USD: Will the Fed’s Taper Plans be Swayed by Data?

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Daily FX Market Roundup 01-22-14

USD: Will the Fed’s Taper Plans be Swayed by Thurs Data?
EUR: Time for Flash PMIs
GBP Soars to Fresh Yearly Highs as UK Jobless Rate Hits 5 Year Lows
Bank of Canada Drives USD/CAD to Fresh 4 Year Highs
AUD: Supported by Rise in Q4 CPI
NZD: Oil Up 1.7%, Gold Down Slightly
JPY: BoJ Leaves Policy Unchanged, Slight Downgrade to 2014 GDP Forecast

USD: Will the Fed’s Taper Plans be Swayed by Thurs Data?

After 3 days of complete radio silence from U.S. agencies responsible for releasing the latest metrics on the economy, we finally have U.S. data on the calendar. Thursday is the only day this week with U.S. releases so for a market that has been on hold waiting for new direction, tomorrow’s reports could have a larger than usual impact on the dollar. However jobless claims, existing home sales and leading indicators are second tier reports that rarely affect Federal Reserve policy unless there is a consistent trend of deterioration or improvement. For the most part, jobless claims are expected to remain unchanged, existing home sales should rebound slightly and leading indicators are expected to grow at a slower pace but none of these will be game changers for the Federal Reserve. The FOMC’s monetary policy plans are in focus next week with the central bank gathering for its first meeting of the year. This will also be the last meeting presided by Fed Chairman Ben Bernanke. Last month, when Bernanke started unwinding the central bank’s asset purchase program, he said he expects asset purchases to be reduced by $10 billion at each successive meeting. However job growth slowed significantly in December, causing consumer demand to be sluggish. So the big question for the outgoing Fed Chairman is whether he should ignore the data and press forward with unwinding Quantitative Easing or pause, leaving his successor Janet Yellen with the choice of restarting the process in March. Unfortunately tomorrow’s economic reports are not likely to affect his decision and if we had to take a guess, Bernanke won’t retract his views and will instead reduce asset purchases by another $10 billion next week. Meanwhile U.S. stocks were mixed today with the Dow falling but the S&P 500 and Nasdaq rising. A number of big names report earnings today and according to Bloomberg, of the 81 S&P index companies that have posted results, 70% beat estimates for profit and 64% exceeded sales projections.

EUR: Time for Flash PMIs

Tomorrow’s Eurozone flash PMI reports are some of the most market moving releases for the euro as they provide important up to date insight into the performance of the Eurozone economy. Economists are currently looking for broad based improvements with activity increasing in the Eurozone, Germany and France during the month of January. German industrial production and factory orders have been firm and even though investors are less optimistic about the future outlook for Germany, they have grown more confident about current conditions. For the region as a whole, investor confidence hit a 9-year high according to the Eurozone ZEW survey. ECB member Nowotny shares this rosy outlook. If the flash PMIs show that the Eurozone economy improved in the month of January, EUR/USD could trade back above 1.36. However if the flash PMIs shows any deterioration in France, Germany or the region as a whole, we could see 1.35 broken. EUR/USD has been stuck in a range between 1.35 and 1.36 since the beginning of the week and tomorrow’s report could very well cause the pair to break out of this range.

GBP Soars to Fresh Yearly Highs as UK Jobless Rate Hits 5 Year Lows

The British pound traded sharply higher against all of the major currencies today, hitting fresh 1 year highs against the euro and Swiss Franc on the back of stronger U.K. employment numbers. As we surmised from the PMI reports, the U.K. labor market improved significantly in the month of December, easing concerns that the economy peaked towards the end of the year. Jobless claims dropped by 24k which was less than economists expected but the unemployment rate plunged to 7.1%, just a hair above the Bank of England’s 7% threshold. At the last central bank meeting, policymakers stressed that 7% is a threshold and not trigger for a rate hike. According to the minutes released today, members “saw no immediate need to raise Bank Rate even if the 7% unemployment threshold were to be reached in the near future. Moreover, it was likely that the headwinds to growth associated with the aftermath of the financial crisis would persist for some time yet and that inflationary pressures would remain contained. Consequently when the time did come to raise Bank Rate, it would be appropriate to do so only gradually.” Come February when the Quarterly Inflation Report is released, the central bank will have a difficult decision to make – do they advance their unemployment rate forecasts, lower their unemployment rate threshold to 6.5% or both? The key lies in wage growth. Average earnings growth slowed in December, providing the central bank with the flexibility to wait. As long as wage growth is lagging behind inflation, the Bank of England won’t be hard pressed to tightened monetary policy. Sterling performed well on the back of the U.K. employment report and we expect these gains to be sustained. The Vodafone / Verizon deal closes in a month and until that happens, the M&A flow will provide underlying support for GBP/USD.

