FX and Stocks: What Does the Divergence Tell Us?

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Daily FX Market Roundup 08-17-12

FX and Stocks – What Does the Divergence Tell Us?
EUR: More Range Trading Next Week?
GBP: Hovering Near Top of Monthly Range
CAD: Surprise Drop in CPI
AUD: Sells Off Aggressively on Treasury Comments
NZD: Shrugs Off Hotter PPI
JPY: USD/JPY Enjoys Fifth Day of Gains

FX and Stocks – What Does the Divergence Tell Us?

There is a major disconnect happening right now between currency and equity traders. The stock market has performed extremely well this month with the S&P 500 rising to its highest levels in 4 months. Currencies on the other hand are struggling with the EUR/USD trapped in a range for the past week and the AUD/USD rolling over. Better than expected corporate earnings and Apple’s new product releases have made equity traders excited but stocks are trading like the U.S. economy has turned a corner, when it hasn’t. While recent economic reports show improvement in the U.S. economy, growth is still happening from a low base. So far we have seen only one month of satisfactory job growth and retail sales, which is not enough to draw any definitive conclusions about the economic outlook. Currency traders on the other hand have found very little cause for optimism. While Europe has stabilized and the volatility in the FX market has subsided, the two greatest risks for the global economy (the U.S. fiscal cliff and Europe’s sovereign debt crisis) still pose an ongoing threat. As a result, we believe that currency traders have the right attitude because caution is warranted.

The divergence between the performance of the currency and equity markets tell us that one asset class needs to correct and we believe it is equities. This may not happen over the next 2 weeks because the markets tend to be dead during this time period. However once traders return after Labor Day, which marks the unofficial end to summer, investors will be looking to see if the Europeans will deliver on their promise to protect the euro and if the Fed will provide any additional support to the U.S. economy. If they do not, equity traders could send stocks lower in disappointment, which would compound the losses in currencies.

The most important release on the U.S. economic calendar next week will be the FOMC minutes. When the Federal Reserve met earlier this month, they left monetary policy unchanged and did not provide any fresh clues on their plans for asset purchases. The minutes will most likely be as unsatisfying as the last FOMC meeting. Aside from the minutes, new and existing home sales will be released along with durable goods orders.

The dollar traded higher today against all of the major currencies outside of the Japanese Yen, which continued to lose ground against the greenback. According to this morning’s U.S. economic reports, consumer confidence increased in the month of August thanks to the stabilization in equities and the rebound in the job growth. Leading indicators also surprised to the upside, rising 0.4% in July compared to a 0.2% forecast. While U.S. data is consistent with a slow but steady recovery in the economy, the risks remain.

EUR: More Range Trading Next Week?

The EUR/USD has been trapped between 1.2255 and 1.2385 for the past week. There is no better example of a low volatility environment than a 130-pip trading range in the world’s most actively traded currency pair. With most of Europe on vacation, the lack of economic surprises and headline risk has constricted the movement of the euro and we expect this dynamic to continue in the new trading week. The most important release on the Eurozone calendar next week will be the August PMI numbers. Judging from the forecasts, economists are not looking for any major improvement or deterioration in activity. However with German factory orders, industrial production and retail sales plunging, there is scope for a downside surprise that could drag the EUR/USD lower. For once, the decline in Spanish 10 year bond yields is not helping the EUR. Yields fell to a 6 week low on Friday and the Eurozone reported its largest current account surplus ever. Aside from the PMI numbers, the big focus for Europe next week will be the meeting between the Greek Prime Minister, German Chancellor, French President and Eurogroup head at the end of the week. It is now believed that Samaras may NOT ask the key players in Europe to extend its bailout program by 2 years, choosing instead to wait until the October EU Summit after the Troika report is complete. Samaras could still broach the subject to see if they are amenable and then formally submit the request 2 months from now. Second quarter GDP Numbers are also scheduled for release but these are final figures, which means no major revisions are expected.

GBP: Hovering Near Top of Monthly Range

Although the British pound weakened against the U.S. dollar today, it ends the week at the top of its monthly range. The 1.58 level remains the key resistance point for the pair, a break of which would expose the currency for a possible rally to 1.60. While we are bullish sterling in the near term, there is not enough catalyst on the calendar for the breakout to happen in the coming week. The only pieces of data worth mentioning are public sector finances and revisions to Q2 GDP – neither of which will have a major impact on the currency. GDP is expected to be revised higher after a sharp upward revision to June retail sales. This week’s economic reports were overwhelmingly positive for the British pound. Inflationary pressures increased more than expected in July, the number of people filing for unemployment benefits dropped by 5.9k and consumer spending beat expectations. While the Bank of England is still open to the idea of more stimulus the latest numbers will give them the flexibility to hold monetary policy steady at their next meeting in September.

CAD: Surprise Drop in CPI

The Canadian, Australian and New Zealand dollars ended the day lower against the greenback. Earlier this morning Canada released its consumer price report and CPI fell for the third consecutive month by 0.1%. The market was looking for an increase in inflationary pressure but discounts on clothing and lower energy prices offset higher food costs. On an annualized basis, CPI growth dropped from 1.5 to 1.3%. For the Bank of Canada, lower CPI challenges their hawkish monetary policy stance and the rally in the Canadian dollar. Eventually we believe that the BoC will need to adjust their outlook based on the deterioration in the economy, global economic risks and lower price pressures. While there was no Australian data on the calendar, the real action today was in the AUD, which fell as much as 0.85% against the U.S. dollar. The AUD became the day’s worst performing currency after the Treasury said rate cuts would be more effective in weakening the value of the Australian dollar than intervention. Despite the market’s big reaction, comments such as these are not unusual from the Treasury. However they lack punch because decisions on rate cuts are made by the Reserve Bank of Australia and not the Treasury. The New Zealand dollar dropped in sympathy with the Australian dollar despite hotter inflationary pressures. Producer prices (inputs) rose 0.6% in the second quarter while output prices rose 0.3%. The minutes from the most recent RBA meeting will be released next week along with Canadian consumer prices.

JPY: USD/JPY Enjoys Fifth Day of Gains

USD/JPY traded higher for the fifth straight day, enjoying its the longest stretch of gains since February. While the Yen weakened against the greenback, it strengthened against all other major currencies. It’s a quiet day in Japan and with U.S. stocks ending the day unchanged, it is hard to attribute the sell-off in the Yen crosses to risk aversion. Japanese stocks rallied after yesterday’s better than expected US housing data and German Chancellor Angela Merkel commitment to working with the ECB. The Nikkei 225 Index rose 0.77%, 69.74 points, to 9,162.50 amidst the lack of any meaningful Japanese economic reports. The Japanese government released its budget guidelines for fiscal 2013, which limit total spending for key policy programs but leaves debt services to 71 trillion yen, the same as this year’s. The spending cap is crucial especially since the Eurozone crisis pointed out flaws in Japan’s fiscal system. Noda’s bill to double sales tax was passed last week in efforts to curb the nation’s deficit. The guidelines plan on funding programs for growth industries by cutting spending by 10% on other programs such as public works.

Kathy Lien
Managing Director

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