Temporary Stability in EURO?

Posted on

Daily FX Market Roundup 05-14-14

Temporary Stability in EURO?

Dollar Tumbles as Yields Drop to 7 Month Lows

GBP/USD Extends Losses, BoE Fails to Deliver

AUD Closes in on 1 Month Highs on News from China

NZD: Retail Sales Growth Slows Raising Odds of RBNZ Pause

CAD Shrugs Off Higher House Prices

JPY Rallies Ahead of Q1 GDP

Temporary Stability in EURO?

After 5 days of steep losses, the euro stabilized against the U.S. dollar. Considering that the sell-off stalled at 1.37, a level that could be seen as important support for the currency pair, many traders are wondering whether this marks a bottom or a pause before further losses. In other words is EUR/USD exhibiting a false sense of stability? In order to address this question, we have to understand what prevented EUR/USD from extending its losses today. While today’s economic reports highlight the challenges the ECB faces including weaker industrial production and low inflation, all of the reports were in line with expectations. Instead the resilience of EUR/USD had less to do with the market’s appetite for euros and more to do with its distaste for U.S. dollars. Both ten year U.S. and German bond yields ended the day lower but the decline in Treasury yields overshadowed the drop in Bund yields. A number of ECB officials also spoke today and they all seem to agree that the high level of the currency is causing problems for inflation. They also appear to support Mario Draghi’s plans to ease monetary policy next month. Bundesbank President Weidmann said they see a slight risk of deflation and would support ECB action if needed. ECB member Praet said the central bank is preparing to combine a range of measures and ECB member Mersch said that while the government cannot buy bonds in the primary market, they can buy them in the secondary market. It is not unusual to hear relatively cohesive comments from European central bank officials ahead of a big change in monetary policy and in fact when many policymakers are reinforcing the same message, the chance of a move increases. We believe the most likely course of action for the central bank will be a combination of small steps that include a cut to the refi rate, a mildly negative deposit rate and a decision to end sterilization of SMP purchases. From a monetary policy perspective, the euro should be trading lower but as long as U.S. yields fall at a faster pace than Eurozone yields, the currency pair could find support. Also, in the short term Eurozone GDP numbers are scheduled for release tomorrow and a bounce in growth could extend the relief rally. In the longer term, we believe Eurozone rates will decline and U.S. rates will bounce so we view any uptick as an opportunity to sell at higher levels with an eventual move down to 1.3600 for the pair.

Dollar Tumbles as Yields Drop to 7 Month Lows

The persistent decline in Treasury yields drove the U.S. dollar lower against most of the major currencies. Despite a surprise increase in producer prices, 10-year yields hit its lowest level in 7 months and as long as U.S. rates are falling, the dollar will have a tough time rallying. Economists were looking for PPI growth to slow to 0.2% but instead, prices rose 0.6% in the month of April and excluding the cost of food and energy, PPI rose by a healthy 0.5%. This strength drove annualized growth to 2.1% from 1.4%, its highest level in nearly 2 years. The increase in prices was driven primarily by higher food costs with the drought in the West and a porcine epidemic pushing up the prices of meat. Although the increase in inflationary pressures puts the central bank closer to reaching their inflation target, investors have mostly ignored the release because they believe that consumer price growth remains limited and until inflation becomes a bigger issue, it won’t affect monetary policy. CPI is scheduled for release tomorrow along with jobless claims, the Empire State manufacturing survey, Treasury International Capital Flow report and the Philly Fed index. Of these reports, the 2 manufacturing reports are the most important but even then, the impact on the dollar could be limited. The pace tapering won’t accelerate because of stronger data tomorrow but weak data could drive yields even lower.

