EURUSD Caught Between Spain Troubles and Bernanke

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Daily FX Market Roundup 08-31-12

EURUSD Caught Between Spain Troubles and Bernanke
USD: Bernanke Commits to Nothing but Makes Powerful Case for More Support
GBP: House Prices Increases
CAD: Stronger Growth in June
AUD: Rebounds Despite Concerns about RBA
NZD: Gold and Oil Up Nearly 2%
JPY: More Disappointments in Data

EURUSD Caught Between Spain Troubles and Bernanke

Bernanke’s speech at Jackson Hole was the main act today, but Spain banking’s troubles stole the show. The EUR/USD was the victim of a surge in volatility that came first from the market’s disappointment in Bernanke, who failed to make any specific commitments on monetary policy. Then when the dust settled and everyone had an opportunity to read through Bernanke’s speech, they realized that he made a powerful case for more stimulus and sold dollars against the euro. Unfortunately the EUR/USD failed to hold onto its post Bernanke gains when the news broke that Bankia, Spain’s fourth largest bank needs an immediately capital injection. Around the same time, S&P downgraded Catalonia’s credit rating to junk after the region officially requested for support from the national government. In reaction, borrowing costs in Spain jumped 25bp to 6.8%.

The EUR/USD would have probably suffered more losses if not for the prospect of QE3 from the Federal Reserve and more importantly, help from the European Central Bank next week. The downgrade of Catalonia, the recapitalization of Bankia and rise in Spanish bond yields increases pressure on the ECB to outline a new initiative to support the region. When the central bank last met at the beginning of this month, President Draghi spent a lot of time talking about a new “framework” for open market operations and the amount of details that he provides next week will determine whether the euro can hold onto to its gains. The ECB has made it clear that they are coming to the rescue, the only question is whether they can get their act together by next week. Mario Draghi’s decision to cancel his trip to Jackson Hole shows that European policymakers are hard at work.

At the last ECB meeting, Draghi said the details of the intervention in the bond market will be developed in the coming weeks and will provide “full transparency” on the countries involved and the size of the bond purchases. Mario Draghi made it a point to say that intervening in the bond market to buy short term bonds “falls squarely in our mandate.” While the Bundesbank opposes the ECB’s plan to resume bond purchases, comments from German Chancellor Merkel yesterday suggests that they will not stand in the way of limited purchases of short term bonds. Sooner or later the ECB will have to come to the rescue. If the central bank unveils full details for their new program next week, investors will respond positively and take the EUR/USD higher in approval but if they are light on details, the EUR/USD could suffer.

USD: Bernanke Commits to Nothing but Makes Powerful Case for More Support

When the dust settled, the U.S. dollar ended the day lower against all of the major currencies. Bernanke’s speech at Jackson Hole proved to be a big driver of volatility for the currency market. The Fed Chairman had some tough words to say about the state of the U.S. economy, the most important of which was his concern for the labor market. Unfortunately the recent uptick in job growth last month did not make the central bank feel any better – Bernanke said the stagnation in the labor market is “grave concern” and high unemployment could wreck structural damage on the economy. He believes that the economy still faces daunting challenges from the weak housing market, uncertainty in Europe and the U.S. fiscal cliff. While Bernanke started his speech by saying that he “wouldn’t rule out further asset purchases” and promised to “boost accommodation as needed for growth,” these words were not enough to satisfy short U.S. dollar traders looking for a stronger commitment to QE3 because he added that a “big boost in QE could reduce confidence in a smooth exit.” Given his views on the labor market and the overall economy however, the main takeaway from Bernanke’s speech is that the recovery is a big disappointment and more action is to come. Bernanke certainly believes in the effectiveness of Quantitative Easing as he spent most of his speech justifying the effectiveness of past asset purchases.

