Daily FX Market Roundup 10-26-12

FX: Big Intraday Moves and Busy Week Ahead
EUR: Growing Gap Between German and the Rest of Eurozone
GBP: Retreats After a Strong Week
NZD: Boosted by Stronger Trade Numbers
AUD: Holds Steady, Gold and Oil Unchanged
CAD: Bucks the Trend and Weakens
USD/JPY – First Batch of Stimulus Measures Announced

FX: Big Intraday Moves and Busy Week Ahead

What a day it has been in the FX market! EUR/USD collapsed right before the NY open only to recovery slowly throughout the U.S. session. USD/JPY on the other hand, sold off aggressively for absolutely no reason. The sharp sell-off in USD/JPY indicates that the dollar’s rally against the euro, British pound and Canadian dollar have nothing to do with today’s better than expected third quarter GDP numbers. We also can’t blame the weakness of USD/JPY on stocks because the S&P 500 closed in positive territory but the EUR/USD did track equities higher. The only plausible explanation are positioning and trading flow. As we saw earlier this month, mergers and acquisition will oftentimes trigger big moves in currencies that cannot be explained otherwise. For the first time since May, traders also turned net short Yen which suggests that some of the reversal in USD/JPY may have to do with stops being triggered below Thursday’s low of 79.80.

The U.S. economy expanded by 2.0% in the third quarter compared to a forecast for growth of 1.8%. While growth in the U.S. didn’t reach a 5 year high like the U.K., the fact that the economy grew at a faster pace last month is still good news for the U.S. dollar. The drought experienced in the summer shaved 0.4% off of GDP but that was compensated by a 3.7% increase in government spending. While the back to back improvements in U.S. data will help boost President Obama’s chances of reelection on November 6th, the decline in the savings rate suggests that there is still underlying weakness in the U.S. economy. This may explain why investors were not impressed by the increase in GDP and why there was no risk rally. The University of Michigan Consumer Confidence Index was revised slightly lower but even with the revision, confidence in the U.S. is still at a 5 year high. Next week will be a busy week with personal income, personal spending, the Conference Board’s consumer confidence index, ISM manufacturing and non-farm payrolls scheduled for release. We will all be watching the unemployment rate carefully. Joblessness dropped to its lowest level since President Obama took office and any increase will not only hurt his chance of reelection but also weigh on the U.S. dollar.

EUR: Growing Gap Between German and the Rest of Eurozone

It has been a tough week for the euro, which fell 4 out of the last 5 trading days. While there was no specific catalyst, weaker economic data, the slide in global equities and increase in European bond yields all pressured the currency lower. With consumer confidence in France declining, business confidence in Italy moving lower and unemployment reaching record highs in Spain, investors are starting to realize that with or without a bailout for Spain, the Eurozone is deep in recession and won’t be rising out of it anytime soon. In fact, things could worsen before they improve as austerity continues to constrain economic activity. Having traded below 1.29 intraday, the euro recovered on the back of the EU and ECB’s “intensive, productive discussions with Spain on bank assistance program.” The Troika’s talks with Greek however aren’t going as well with politicians gridlocked over labor reform. Consumers in Germany on the other hand grew more optimistic in the month of November. Unlike Spain where unemployment rose to a record high, in Germany joblessness is at a 20 year low, which helped to boost confidence to a 5 year high. The gap between how Germany and the rest of Europe has been performing is widening alongside the spread between German, Spanish, Italian and Portuguese bond yields. The euro’s performance next week will be driven by economic data. Additional disappointments will drive the single currency lower but any good news will help encourage a much needed relief rally in euro. The releases worth watching include German consumer prices, unemployment and retail sales. Based on today’s increase in consumer confidence, retail sales may have increased in September.

GBP: Retreats After a Strong Week

After appreciating sharply over the past 48 hours, the British pound ended the day slightly lower against the euro and U.S. dollar. Profit taking after such strong performance during a week of major risk aversion is not unusual and next to the New Zealand dollar, sterling was the week’s best performing currency. So far this month, the improvements in U.K. data give the Bank of England plenty of reasons to hold monetary policy steady when they meet next month. We don’t expect next week’s economic reports to change their stance. A number of housing market indicators will be released along with consumer confidence, a survey of consumer spending and the manufacturing PMI index. Even if any of these reports are weak, monetary policymakers will most likely err on the side of caution and keep policy unchanged unless there is consistent evidence of weakness. Many members of the central bank fear that inflation will exceed expectations if monetary policy is too easy.

NZD: Boosted by Stronger Trade Numbers

There was very little consistency in the performance of the commodity currencies today. The New Zealand dollar continued to rise against the greenback while the Canadian dollar sold off and the Australian dollar held steady. New Zealand was the only country of the 3 to release economic data overnight. The trade deficit narrowed to -791 million in September thanks to a decline in imports and steady exports. RBNZ Governor Graeme Wheeler spoke last night and while his initial comment that there is scope to lower interest rates sounded dovish, he balanced it by emphasizing the importance of price stability and keeping inflation near 2%. NZD/USD traders appeared to be unfazed by the tone and bias of the central bank governor. There was very little explanation for the weakness in the Canadian dollar outside of the possible concerns for the U.S. economy. U.S. stocks have fallen sharply this week, which could take a toll on consumer sentiment and spending going forward. No major economic reports are expected from New Zealand next week but manufacturing activity and producer prices are due for release from Australia along with GDP and employment reports from Canada. Next week should be a big week for the loonie because GDP and employment growth are very important economic reports but the impact on monetary policy should be limited because we learned this week that while the central bank remains hawkish, they are in no rush to raise interest rates.

USD/JPY – First Batch of Stimulus Measures Announced

A new stimulus program, lower than expected deflationary pressures and the continued sell-off in U.S. stocks drove the Japanese Yen higher against all of the major currencies. After being challenged by the Prime Minister to come up with a fresh stimulus plan, Economy Minister Maehara announced the government’s first batch of planned measures overnight. The package worth 423 billion yen includes subsidies to encourage capital expenditure in areas affected by the nuclear disaster and earthquake, tax grants to help rural areas, subsidies to promote use of renewable energy and spending on training programs for part time employees. The government expects these first initiatives to add 0.1% to GDP. Unfortunately 423 billion and a 0.1% contribution to GDP won’t be enough the turn the economy around. While further steps are expected, even the Japanese government doesn’t know what the final size of the stimulus program will be. Currently the opposition party refuses to debate a bill that would allow the Japanese government to sell bonds and finance their expanding fiscal deficit. If the bill is not passed by November, the government will have to dip into their reserves and in this case, limit any additional stimulus measures. Their only hope would be the Bank of Japan and Maehara made it clear that fiscal stimulus won’t be enough. The BoJ has a monetary policy meeting next week and some investors believe the central bank will ease. Rapidly deteriorating economic conditions and the continual decline in prices certainly supports the case for more asset purchases but having just eased last month, the BoJ may opt to wait until November. However there is a good possibility that inflation forecasts and the central bank’s assessment of the economy will be lowered. The BoJ cut their view of the economy at the last 2 meetings and with trade activity deteriorating further, we wouldn’t be surprised if they did so again next week. Japan has been fighting deflation for years now and while consumer prices fell 0.3% in September compared to 0.4% in August, prices declined for the fifth month in a row. Although investors could be encouraged by the stimulus measures announced today, the rally in the Yen can still be largely attributed to risk aversion.