How Beige Book Could Impact the Dollar

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Daily FX Market Roundup 09-03-12

How Beige Book Could Impact the Dollar
EUR: Hits 5 Week Low
GBP: No Support from Data or M&A Flow
Will Bank of Canada Bias Drive USD/CAD Above 1.06?
AUD: RBA Becomes Less Dovish
NZD: Fails to Participate in Comm Dolllar Rally
JPY: Japan Expected to Proceed with Consumption Tax

How Beige Book Could Impact the Dollar

Five central banks are meeting this week but the focus for currency traders is the monetary policy of a central bank that won’t make any decisions for another 2 weeks. The reason why the Federal Reserve meeting in late September is receiving significant focus is because this week’s economic reports and Fed speeches are expected to shape market expectations. Up until now, economists and investors are divided on how soon the U.S. central bank will reduce asset purchases – some say September and others vote for December. A small majority favors an earlier move and we agree that barring any surprise pullback in job growth, the Fed will taper this month. Economic data from the U.S. hasn’t been terrible (though it hasn’t been great either) and most of the economic reports are consistent with a gradual U.S. recovery that should be satisfactory for the Federal Reserve.

Wednesday’s Beige Book report will provide a more thorough look at how the U.S. economy is performing. We expect Fed districts to report a continued but uneven recovery that will keep the market guessing about when the central bank will taper. For the U.S. dollar, this could mean a bit of profit taking but not a significant sell-off. However if the Beige Book report is optimistic, U.S. 10 year bond yields could edge closer to 3%, taking the dollar higher with it. With the central bank’s singular focus on the labor market, the Beige Book’s assessment of labor market conditions will be particularly important. In the early morning, the Challenger layoff report and trade balance could also trigger a reaction in the dollar.

The greenback gained momentum today after the release of manufacturing ISM. Despite slower manufacturing activity in the NY and Philadelphia regions, the nation as a whole saw its strongest expansion in manufacturing since June 2011. This is a nice surprise that will make U.S. dollars more attractive from both a safe haven, monetary policy and yield perspective. Unfortunately the details of the report were not unambiguously positive as the employment index dropped from 54.4 to 53.3, a sign of slower job growth. The bulk of the increase was driven by higher prices and new orders. Aside from the data releases, forex traders also need to keep an eye on the conversations about Syria because military action could easily overshadow economics.

EUR: Hits 5 Week Low

The euro dropped to its lowest level against the U.S. dollar today in 5 weeks. Eurozone data was positive for the currency – producer prices grew 0.3% in the month of July and on Monday we learned that manufacturing activity was slightly stronger than initially estimated. Obviously none of this matter to the currency as it fell for the fifth consecutive trading day. EUR/USD weakness has a lot more to do with dollar strength than euro weakness. The abundance of U.S. data this week and possibility of Fed tapering will make ECB policy seem even easier than it really is. It will be hard to avoid comparing the current stance of the ECB with that of the Federal Reserve and realizing that the massive divergence in monetary policy direction is negative for EUR/USD. However a break of 1.31 relies on continued improvements in U.S. data and a dovish monetary policy bias from the ECB. Tomorrow’s Eurozone PMI Services report and Q2 GDP numbers are not expected to have much impact on the currency, as they are revisions and not initial releases. Eurozone retail sales on the other hand could add pressure on the EUR/USD because German and French spending weakened in the month of July but the real focus will be on the Federal Reserve’s Beige Book report. Meanwhile the Swiss Franc traded lower against the U.S. dollar and euro despite stronger than expected GDP growth. Switzerland’s economy expanded 0.5% in the second quarter, driving annualized GDP growth to 2.5% from 1.2%. This recovery is in large part thanks to the Swiss National Bank’s policies, which included a rather effective ceiling for its currency.

