Fresh Leg Lower for the Dollar?

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Daily FX Market Roundup 01-10-13

Fresh Leg Lower for the Dollar?
EUR: Super Mario Saves the Euro
GBP: Collapses Against EUR
AUD: Soars on Strong Chinese Trade Numbers
CAD: Weaker Housing Numbers
NZD: Gold and Oil Up Nearly 1%
JPY: New Milestones for Yen Crosses

Fresh Leg Lower for the Dollar?

The U.S. dollar traded sharply lower against all of the major currencies except for the Japanese Yen, which continued to be the worst performer. With no major U.S. economic reports on the calendar today, the sell-off in greenback has been supported by fundamentals. Its weakness against the euro was caused by comments from ECB President Draghi who said the central bank is not considering rate cuts right now. The central bank is satisfied with the performance of the financial markets, which means they are done introducing programs with creative acronyms. Their Outright Monetary Transactions program or OMT has been very effective in reducing tail risk and while the ECB will keep accommodative monetary policy in place, the EUR/USD rallied because investors no longer expect any additional steps from the central bank. Stronger than expected Chinese trade numbers also provided fundamental support for the rally in commodity currencies and weakness in the dollar as everyone stands to benefit from stronger Chinese growth. If investors remain optimistic about the outlook for Europe and Asia, we could see a fresh leg lower in the dollar as investors dip their toes back into riskier assets. However there’s quite a big of resistance above current levels in the EUR/USD at 1.33, 1.3385 and 1.35, so means it may be better to wait for the currency pair to retrace before going long.

U.S. yields are also ticking higher which will provide support for the greenback especially against the Japanese Yen. Today’s jobless claims report wasn’t terrible. While claims increased from 367k to 371k, a downward revision to last week’s release offset the bump. Instead the rise in yields was triggered by comments from Fed Presidents. Today was our first opportunity to hear from 2 new 2013 FOMC voters – St Louis Fed President Bullard and Kansas City Fed President George. As a moderate hawk, George expressed concerns about the central bank’s ultra-easy monetary policy, warning that it could cause a surge in inflation, is disruptive to the market and may be difficult to exit from. She expects the economy to gain momentum and grow a bit more than 2% this year. Bullard was the wildcard and he proved to be even more hawkish than George. The St. Louis Fed President started off by saying that he expects U.S. growth to reach 3.2% in 2013 and 2014, which is far more optimistic than George’s forecasts. Bullard is “a little bit nervous about Fed policy” and believes there could be an inflation problem in the future because monetary policy is very aggressive. Based on today’s comments, its sounds like George and Bullard could throw their support behind ending asset purchases this year, which would positive for the dollar.

President Obama officially nominated Jack Lew as the next Treasury Secretary. For more, read our special report on Jack Lew – Will he be good or bad for the dollar? The U.S. trade balance is scheduled for release on Friday and given the rise in the ISM index, we expect the trade deficit to narrow.

EUR: Super Mario Saves the Euro

The EUR/USD surged on the back of ECB President Draghi’s comments. While the central bank left monetary policy unchanged and Draghi started his press conference with a grim tone, saying that the economy will remain weak into 2013 with a gradual recover later this year and risks to the downside, by the end of the Q&A session, investors realized that his satisfaction with improvements in financial market conditions means the ECB is less inclined to increase stimulus. A rate cut was not discussed at all and that in of itself was enough to drive the EUR/USD sharply higher. With financial market sentiment improving significantly, tail risks removed and funding conditions at satisfactory levels, Draghi believes that the financial markets have now returned to normalcy. This is not to be mistaken with normal economic conditions and the ECB is “not thinking about an exit” from ultra easy monetary policy but the central bank’s primary goal was to stabilize the financial markets and it appears that they are happy with what has been achieved. Strong capital flows are returning to region, bond yields have fallen and inflation risks are broadly balanced. Draghi’s reminder that the mandate of ECB is not full employment but price stability suggests that the ball is being thrown back to European governments because reducing unemployment should be their responsibility. Nonetheless, the ECB will keep their stimulus in place until there are stronger signs of recovery. According to Draghi, economic indicators still signal weak activity and the debt crisis along with geopolitical tensions pose a continued risk to Europe’s economy. There is a significant amount of fragmentation in the region and fiscal consolidation is unavoidable but for the most part, their economic outlook remains unchanged and this was the main reason why their decision to hold rates steady was unanimous. The main takeaway from today’s meeting is that the ECB is no longer in crisis fighting mode because the battle with the financial markets have been won. The markets have stabilized and the worst is over but monetary policy needs to remain accommodative because growth is weak.

