Traders Welcome Yellen with Sell-off in Dollar, S&P 500

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Daily FX Market Roundup 02-03-14

Traders Welcome Yellen with Sell-off in Dollar, S&P 500
How Far Will the BoJ Let USD/JPY Fall?
AUD: What to Expect from the RBA
CAD: Lifted by Positive Development on Keystone Pipeline
NZD: Oil Prices Fall, Gold Rises
GBP: Hit by Weaker Manufacturing PMI
EUR: Only Upside Data Surprise

Traders Welcome Yellen with Sell-off in Dollar, S&P 500

Janet Yellen did not receive a warm welcome from the financial markets on her first day as Federal Reserve Chairman. The U.S. dollar and S&P 500 sold off aggressively and while today’s move does not reflect the market’s lack of confidence in her abilities, the beginning of the Janet Yellen era has not lifted the spirits of investors. Growing concerns about global growth and the Federal Reserve’s determination to continue to taper drove U.S. assets sharply lower. Stocks traded at their weakest levels since November with risk aversion driving USD/JPY below 102 AND 101. In the past, there have been times when the dollar benefitted from a flight to quality but the source of the market’s concerns today stems from the U.S. and for this reason, the greenback sold off as stocks tumbled. Given the recent improvements in manufacturing conditions in NY and Philadelphia, everyone was shocked to see manufacturing activity across the nation expand at its slowest pace since May. The ISM manufacturing index dropped to 51.3 from 56 in the month of January, one of the steepest declines in 2 decades. While part of the decline was due to inclement weather, it “doesn’t account for the entire slowdown” according to the ISM Chairman. Adverse weather conditions will continue to negatively impact business activity in February with severe droughts in the West and the Northeast bracing for 3 snowstorms over a one-week period.

Between the meltdown in emerging markets and slower growth in the U.S. and China, investor confidence has taken a big hit over the past 2 weeks. At this stage, we need an extremely strong non-farm payrolls report to stabilize the market or reassuring comments from Janet Yellen that suggests she may be open to idea of taking a break from tapering if the markets continue to sell-off or economic data weakens. However we don’t expect encouraging comments from Yellen because the U.S. economy is still in the process of recovering. According to a report from the Federal Reserve today, there has been increased demand for business and consumer loans. We are still looking for a rebound in job growth in the month of January and steady service sector activity. Over the past 2 months the U.S. jobless rate has fallen rapidly and if it maintains its current pace of improvement, it could drop to 6.5% this week. We are not looking for an immediate response from Janet Yellen if the threshold is reached because the central bank has been downplaying the significance of the threshold for months now. In fact, the Fed Presidents who are scheduled to speak this week will probably take the opportunity to stress that 6.5% is a threshold and not a trigger for a rate hike. Of the 6 central bank Presidents scheduled to speak, Plosser and Tarullo are the only voting members of the FOMC this year and they are on the opposite sides of the dove / hawk scale. Since there are no U.S. economic reports scheduled for release tomorrow, the U.S. dollar and S&P 500 could be vulnerable to additional weakness.

How Far Will the BoJ Let USD/JPY Fall?

A further sell-off in the U.S. dollar would also mean a deeper slide in USD/JPY. Having broken through its December support level of 101.60, the currency pair is now vulnerable for a test of 100. Although the direction of U.S. and Japanese monetary policy supports a rally in USD/JPY, the currency pair has been hit hard by risk aversion. In order for USD/JPY to rally, investors need to be optimistic about the outlook for the U.S. economy and unfortunately today’s ISM number gave them more reasons to be worried about whether the U.S. central bank’s decision to continue tapering asset purchases was a wise one. Also, it is very difficult for USD/JPY to rise when U.S. yields and stocks are falling and in fact their decline puts downside pressure on USD/JPY. The Nikkei fell nearly 2% overnight and after today’s steep sell-off in U.S. stocks, we expect further losses in Japanese equities and the continued risk aversion could carry USD/JPY lower. On CNBC today, I was asked if the Japanese government would take steps to stop the Yen from rising. I believe that they will save their bullets and wait until the consumption tax is increased. While the government won’t be happy to see the recent change in the Yen’s trend, as long as USD/JPY is trading above 97, they won’t feel pressured to act. With no major U.S. or Japanese economic reports scheduled for release this evening, risk appetite should drive Yen flows.

AUD: What to Expect from the RBA

The Reserve Bank of Australia has a monetary policy meeting this evening and while no changes in interest rates are expected, the tone of the central bank could have significant impact on how the Australian dollar trades. The following chart shows how the Australian economy has performed since the last RBA meeting in December. As you can see, there has been a significant amount of deterioration in economic activity in Australia and its largest trading partner China. Based on the activity indices alone, the RBA has plenty of reasons to grow more cautious and take the idea of another rate cut more seriously. However inflation is on the rise with consumer prices ticking up in the fourth quarter and rising further in the month January according to TD. At 2.7%, the annualized pace of CPI growth is near the top of the RBA’s 2-3% range, making it difficult for the central bank to ease. If the monetary policy statement does not show any new willingness to lower rates, the currency pair could squeeze higher as speculators unload part of their short positions. However if the RBA decides to put growth ahead of inflation and sees the growing need for easier monetary policy, it would be a surprise that could take the AUD/USD to fresh multi-year lows. Meanwhile progress on the Keystone pipeline talks has been positive for the Canadian dollar, leading to a bit of profit taking on USD/CAD longs.

GBP: Hit by Weaker Manufacturing PMI

The British pound sold off sharply against all of the major currencies today on the back of weaker manufacturing data. Recent disappointments in U.K. data h hit the currency pair hard even though there have bright spots in each report. This may be a function of the amount of enthusiasm that investors have had for the currency and their desire to unwind risk on brutal trading days such as today. As our colleague Boris Schlossberg noted in his morning piece, “UK PMI Manufacturing data printed a bit below expectations at 56.7 versus 57.1 eyed. Although the headline reading was a bit softer the new orders component surged to news highs, but the market ignored the underlying data and sold sterling on the headline number as traders continue to worry that UK economic growth may have peaked in Q4 of last year. Cable has failed several times this year at its attempt to break above the key 1.6600 level suggesting that the six months rally from 1.4800 may be running out of steam as the BoE is unlikely to tighten monetary policy anytime soon unless the economic indicators improve markedly from current levels. This week the market will get a look at the UK Construction and Services PMI reports and if those miss their mark, the pound could slide towards the 1.6200 figure as profit taking accelerates.”

EUR: Only Upside Data Surprise

Better than expected economic data drove the euro higher against the U.S. dollar. Of all major countries or regions that we follow, the Eurozone was the only one to report an improvement in manufacturing activity today. Aside from the drop in the U.S. ISM report, manufacturing conditions also weakened in China, Australia and the U.K at the start of the year. However in the Eurozone, manufacturing activity was revised up for the region as whole, led by stronger activity in Germany and France. These reports are consistent with an overall recovery in the region. The European Central Bank meets this week and they will be happy to see this recent improvement but unfortunately there are still areas of weakness such as consumer spending. Inflation remains low, which means the central bank will most likely maintain its dovish bias. Eurozone producer prices are scheduled for release tomorrow and given the drop in CPI, PPI growth is expected to slow. Today’s sell-off in the EUR/USD stopped right at the 38.2% Fibonacci retracement of 2008 to 2010 sell-off near 1.3470.

Kathy Lien
Managing Director

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