Bank of Canada Drives USD/CAD to Fresh 4 Year Highs

The Canadian dollar dropped to a fresh 4 year low against the U.S. dollar on the back of the Bank of Canada’s monetary policy announcement. While the central bank left interest rates unchanged at 1%, they have grown more concerned about low inflation. Here are the 3 main takeaways from the BoC statement:

3 Main Takeaways from Bank of Canada Statement

1. Not worried about 6% drop in CAD since Oct
2. Downside risk to Inflation has increased
3. Outlook for 2014 growth brighter but softer 2015 growth

Despite a 6% drop in the value of the Canadian dollar versus the U.S. dollar since October, the central bank still thinks the currency can fall further. They need it to weaken because they want more support for the export sector. If you recall, Canadian trade activity deteriorated significantly in October and November with export volumes to the U.S. falling. Part of the reason why the central bank can tolerate a weaker currency is because they believe that the “downside risk” to inflation increased and to reinforce this view, they cut their 2014 inflation projections. While Finance Minister Flaherty, the OECD and the IMF feel that the Federal Reserve’s plans to scale back asset purchases increases the risk of inflation in Canada by driving the U.S. dollar higher and the Canadian dollar lower, the BoC believes retail competition is pushing down inflation. The latest consumer price report shows inflation running at an annualized rate of 0.9% in November. Interestingly, the BoC raised its growth outlook for 2014 from 2.3% to 2.5% but cut their 2015 outlook to 2.5% from 2.6%. In other words they don’t expect any major acceleration in growth in 2014 and 2015.

By notching down their inflation outlook and saying that the currency is too strong, the Bank of Canada strengthened their easing bias. While we don’t expect the central bank to cut rates in 2014 unless the housing market crashes, they will not succumb to the pressure to raise rates. With economic data deteriorating significantly since the December meeting, Poloz is recognizing the downside risks to the economy and the need to keep monetary policy very easy. It is almost hard to believe that back in September, the central bank was talking about raising rates and with today’s announcement, the market will price in a greater chance of a rate cut, although we still think odds are less 30% this year. The last time the BoC changed monetary policy was in September 2010. Since the beginning of October, the Canadian dollar lost over 6% of its value against the U.S. dollar, euro and British pound. While we haven’t seen inflation rise as a result of the weaker currency, eventually the lower currency will boost inflation and activity.

JPY: BoJ Leaves Policy Unchanged, Slight Downgrade to 2014 GDP Forecast

As expected the Bank of Japan left monetary policy unchanged. In his post monetary policy meeting press conference, central bank governor Kuroda sounded relatively optimistic about the outlook for Japan’s economy even with the government’s plans to raise the consumption tax. Kuroda believes that many Japanese households are prepared for the hike and have accounted for it in their spending plans. He also expects the government’s stimulus package to provide support and for households to be more optimistic once they realize that the tax hike will make the social welfare system more stable. While we are worried about the central bank’s over optimism, it is clear that they are comfortable with the current level of monetary policy. Nonetheless, the BoJ downgraded its 2014 GDP forecast by 0.1% to 1.4% and kept its 2015 forecast unchanged at 1.5%. No changes were made to their forecasts for inflation they still expect CPI to hit 1.3% this year and 1.5% next year. Once the impact of the consumption tax passes, Kuroda expects prices to rise as “Japan’s GDP is expected to grow faster than its potential.” Given that the consumption tax still poses a major risk to Japan’s economy, we believe that another round of stimulus remains on the table. Consumers can be very fickle so it will be interesting to see if the BoJ’s view that households have discounted the increase is accurate. We believe that there will still be an initial shock to consumer spending when taxes are raised and the stability of the welfare system will be an afterthought that comes months later.

Kathy Lien
Managing Director

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