USD: 3 Questions for Janet Yellen

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Daily FX Market Roundup 02-10-14

USD: 3 Questions for Janet Yellen
Why Euro Shrugged Off Weaker IP
GBP: Treading Water Ahead of BoE Inflation Report
CAD: Finance Minister Presents Annual Budget Tomorrow
AUD: Toyota Pulls Out of Australia
NZD: Looking Ahead to Chinese Trade
JPY: Weak Yen Fails to Lend Support to Economy in December and January

USD: 3 Questions for Janet Yellen

For the first time ever, Janet Yellen will be making the trip up Capitol Hill to testify on the economy and monetary policy. While market participants will be waiting with bated breath to hear what the new Fed Chairman has to say, one of her primary goals will be to minimize the market’s reaction to her comments. Maintaining low volatility is a top priority for a central banker especially when it is her first time on the podium and this is why we expect Yellen to say as much as possible tomorrow, but reveal very little. Members of Congress will have a long list of questions for her but investors are only concerned with three:

1. Is She Worried About Muted Job Growth?
2. What Will She do with Forward Guidance?
3. Is Taper on a Preset Course?

Given Yellen’s support for the tapering in December and January, we don’t believe that she will be overly concerned with 2 months worth of weak job growth especially given the recent improvement in the unemployment rate, participation and average hourly earnings. There’s also one more non-farm payrolls report before the March meeting and she will want to wait for that release before establishing a clear judgment on the state of the economy. We also do not expect any new revelations about forward guidance. While it will be necessary to make changes, she will most likely relegate the decision to March when she leads her first FOMC meeting and discusses what the Fed’s official stance should be with the rest of committee. As for tapering, we expect her to say there is no preset course but tapering could end this year. However Yellen will face tough grilling from U.S. lawmakers and investors will be listening very closely for any unintentional revelations. They will over analyze everything that she says and doesn’t say about the outlook for the economy and monetary policy. If she expresses even the slightest concern about the labor market or pace of growth, the dollar will weaken as investors start to price in the possibility of lower forward guidance in March. If she gives off a nonchalant attitude and sounds optimistic, the dollar should rally. The fact that currencies, equities and Treasuries treaded water throughout the North American session is a sign that investors are cautious ahead of this key event risk. If Yellen provides any new revelations, it could trigger a breakout in many major currencies. Her testimony before the House begins at 10am ET / 14 GMT but her prepared remarks will be released at 8:30am ET / 13:30 GMT so despite the lack of U.S. data tomorrow, volatility in the financial markets could pick up as soon as her statement is released.

Why Euro Shrugged Off Weaker IP

Euro traded slightly higher against the U.S. dollar today despite weaker economic data. During the month of December, industrial production declined 0.3% in France and 0.9% in Italy. This follows last week’s 0.6% contraction in Germany and together they confirm that at the end of last year, manufacturing activity slowed across the region. The euro has taken the news in stride because the PMI numbers, which provide a more up to date assessment of how the Eurozone economy is performing, increased in January. For the time being the European Central Bank is comfortable with the outlook for the economy and monetary policy. Just last week, the euro soared to 1.36 after Draghi acknowledged the encouraging signs in the recovery, pickup in consumer demand, rise in confidence and stable savings rates. The French want the euro to weaken but there’s no need for the ECB to consider easier monetary policy at this stage. Meanwhile the Swiss Franc traded slightly higher versus the euro and U.S. dollar thanks to a steady unemployment rate, a confirmation there’s no reason for the Swiss National Bank to change their 1.20 EUR/CHF peg this year. With no Eurozone economic reports scheduled for release tomorrow, Janet Yellen’s comments and the market’s risk appetite will drive the EUR/USD.

GBP: Treading Water Ahead of BoE Inflation Report

The British pound treaded water throughout the North American trading session to end the day unchanged against the euro and U.S. dollar. The only U.K. event risk that could potentially move the British pound this week will be the Bank of England’s Quarterly Inflation Report and like the Federal Reserve, their backs are against the wall because the unemployment rate is falling faster than they anticipated. The BoE also tied itself to an unemployment rate threshold and they are now only 0.1% away from that level. Unfortunately the recovery in their economy is not strong enough to handle an increase in interest rates, which they promised would be their first step in unwinding stimulus. Aside from providing their latest economic forecasts, the Monetary Policy Committee has oftentimes used the Quarterly Inflation Report to telegraph major changes in policy. They will need to update their forward guidance this quarter and they could either choose to abandon their unemployment rate threshold or lower it. We think tying monetary policy to the jobless rate was a big mistake for U.K. and U.S. policymakers and both should abandon this rule completely and move to something more qualitative to manage the market’s expectations. This option would create less volatility for their financial markets and the currency than a change in the level of the threshold but both scenarios would most likely be negative for sterling.

CAD: Finance Minister Presents Annual Budget Tomorrow

The Australian, New Zealand and Canadian dollars traded slightly lower against the greenback today. Canada was the only country to release economic data and the decline in housing starts in January contributed to the pullback in the loonie. The Australian dollar was pressured by the news that Toyota will be pulling out of country in 2017. While this announcement was not a major surprise, it reflects the death of country’s automotive industry. Australian business confidence and housing market numbers are due for release tonight and given the Reserve Bank of Australia’s recent shift in monetary policy bias, improvements need to be seen all around in order to validate their rosier outlook for the economy. Canada’s Finance Minister will also present his budget for the 2014-15 fiscal year tomorrow to Parliament. Flaherty said in November that the deficit would shrink to $5 billion this year before returning to a surplus in 2015. Meanwhile the Chinese economy is slowing and this week’s trade balance will tell us just how much export growth slowed in at the beginning of the year. Exports are expected to have grown by only 1% in January, down from 4.3% at the end of last year. If exports decline and the trade surplus contracts concerns about slower Chinese growth could drag equities and currencies lower. The Australian and New Zealand dollars could suffer the most as investors wonder whether it was wise for the Reserve Bank of Australia to drop its easing bias. At the start of the year we saw how concerns about U.S. and Chinese growth weighed on the markets and this is a reason why risk is vulnerable this week.

JPY: Weak Yen Fails to Lend Support to Economy in December and January

Japan was the only country to release any meaningful economic data over the last 24 hours. According to the latest economic reports, the recovery in Japan’s economy lost momentum in December and January. The country’s trade deficit narrowed but its current account deficit increased. Two important measures of sentiment – the consumer confidence index and Eco Watchers survey also declined. This indicates that the weakness of the yen towards the end of the year failed to lend support to the economy. Yet the Japanese Yen traded higher against all of the major currencies today. This movement is at odds with the rise in the 1.5% Nikkei but the Yoichi Masuzoe’s successful bid for the gubernational election in Tokyo contributed to the enthusiasm for stocks. As a candidate supported by Prime Minister Abe, his victory is seen as a sign of support for Abe’s administration.

Kathy Lien
Managing Director

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