is ready to provide “more medicine” if the economy needs it. The main takeaway from Dudley’s comments is his support for the Fed’s decision last week and its ongoing commitment to easy monetary policy. Fed President Evans and Fisher also spoke this morning but unlike Dudley, they are not voting members of the FOMC. Nonetheless Evans expressed his concerns about the significant risk in the global economy and like Dudley said there are additional steps the Fed can take. Dallas Fed President Fisher on the other hand does not support the central bank’s decision to ease. He said he argued against QE3 last week and would have voted no if he were a voting member this year. More importantly however, Fisher also noted that there are some on the FOMC who would like to do a lot more and in light of similar comment from Dudley and Evans, there’s clearly a newfound resolve to tackle slow U.S. growth head-on within the central bank.

Housing market numbers are due for release on Wednesday and small improvements are expected all around. Builder confidence rose to a 6 year high according to this morning’s NAHB Home Builders Index. Today’s data was mostly positive for the greenback. The nation’s current account deficit narrowed to -$117.4B in the second quarter from a downwardly revised -$133.6B. Stronger exports and a larger income surplus helped to return the deficit back to Q4 levels. Unfortunately this improvement is not expected to last, as the recent slowdown in Chinese growth is likely to restrain export demand in the third quarter. Demand for dollar denominated assets has also been very strong according to the Treasury International Capital Flow report, which saw net inflows rise by $73.7B in July, up from $15.1B the previous month. Purchases of long term Treasuries accounted for most of the increase. This is consistent with the sharp rally that we saw in the U.S. dollar against the euro that month. If you recall, the EUR/USD dropped to its 2 year low of 1.2042 in July. While demand for U.S. Treasury bonds was strong, foreign investors sold a large amount of shorter-term Treasury bills.

EUR – Watch Out for Portugal

Of all the major currencies, the euro experienced the largest movement against the U.S. dollar. For the first time in 6 trading days, the euro weakened against the greenback, which for the record is only the second time in 10 days that the EUR/USD has fallen. Weaker economic data could be blamed for the move but even though investors grew less optimistic about current situation, they also grew less pessimistic about the German economic outlook, so we consider it a wash. Instead, we attribute part of the EUR/USD’s weakness to the rise in Portuguese 10 year bond yields. In the past 2 days alone, the country’s 10 year yields have increased more than 55bp from 8.08 to 8.65%. The Portuguese government’s decision to raise taxes has led to protests and strikes across the nation. Countries like Portugal are beginning to feel the brunt of the pain brought on by the austerity measures that they exchanged for a bailout. While this may be positive for their economy in the long run, in the short term, it will lead to more pain for their workers and weaker growth. Spanish and Italian bond yields declined but Portugal’s problems gives them a taste of the social issues that will arise if they ask for a sovereign bailout that will undoubtedly come with a tough austerity program. No major European economic reports are scheduled for release tomorrow. The Swiss Franc traded higher against the euro despite weaker GDP forecasts from the State Secretariat for Economic Affairs. SECO downgraded their 2012 forecast from 1.4 to 1.0% and 2013 forecast from 1.5 to 1.4%. The bulk of the weakness is expected to come from lower government spending, equipment expenditure and employment. Household spending is also expected to be softer than anticipated. These forecasts tell us that the Swiss government does not believe that their intervention efforts will sufficiently offset weaker growth and export demand from the Eurozone.

GBP: BoE Minutes Will be Important

Despite lower inflationary pressures on an annualized basis, the British pound held steady against the U.S. dollar and extended its gains versus euro. We continue to believe that the sell-off in EUR/GBP is attributed to the flow of funds out of euros and back into sterling. Investors thought that the ECB’s Outright Monetary Transaction program would save the euro but once the initial enthusiasm faded, they realized the difficult process that is involved in initiating OMT, the first of which requires a country to bow their heads and admit defeat. Meanwhile inflation in the U.K. continues to ease. While consumer prices rose 0.5% in the month of August, which is a faster pace of growth compared to July, on an annualized basis, CPI growth slowed to 2.5% from 2.6%. Core prices, which excludes more volatile items such as food and energy also slowed to 2.1% from 2.3%. Inflationary pressures are expected to remain subdued but we don’t expect CPI to fall far below its current levels because the recent rise in oil prices should start to filter down the production chain process. The minutes from the most recent BoE meeting is scheduled for release on Wednesday. This is an important event risk for the British pound because the outlook for the currency will depend on where the central bank stands on monetary policy in relation to the ECB and the Federal Reserve. While we expect the BoE to remain dovish, we don’t anticipate a strong bias to ease again in October.

AUD: Neutral RBA Minutes

The Canadian and New Zealand dollars held steady against the greenback while the Australian dollar weekend. The minutes from the most recent Reserve Bank of Australia meeting was released last night and unfortunately it provided very little clues about future monetary policy. Our colleague Boris Schlossberg wrote about the minutes extensively. He said “The minutes of the latest RBA monthly meeting revealed that Australian monetary authorities were becoming aware of softening demand but unwilling to change policy quite yet. The minutes stated that, “Information that became available over the past month pointed to slightly softer conditions in many parts of the global economy. A month earlier, members had noted that there were some tentative signs that Chinese growth might be stabilizing at a more sustainable pace. However, the most recent data had been a touch weaker, and this had been accompanied by a sharp decline in spot prices for iron ore and coking coal. If sustained, this decline would imply a larger fall in the terms of trade than the staff had earlier forecast, though the terms of trade would still remain high by historical standards.” The RBA board was also mildly concerned about the strength of the Australian dollar noting that, “Members discussed the possibility that the high level of the exchange rate was weighing more heavily on the economy than might be expected. Overall, despite the ongoing structural change, the unemployment rate had remained relatively low to date.” In the end while acknowledging that the “global economy remained subject to significant downside risks,” the RBA concluded that, “the domestic economy appeared to be growing at around trend pace and there were signs that the effects of earlier reductions in the cash rate were still working their way through the domestic economy.” Leading indicators are due for release from Australia this evening followed by current account numbers from New Zealand.

JPY: Will the BoJ Ease Again?

It was a mixed day for the Japanese Yen, which traded lower against the U.S, Canadian and New Zealand dollars and higher against the euro and Australian dollar. Tonight the Bank of Japan has a monetary policy announcement and with the economy weak and the Yen at elevated levels, the BoJ could be looking to ease monetary policy again. Intervention in the Yen rarely works and monetary stimulus could be far more effective because when the Bank of Japan surprised the market with a 1% inflation target and an increase in asset purchases in February of this year, they successfully set off a rally in USD/JPY that took the currency pair from 77.50 to 84.15 in one month. Given the recent deterioration in economic data and the slowdown in global growth, the Bank of Japan is widely expected to increase their asset purchase program by JPY10 trillion. However, most economists expect the BoJ to move in October instead of this week because the central bank’s semiannual Outlook Report will be completed and released at that time. Also, it will give the Japanese the opportunity to see how the market reacts to the Federal Reserve and the European Central Bank’s recent actions. If the BoJ were to ease alongside the Fed and the ECB, the surprise would be large enough to drive USD/JPY higher. Even if the central bank doesn’t ease, they are still expected to downgrade their view on exports and their overall assessment of current economic conditions.

Kathy Lien
Managing Director

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