Euro – Our January ECB Preview

Posted on

Daily FX Market Roundup 01-08-14

Euro – Our January ECB Preview
Dollar – Fed Minutes Show Commitment to Taper but No Timetable
GBP: Extends Higher Ahead of BoE
CAD: Drop in Oil is Finally Catching Up
AUD: Construction Sector Activity Slows
NZD: Hits 5 Year High Versus Yen
JPY: Aso Says 2015 Tax Hike Hinges on 2014 Third Quarter Growth

Euro – Our January ECB Preview

The euro dropped to a 1 month low against the U.S. dollar ahead of the European Central Bank’s monetary policy decision. The ECB is not expected to change interest rates but Mario Draghi will be holding his usual post monetary policy meeting press conference and investors will be listening in closely to see if they have become more serious about lowering interest rates. Unfortunately we don’t think the central bank’s views have changed much since the last meeting. The following table shows how the Eurozone economy performed since the last monetary policy meeting and there have been both improvements as well as deterioration. German and Eurozone retail sales increased strongly in the month of November and consumer confidence is up thanks to healthier activity in the manufacturing sector. Unfortunately the rest of the region is not enjoying the same momentum with Eurozone unemployment at a record high and inflation as measured by core CPI at a record low. EUR/USD is trading slightly lower than where it was on December 5th, easing the pressure on the central bank to act quickly.

So What Will Mario Draghi Say?

Tomorrow, we expect Mario Draghi to say that while further stimulus remains an option, they are comfortable with the current level of monetary policy and are in no rush to ease again. When the central bank last met in December, Draghi downplayed the need for negative rates and we don’t think they will resort to this option as long as inflation does not move significantly lower. In other words, the bar for negative rates is remains very high. There has been some talk about a smaller cut to 10bp, which is an option that would send a strong message to the market but the impact on the economy would be limited. Another LTRO is also possible but based on last month’s comments, the central bank thinks that the current situation is substantially different than when they introduced LTRO (in a good way) which this implies that there is no urgency to introduce another long term refinancing program when the current one ends. The Eurozone economy is expected to grow gradually this year and if the economy needs further support, they will most likely opt for LTRO, large scale asset purchases or forward guidance before negative rates.

The bottom line is that the ECB is comfortable with the current level of monetary policy and Draghi’s comments on Thursday will most likely reinforce this sentiment. While this may not be shocking to EUR/USD traders, it could be enough to trigger a relief rally above 1.36.

Dollar – Fed Minutes Show Commitment to Taper but No Timetable

To our disappointment, the FOMC minutes did not trigger any major movement in the U.S. dollar. Central bank officials saw “waning benefits from monthly bond purchases” and are growing more concerned about the risks that Quantitative Easing poses to stability. Lower unemployment and inflation rate thresholds were discussed but most policymakers felt that it would be more fruitful to retain the current thresholds and to instead provide “qualitative guidance” after the threshold is crossed. In other words, central bankers don’t want to box themselves in more than they already have. Ongoing improvements in the labor market gave Fed officials the confidence to reduce asset purchases but the minutes provided very little detail on the future pace of reductions. It did not mention the $10 billion per meeting reduction proposed by Bernanke but did say that policymakers favored tapering in “measured steps.” While the minutes showed a commitment to unwinding QE, there was nothing to get investors excited about buying dollars and for this reason, USD/JPY declined slightly after the release. Nonetheless, the greenback still managed to appreciate against all of the major currencies today except for the sterling. This morning’s better than expected ADP report also provided very little support to the U.S. dollar. USD/JPY spiked briefly to 105 but failed to hold its gains and the same was true for EUR/USD, which bounced off 1 month lows. While ADP does not have the best track record of forecasting NFPs, its gap with payrolls is shrinking and there is still a good correlation between the two employment reports. The small increase in ADP last month suggests that payrolls could exceed 200k for the third month in a row. This is consistent with the signal from the non-manufacturing ISM report. While service sector activity slowed in December, the employment component of the report rose to 55.8 from 52.5. This indicates that more jobs were created in the service sector last month, which bodes well for payrolls. Confidence also improved leaving jobless claims as the one major report pointing to weaker job growth. The simultaneous increase in ADP and the employment component of ISM should keep the dollar supported ahead of payrolls.