Looking ahead the most important question for the U.S. dollar is whether the Federal Reserve will change monetary policy on September 13th. Unfortunately Bernanke did not lay out a clear road map for monetary policy and only implied that more stimulus will come eventually. Yet the Fed could still ease in September without resorting to the extreme measure of QE3. As a middle ground, the central bank could opt to extend their low rates pledge from 2014 to a later date and combine it with a statement that pledges to maintain a highly accommodative stance as the economy recovers. They could also tie this pledge to changes in the economy such as inflation or employment. Either way, September 13th is a very important FOMC meeting that will require a lot of preparation by the central bank because fresh forecasts for the U.S. economy including GDP, inflation and unemployment will also be released. Bernanke has a press conference scheduled where he will have an opportunity to explain any policy actions or lack thereof and changes to the Fed’s view. In other words, it is a critical meeting and one with all the right ingredients for easier monetary policy. Next week’s non-farm payrolls report could play a big role the central bank’s decision.

GBP: House Prices Increases

The British Pound strengthened against the greenback and held steady against the euro. UK house prices rebounded after falling two months in a row. Prices increased by 1.3% for the month in August and declined 0.7% annually when it was anticipated to plunge by 2.2%. Nationwide Chief Economist Robert Gardner said, “Given the difficult economic backdrop, the extent of the rebound in August is a little surprising. However, we should not read too much into one month’s data, especially since monthly prices have been impacted by a number of one-off factors this year.” Consumer confidence declined to -29 and continued to remain low in August despite a modest boost from the Olympics. British Chamber of Commerce expects the economy to shrink by 0.4% in 2012 and advised the government to bolster growth. In the second quarter the UK economy shrank 0.7%. The BCC anticipates the UK’s national borrowing to exceed the target and the government is unlikely to accomplish the goal of eliminating the budget deficit by 2016-2017. PMI numbers, industrial production, producer prices are scheduled for release next week along with the Bank of England.

CAD: Stronger Growth in June

Thanks to the weakness of the greenback, the Canadian, Australian and New Zealand were able to recover some recent losses. Commodity prices soared on the heels of Bernanke’s testimony, helping to add fuel to the rally in the comm dollars. Both gold and oil prices ended the day up nearly 2 percent. This morning’s Canadian GDP numbers were also better than expected with the economy expanding by 0.2 percent in June. On an annualized basis, growth held steady at 1.8 percent, which was better than the market’s forecast for a slowdown to 1.6%. These healthier growth numbers could give the Bank of Canada the confidence to stick to their view that tighter monetary policy could be needed. The BoC is the most hawkish G7 central bank and we don’t expect this to change even if they grow less hawkish. Aside from the BoC meeting, Canadian employment and IVEY PMI numbers are also scheduled for release. The Reserve Bank of Australia has a monetary policy meeting next week and unlike the BoC, the RBA could grow more dovish. The 38 percent decline in iron ore prices over the past 4 months and the recent strength of the Australian dollar will take toll on the profitability of local companies. The drop in the Shanghai stock market adds pressure on an already slowing Chinese economy. The last time the RBA met, they were fairly neutral – this time we expect to hear more caution and dovishness. Australian GDP, PMI and employment numbers are also scheduled for release.

JPY: More Disappointments in Data

The Japanese Yen weakened against all major currencies except for the US dollar. Industrial production declined 1.2% when it was anticipated to increase by 1.7%. Upon the release the Ministry of Economy, Trade and Industry maintained its assessment that industrial production “appears to be flat.” Housing starts also declined for the second month by 9.6% annually. The jobless rate remained unchanged at 4.3% while average household spending increased 1.7% annually beating forecasts for a 1.2% increase. Yoshihiko Noda’s administration today predicted that it will miss a deficit-reduction target. Finance Minister Jun Azumi told reporters that spending cuts may come if Noda’s approval of deficit-financing bill is delayed. Japanese manufacturing worsened by the sharpest pace in 16 months in August according to the latest PMI numbers. The index dropped to 47.7 in August from 47.9 in July. Core inflation rate declined to 0.3% which the Ministry of Internal Affairs and Communications anticipated. CPI excluding fresh food and Tokyo core CPI declined 0.3% and 0.5% annually, respectively. Bank of Japan Masaaki Shirakawa said that CPI will “gradually rise to a range of 0.5%” by April 2013 therefore “it will likely be not too long” before it hits the target of 1%.

Kathy Lien
Managing Director

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