GBP: No Support from Data or M&A Flow

The British pound failed to extend higher despite better than expected economic data and a major M&A flow that should have been positive for sterling. Vodafone’s sale of its $130 billion (GBP84 billion) stake in U.S. based Verizon is one of the largest deals in corporate history. The sale will return billions of dollars to Vodafone shareholders and according to management a sizeable portion will go directly to investors. Merger and acquisition flows will typically create a short-term movement in the currency but so far we have not seen the Vodafone Verizon sale affect sterling in a significant way but the flow from the deal should keep the currency bid. Demand for sterling has not been but should also be supported by better than expected data. Acceleration in construction sector activity coupled with the increase in manufacturing activity reported on Monday indicates that the U.K. recovery is gaining momentum. If tomorrow’s PMI services index also shows a faster expansion in the month of August, the trifecta of improvements will make it difficult for the BoE to justify a significant level of dovishness when they meet later this week. We have already seen 6 consecutive months of improvement in the manufacturing sector and in July, the service sector grew at its fastest pace since 2006. With confidence ticking upwards, we think there is a reasonable chance that service sector activity also gained momentum last month and stronger data should eventually drive the GBP higher.

Will Bank of Canada Bias Drive USD/CAD Above 1.06?

Wednesday is a busy day for the Canadian dollar with a central bank rate decision and trade numbers scheduled for release. Naturally the rate decision will be the more important event risk of the two and the deciding factor of whether 1.06 will be broken in USD/CAD. For the past 1.5 weeks, USD/CAD quietly consolidated below this key level after weaker economic data drove investors to sell the loonie. The reason why 1.06 is so significant is because the currency pair hasn’t managed to break this level in a meaningful way since the first half of 2010. Economic data from Canada has been weak with the economy contracting 0.5% in June and growth slowing to 1.7% in Q2 from 2.2% in Q1. Manufacturing activity also contracted in July for the first time this year. Some of the weakness can also be attributed to temporary factors such as floods in Alberta and strikes in Quebec but there are also underlying issues in Canada’s economy. We would not be surprised if Bank of Canada Governor Poloz grew more cautious after having already notched down the central bank’s level of hawkishness at his first monetary policy meeting. When the BoC last met, Stephen Poloz led his first monetary policy meeting and immediately adjusted the central bank’s statement to say 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” instead of a “modest withdrawal will likely be required, consistent with achieving the 2 per cent inflation target.” Unfortunately we don’t believe additional caution is enough to drive a sustained break above 1.06 for USD/CAD. Meanwhile, the Reserve Bank of Australia was the first major central bank to meet on monetary policy this week and their less dovish stance drove the AUD/USD above 90 cents. Even though the central bank still feels that the Australian dollar is too high and the economy is beginning to adjust to lower levels of mining investment (hardly a positive development), they omitted the words “scope to ease policy further” from their statement, leading investors to believe that the RBA is no longer considering any rate cut this year. Unfortunately mixed economic data means that the central bank cannot rule out this possibility completely. Retail sales growth fell short of expectations in July but manufacturing activity improved. Service sector PMI and Q2 GDP figures are scheduled for release tonight. Growth will be supported by trade activity because consumer consumption last quarter was very weak. Despite the lack of data, the New Zealand dollar weakened against all of the major currencies.

JPY: Japan Expected to Proceed with Consumption Tax

It was a mixed day for the Japanese Yen, which traded lower against the U.S. dollar and higher against the euro. The currency’s performance against other major currencies was equally divergent even though Japanese stocks performed extremely well with the Nikkei rising nearly 3% overnight. Labor cash earnings growth slowed slightly in the month of August, a development that had barely any impact on the currency. Instead the big story for Japan is their plans to proceed with a consumption tax hike. According to Finance Minister Aso, Japan will inform its international counterparts that they plan to raise taxes at this week’s G20 Summit. While an official decision probably won’t be made until early October, it certainly appears that the government wants to press hard for higher taxes to curb their fiscal deficit. Their original plans call for raising the consumption tax to 8% from 5% in April 2014 and then to 10% in October 2015. Approximately 13.5 trillion yen or $140 billion in revenue is expected to come from the tax. Most likely, Abe will cushion the blow by boosting spending because there are widespread concerns that a tax hike would slow the recovery. Japan may also be criticized for Yen weakness at this week’s meeting but don’t expect any concerns to officially make it way into the communiqué. No major Japanese economic reports are scheduled for release this evening but the Bank of Japan will begin its 2 day monetary policy meeting.

Kathy Lien
Managing Director

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