USD: FOMC Minutes Rock the Markets

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Daily FX Market Roundup 02-20-13

USD: FOMC Minutes Rock the Markets
EUR: Will the PMI Numbers Save the Euro?
GBP: 2.5 Year Low Against the USD
NZD: RBNZ Comments Kill the NZD
AUD: Watch Out for RBA Semi-Annual Testimony
AUD: Gold Prices Sink
JPY: How the Weak Yen is Hurting Japan’s Trade Balance

USD: FOMC Minutes Rock the Markets

Currencies, equities and commodities reacted strongly to the FOMC minutes. In the month of January, “many” Fed officials were concerned about the “efficacy, costs and risks of asset purchases.” An ongoing evaluation of these factors could lead the “committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labour market had occurred”. In plain English this means that Fed officials could end Quantitative Easing way before they reach their 6.5% unemployment target. As shown in today’s producer price report, inflation is not the main problem. Policymakers are worried about the potential volatility and increase in interest rates that could occur when they decide to sell assets. So therefore they want ease the flow of assets back into the market gradually to avoid any shocks to the economy. The fact that the discussions about phasing out asset purchases has gained traction suggests that the Fed believes that the U.S. economy is on firm enough footing to handle a slowdown in asset purchases. In response, the U.S. dollar has soared and stocks have fallen.

While we are not surprised that Fed officials talked about phasing out asset purchases again (in fact, we told our readers to expect it), we were surprised by how willing they are to look beyond the 7.9% unemployment rate. Of course it won’t be easy to unwind asset purchases when the time comes, but we had expected them to do so when the economy was performing better and therefore more able to handle asset sales. Recent economic data including today’s housing markets reports show the economy recovering very slowly and we expect Thursday jobless claims, CPI, Philly Fed and existing home sales reports to paint a similar picture of sluggish growth. The rally in stocks has helped to support consumer sentiment but has yet to translate into stronger spending. Nonetheless, our skepticism matters little when investors have bought dollars this aggressively. We expect this rally to continue as long as policymakers do not backpedal on the discussions. Fed Presidents Bullard, Williams, Fisher and Powell will be speaking over the next 48 hours and they will undoubtedly be asked about the central bank’s plans but the real test will be Bernanke’s semi-annual testimony next week. If the Fed Chairman confirms that asset purchases are being reviewed, today’s rally could become a real turnaround in the U.S. dollar. If he downplays the possibility and suggests that these are very initial discussions, the dollar could give back its gains quickly.

EUR: Will the PMI Numbers Save the Euro?

The euro dropped to a 1 month low against the U.S. dollar today on the back of the less dovish FOMC minutes. The fate of the EUR/USD now lies in the hands of tomorrow’s Eurozone PMI numbers. The only factor preventing a deeper slide in the euro is the stability of the German economy. Germany is carrying the entire Eurozone on her shoulders and according to this week’s ZEW survey investors expect this trend to continue. The PMI numbers will give us a sense of much buffer Germany and the Eurozone really have. If the data continues to surprise to the upside with the manufacturing and service sectors in Germany growing at a faster pace in the month of February, the EUR/USD could find support after today’s sharp sell-off. However if the data surprises to the downside, investors will look at the more dovish comments from the ECB versus the less dovish comments from the Federal Reserve and drive the EUR/USD lower. The euro was already under pressure before the FOMC minutes because Spain’s Prime Minister said the decline in their public debt levels will fall short of the European Union’s agreed target of 6.3%. The 2012 deficit is expected to come in under 7%, which we believe is still good news for Spain because anything below 8% limits the risk of a downgrade.

GBP: 2.5 Year Low Against the USD

The British pound dropped to a 2.5 year low against the greenback after the Bank of England minutes revealed 1 additional member voting in favor of easier monetary policy. Between weaker economic data, deteriorating fiscal finances, the prospect of easier monetary policy and the risk of a sovereign downgrade, investors have pulled out of sterling quickly and aggressively. We believe that this trend will continue as there is no support in the GBP/USD until 1.50. Our colleague Boris Schlossberg covered the minutes thoroughly – “the BOE minutes revealed that the MPC vote on increasing QE saw it margin rise to 6-3 indicating that UK monetary policymaker may be moving closer to additional easing. Governor Mervyn King joined Paul Fisher and David Miles in voting to increase QE by another 25 Billion to 400 Billion. The UK monetary officials are clearly frustrated by the lack of growth in the economy and appear to be running out of any viable policy options. The UK economy registered its third quarterly contraction in Q4 of 2012 since the credit crunch of 2008 and shows no signs of gaining traction. Cable was further hurt by rumors earlier in the Asian session that the S&P may downgrade UK sovereign debt. Last December the agency affirmed UK’s AAA status but revised the outlook to negative.” Since the beginning of the year, we have been saying that one of the greatest risks for the U.K. is a sovereign downgrade and it appears that this notion is gaining traction in the markets. U.K. public sector finances are due for release tomorrow and a decline in public sector net borrowing is expected, which would add salt to the wound.

NZD: RBNZ Comments Kill the NZD

The worst performing currency today was the New Zealand dollar, which fell nearly 1.4% against the greenback. The sell-off in the NZD was caused by comments from RBNZ Graeme Wheeler who suggested that New Zealand dollar was overvalued and that the central bank stood ready to intervene if necessary. Having failed at intervention in the past and admitting that they don’t have the resources to control currency, intervention is not a realistic risk for New Zealand. However with economic data improving, Wheeler is trying to prevent the NZD from being a one-way trade. As long as there is more upside than downside surprises in New Zealand data, we still think the NZD is headed higher. The Australian dollar also traded sharply lower on the back of weak leading indicators and slower annualized wage growth. Another monthly decline in Canadian house prices kept the CAD under pressure and the currency extended its losses after the FOMC minutes.

JPY: How the Weak Yen is Hurting Japan’s Trade Balance

The Japanese Yen traded higher against all of the major currencies except for the U.S. dollar, which benefitted from the FOMC minutes. While the Fed’s discussion about phasing out asset purchases helped USD/JPY, it was still not enough to drive the currency pair to fresh highs. Yen traders are waiting for their next catalyst to come out of Japan and we believe that it will come from the nomination for Bank of Japan Governor. The announcement can come any day now but is likely to occur right either right before or after Prime Minister Abe returns from his visit to the U.S. early next week. The short term reaction in USD/JPY will depend on his choice of BoJ Governor with Iwata being the most dovish, Muto being the least and Kuroda in the middle. However, at the end of the day we believe that regardless of which man Abe chooses, the new head of Bank of Japan will come out quickly and reaffirm his plans to follow through with reaching the government’s 2% inflation forecast which will require an aggressive amount of easing and drive the Yen lower once again. Based on the latest trade numbers, Japan’s economy needs a lot more help. Despite the significant amount of Yen weakness that has occurred over the past 3 months, Japan’s trade deficit ballooned to a record high of 1.629 trillion yen. What was interesting about the results was the fact that exports increased for the first time in 8 months but it was not enough to offset the impact that the weak Yen had on Japan’s energy import bill. The combination of higher oil prices and a weaker currency pushed the value of imports up 7.3% and this is an example of how a weak currency can also hurt trade activity.

Kathy Lien
Managing Director

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