Daily FX Market Roundup 09-04-13

FX: What to Expect from ECB and BoE
GBP: More Optimism from the BoE?
USD – Beige Book Keeps September Tapering Expectations Intact
AUD Up More than 1% on Strong Data
CAD: BoC Leaves Rate Guidance Unchanged
NZD: Best Performing G20 Currency
JPY: BoJ Meeting Should be a Nonevent for Yen

FX: What to Expect from ECB and BoE

European currencies will be in focus over the next 24 hours with the European Central Bank and Bank of England scheduled to make monetary policy announcements. Both central banks are set to leave monetary policy unchanged but a lack of action does not equate always to a nonevent for currencies. In the case of the ECB, the press conference by Mario Draghi always receives a lot of attention. When the central bank last met in August, Draghi acknowledged improvements in the economy that “tentatively confirm the expectation of a stabilization in economic activity.” The euro rallied in reaction but the gains did not last long as Draghi’s warning that even if the economy improves, “money-market prices signaling rate rises are unwarranted” rang in the back of everyone’s minds. The ECB has made it clear through their version of forward guidance that there is no exit in sight. They plan to keep rates low for an extended period of time, are keeping an open mind on negative deposit rates with future decisions dependent on data.

Unfortunately data has been mixed which is why we don’t anticipate any major changes in the ECB’s stance. Stronger manufacturing and service sector signal stabilization in the Eurozone economy but weaker labor market conditions and lower consumer spending in Germany along a rise in oil prices and global uncertainty should keep the ECB cautious. The central bank has taken a more conservative approach to their Eurozone outlook after cutting rates and the recent rise in oil prices poses a greater risk to consumer and business spending in this low inflation environment. Therefore we expect the central bank to remain dovish, a stance that could hurt the euro if the investors compare ECB policy with Fed policy. Most likely Mario Draghi will want to wait to see if the Federal Reserve changes monetary policy this month before taking any additional action. If the ECB is suddenly more optimistic however the EUR/USD could make its way back to 1.33. The 1.34 level on the other hand will be very difficult for the EUR/USD to break unless non-farm payrolls are shockingly weak. If the U.S. data is strong, 1.31 could be achievable.

GBP: More Optimism from the BoE?

Back to back improvements in U.K. data will make it difficult for the Bank of England to convince investors that they should be worried about the outlook for the U.K. economy. The manufacturing sector experienced 6 consecutive months of stronger activity while the service sector expanded for the 7th straight month. Not only did services expand at its fastest pace in 6 years but the all sector index reached a record high. So while the Bank of England could talk about the weakness of the banking system, the lack of wage growth and the vulnerability of the recovery, it will be difficult to ring these warning bells if data shows that the recovery is gaining and not losing momentum. While monetary policy is not expected to change, we are very interested in seeing whether a detailed statement is released after the rate decision. BoE Governor Carney chose to provide one in his first monetary policy meeting but comments in his second statement was much shorter. As a new central bank governor, the market is still trying to understand his rhythm. Having just spoken last week, we know that Carney recognizes the improvement in data but wants to leave the door open to additional easing. However some of his counterparts could be more optimistic given recent economic reports and we will have to see whether this optimism makes its way into the BoE statement or the minutes.

USD – Beige Book Keeps September Tapering Expectations Intact

Despite a minor rise in U.S. yields, the dollar traded lower against all of the major currencies except for the Japanese Yen. USD/JPY held steady at its one-month highs as investors wait for labor market data. Unfortunately the Federal Reserve’s Beige Book report did not have much impact on the greenback. According to the 12 Fed districts, the economy expanded at a “modest to moderate” pace since the last central bank meeting. Most Fed districts reported an increase in demand for cars, homes and other related items despite higher borrowing costs. The labor market also held steady or improved in all districts. This should be a relief for any policymakers who may have been worried about a slower recovery. Today’s report poses no threat to our belief that the Fed will taper in September. The only question is how much asset purchases will be reduced on a monthly basis and that will depend in large part to Friday’s non-farm payrolls report and the level of yields on September 18th. We believe that the central bank has every reason to make only an incremental change because data has been mixed. Today for example, we learned that the trade deficit increased in the month of July. The worse than expected trade balance was caused by a decline in exports and increase in imports. The trade gap with China and the European Union specifically climbed to record highs as U.S. demand strengthened and global demand weakened. According to Fed President Williams who is a non-voting member of the FOMC, Syria could also play a role in their monetary policy discussions. For the dollar, focus will begin to shift to non-farm payrolls with tomorrow’s release of ADP Employment change and non-manufacturing ISM. The employment component of the service sector index is one of favorite leading indicators for NFPs.

AUD Up More than 1% on Strong Data

The Australian and New Zealand dollars rose more than 1% against the greenback today thanks to better than expected economic data from Australia and China. Both the AUD/USD and NZD/USD have been deeply oversold and recent improvements in economic data along with less dovishness from the Reserve Bank of Australia triggered a short squeeze in both currencies. The outlook for Australia appears brighter but we only cautiously optimistic because the GDP data is for the previous quarter and while manufacturing activity improved, service sector activity deteriorated slightly last month. Australian trade data is scheduled for release this evening and investors are still looking for a smaller surplus. No data was released from New Zealand but the currency rose in lockstep with the AUD. Meanwhile the CAD saw very little impact from the Bank of Canada’s decision to leave interest rates at 1%. While they sounded more cautious about the economic outlook, their guidance on interest rates remained unchanged. The BoC still believes that “over time, as the normalization of these conditions unfold, a gradual normalization of policy interest rates can also be expected, consistent with achieving the 2% inflation target.” Yet their concerns about emerging market volatility, global uncertainty, slightly less momentum in the U.S. and a moderation in the “dynamic” of the global economy means the central bank has grown a bit more cautious. There is hope however because household imbalances are evolving constructively and they expect the output gap in the economy to begin to narrow next year. Overall the tone of caution means that the central bank is comfortable with the current level of monetary policy. Economic data from Canada continues to be weak. Like the U.S., the country reported a wider trade gap this morning as metal exports declined, causing exports to fall 0.6% while imports rose by the same amount. If economic data continues to deteriorate, the BoC may eventually feel compelled to shift to neutral. This may be only the second monetary policy meeting led by Stephen Poloz but so far, he appears to be less hawkish than his predecessor.

JPY: BoJ Meeting Should be a Nonevent for Yen

The Japanese Yen traded lower against all of the major currencies today supported by the rally in equities and the prospect of continued stimulus from the Bank of Japan. The BoJ is not expected to alter monetary policy, which means the rate decision will most likely be a nonevent for the Yen. The monetary base is currently on track to be increased by JPY60-70 trillion a year. Inflation is also moving in the right direction, with the national consumer price index rising from 0.2% to 0.7% in July. Recent improvements in Japan’s economy including stronger manufacturing activity and a recovery in capital spending means the central bank won’t be eager to increase stimulus especially since they firmly believe that current programs need time to affect the economy. Last month, Deputy Governor Iwata said it could take up to a year before Japan sees any real benefit but the signs should be clearer in FY2014. Instead what monetary policy committee members will spend a lot of time talking about is the role of monetary policy in the context of fiscal policy. Policymakers will share their views on whether a higher consumption tax could derail the recovery and if it does, will the BoJ be prepared to increase stimulus.

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