GBP: Extends Higher Ahead of BoE

The British pound traded sharply higher against all of the major currencies today despite the lack of U.K. data. The rally caught many traders by surprise because the sell-off in stocks means that there was no support from risk appetite. Part of the move was attributed to EUR/GBP flows with traders selling the currency pair down to 1 year lows. Despite today’s decline, the FTSE has been trading very well and this resilience in equities is making U.K. assets more attractive. The Bank of England also has a monetary policy meeting tomorrow and like the ECB, they are not expected to make any changes. We are not particularly concerned about the recent decline in PMIs because the underlying components are still relatively healthy. This year, the BoE has a very tough decision to make. The unemployment rate is now only 0.4% away from the central bank’s 7% target and while they believe that it will hit this level in the third quarter of 2015, we believe that its realistic for the target to be met this year. In anticipation of this possibility, the central bank has made it clear that 7% unemployment is a threshold and not a trigger for a rate hike but come February when the next BoE Inflation Report and economic projections are scheduled for release, policymakers have a very important decision to make and two of the things they will consider include pulling forward their unemployment rate forecasts and/or lowering the threshold to 6.5%. The key lies in the wage growth. Right now wage growth is lagging behind inflation but if it starts to accelerate, the Bank of England will feel more pressure to raise interest rates. Unlike the Fed whose first step is to reduce asset purchases, the BoE has made it clear that their first move will be a rate hike. The U.K. curve is currently pricing in 50bp of tightening by the end of 2015. If economic data continues to improve and wage growth rises, investors will be looking for an even earlier move.

CAD: Drop in Oil is Finally Catching Up

Better than expected U.S. labor market numbers drove USD/CAD to a fresh 3.5 year high. After consolidating for the past month, yesterday’s disappointing IVEY PMI report was the straw that broke USD/CAD’s back. Since peaking above $100 at the end of last year, oil prices have been falling but it was not until this week that the sell-off caught up to the Canadian dollar. There has also been more upside than downside surprises in U.S. data but significantly weaker Canadian data made investors aware of the challenges facing Canada’s economy this year. USD/CAD broke to the upside but so far gains above 1.08 have been limited by the 38.2% Fibonacci retracement of the selloff between 2009 and 2011 that took the currency pair from a high 1.3064 down to a low of 0.9407. If this level is broken, the next level that the rally could stall at is the 2010 high of 1.0854. Meanwhile, the Australian and New Zealand dollars gave up earlier gains to end the North American trading session lower. No economic reports were released from New Zealand or Canada but the AUD continues to be pressured by weaker data. Construction activity grew at its slowest pace in 3 months. As our colleague Boris Schlossberg pointed out, “All three of the country’s PMIs have declined in the past month suggesting that growth Down Under continues to decelerate. Tonight’s Retail Sales data which is expected to match last month 0.5% gain could be the key driver of near term trade in the unit. If the number misses the forecast indicating that consumer demand is weakening, it may reignite speculation of further rate cuts by the RBA in Q1 of this year.”

JPY: Stocks Soar as China Opens Up Game Console Market

Between the overnight recovery in the Nikkei and the rise in U.S. yields, USD/JPY traded back above 105. While the currency pair still struggles to maintain its gains above this key level, the fact that Japanese stocks rebounded is good news for the Yen crosses. The recovery in the Nikkei was attributed to the strong U.S. trade data but overseas fund managers are also increasing their exposure to Japanese assets with the economy expected to gain momentum before the consumption tax is increased in April. The Topix, which is a broader measure of trade than the Nikkei rose to its highest level since July 2008. China’s decision to temporarily lift a 14-year ban on selling game consoles, provides a huge opportunity for companies like Sony and Nintendo. Back in 2000, China banned consoles because they were worried about the negative impact on the mental health of children. However now they will allow game consoles to be made in Shanghai’s free trade zone and then sold after passing the inspection of the government’s cultural departments. There is no end date for the suspension of the ban and in all likelihood it will years before they bring it back. While this provides a massive opportunity for some of Japan’s largest companies, lower price points in China will be a challenge for console makers. Meanwhile, the Japanese economic calendar remains quiet with no major reports expected over the next 24 hours.

Kathy Lien
Managing Director

Leave a Reply

Your email address will not be published. Required fields are marked *