GBP: Collapses Against EUR

The British pound traded higher against the U.S. dollar but weakened sharply against the euro. As expected, the Bank of England left monetary policy unchanged. We will have to wait for the minutes, which are scheduled for release on January 23rd to get a better sense of the central bank’s bias. While additional QE is not expected for the time being, recent deterioration in economic data should encourage the monetary policy committee to leave the door open for additional easing. One of our favorite calls for 2013 is higher EUR/GBP because we believe that investments flows will return to the Eurozone. Today, ECB President Draghi confirmed that there have been strong capital flows into the region. With financial market conditions stabilizing and returning to normalcy, we expect this trend to continue. At the height of the crisis, the GBP and U.K. assets were considered safe havens and now that European investors no longer need to turn to the currency for safety, EUR/GBP should rise. U.K. industrial production is due for release tomorrow and stronger numbers are expected after the surprise increase in PMI manufacturing.

AUD: Soars on Strong Chinese Trade Numbers

The Australian, New Zealand and Canadian dollars benefitted significantly from the rise in commodity prices and stronger Chinese trade numbers. China’s trade surplus surged to $31.62 billion in the month of December from $19.63B the previous month, which easily beat the muted expectations of economists who were looking for only a meager rise. Exports soared 14.1%, which was the strongest pace of growth in 8 months. Even imports increased by 6%, easing the concerns of anyone who was skeptical or worried about Chinese growth. Exports to the E.U., U.S. and Asia increased strongly in a sign of stabilizing global growth. The currency that benefitted the most from the eye popping surprise in Chinese trade numbers was the Australian dollar as imports from Australia increased 7%. Australian building approvals increased 2.9% in November, which was in line with expectations especially after the upward revision to the last month’s report. The rise in the Canadian dollar was more moderate because house prices increased less than expected and building permits fell. Canadian trade numbers are due for release tomorrow and given the rise in IVEY PMI, we expect the country’s trade deficit to narrow.

JPY: New Milestones for Yen Crosses

All of the Japanese Yen crosses performed extremely well today with EUR/JPY leading the pack. Unlike what we have seen over the past 2 months, today’s rally in the Yen crosses was not driven by Yen weakness but strength in high beta currencies. EUR/JPY rose approximately 1.5% to its highest level since July 2011 while AUD/JPY and NZD/JPY rose to their highest since September 2008. A milestone was also reached in CHF/JPY, which hit a 16-month high today. While the rise in U.S. yields continues to support the rally in USD/JPY, the currency pair is struggling to extend its gains. The uptrend remains in tact but 88.40 is proving to be a tough resistance level to break. Nonetheless, we still believe that USD/JPY will test 90. Japanese trade and current account numbers are scheduled for release tonight. Economists are looking for the trade deficit to nearly double and the current account surplus to decline during the month of November. Some investors may be a bit surprised by this pessimistic forecast since the Yen began its more than 10% slide that month but it can take a month or two for a weaker currency to benefit the economy. Industrial production plunged in November and manufacturing activity contracted at a faster pace, which would be consistent with a further deterioration in trade activity but expect the balance to improve in December.

Kathy Lien
Managing Director

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