GBP/USD Extends Losses, BoE Fails to Deliver

The British pound extended its losses against the U.S. dollar after the Bank of England failed to boost expectations for monetary tightening. Going into the release of the Quarterly Inflation Report, most investors were positioned for a more optimistic and hawkish outlook from the central bank. They were hoping that the BoE would signal plans to raise interest rates this year but the central bank refused to deliver. As we warned in yesterday’s note, the risk of disappointment was high. Although economic activity improved in the month of April, we said weak retail sales, lower inflation and a strong currency encourages the central bank to keep monetary policy steady. We also noted that inflationary pressures have been confined to the housing market and instead of raising rates, the U.K. government could opt to scale back the Help to Buy Scheme or impose restrictions on mortgages as a first step to cool growth in a very overheated sector – and that was exactly what the central bank said today. According to Bank of England Governor Carney, “monetary policy is not the appropriate policy to control the housing market” and that the “Financial Policy Committee has a rage of tools to address housing risks.” Although Carney did admit that the “economy is moving closer to the point of a rate increase, the timing of the increase will depend on the economy” and with significant slack in the labor market he is not ready to act. The BoE also left its 2014 CPI and GDP forecast unchanged (raising only its 2015 forecast), supporting the central bank’s plans to keep monetary policy easy. Concern about slack in the labor market and latest labor market numbers explains the lack of changes to the forecasts. While the unemployment rate edged lower, the number of people filing for jobless benefits fell less than expected and more importantly average weekly earnings growth held steady at 1.7%, versus expectations for an increase to 2.1%. The slightly more dovish BoE Quarterly Inflation Report should deflate expectations for monetary tightening and lead to a further unwind of long GBP/USD positions. We expect the currency pair to drop through 1.67 in the near term.

AUD Closes in on 1 Month Highs on News from China

The Australian and New Zealand dollars extended their gains against the greenback today with AUD/USD rising to its strongest level in nearly a month. No major economic reports were released from Australia but the country’s currency received support from the news that the People’s Bank of China has called on its commercial banks to improve mortgage lending by accelerating the approval of home loans and setting mortgage rates at are more reasonable levels. After almost 2 decades of continuous increases in real estate prices, the bubble in the housing market is beginning to deflate. According to a recent report from the Chinese government, housing starts dropped 25% in the month of April with prices falling on new and previously owned apartments. Today’s guidance from the central bank represents a soft attempt to avert a deeper slowdown in the sector that could spread into the economy. Stability in the housing market is not only positive for China but also its trading partners such as Australia, which explains why AUD responded positively to the news. Even the New Zealand dollar tacked on some gains despite weaker than expected retail sales. Spending growth slowed to 0.7% in the first quarter from 1.4% in Q4. This pullback in demand reinforces our view that the RBNZ could refrain from tightening in June and this possibility should cap gains in NZD/USD. Meanwhile the Canadian dollar received very little support from higher house prices. Tonight, New Zealand’s Business PMI index is scheduled for release followed by Canadian manufacturing sales tomorrow.

JPY Rallies Ahead of Q1 GDP

The Japanese Yen ended the North American trading session higher against most of the major currencies. First quarter GDP numbers are scheduled for release this evening and like last night’s Corporate Goods Price Index (CGPI), the data will be impacted by last month’s sales tax increase. With the sales tax, CGPI rose 4.1% yoy and according to the Bank of Japan, without the effect of the tax, price growth slowed to 1.4% from 1.7%. Unlike CGPI however, it is the lead up to the rise in taxes that is expected to drive stronger GDP growth in the first quarter. Economists are looking for the economy to have grown 1% in Q1, which would lift the annualized pace of growth from 0.7% in Q4 to a whopping 4.2%. While this is encouraging it is important to remember that GDP growth in Japan has been extremely volatile in recent quarters and what the central bank really wants to see is how the economy performed after taxes were increased. If GDP growth exceeded 4.1% in Q1, investors will most likely write it off to a rush to spend ahead of the tax. Aside from the GDP, report, the Ministry of Finance’s weekly portfolio flow report and consumer confidence report are also scheduled for release.

Kathy Lien
Managing Director

Leave a Reply

Your email address will not be published. Required fields are marked *