Why the Dollar is Due for a Recovery

Posted on

Daily FX Market Roundup 05-12-14

Why the Dollar is Due for a Recovery

EUR – Potential Move to 1.36

Will the Federal Budget Hurt AUD?

NZD: Chinese Retail Sales and Industrial Production Due

CAD: Oil Prices Rebound

Sterling: Testing the Waters Before Inflation Report

JPY: Takes Weaker Current Account Balance in Stride

Why the Dollar is Due for a Recovery

The U.S. dollar is due for a recovery. Having traded to a 1.5 year low last week on the back of falling yields, the Dollar Index is already in the process of rebounding and we believe there’s scope for a stronger rally. It is no secret that the dollar had been pressured by the decline in U.S. rates which has been caused by the deceleration in economic activity in the first quarter. This was a direct function of a difficult winter that depressed economic activity across the nation. Now that the weather is improving, economic activity is expected to accelerate providing underlying support for U.S. rates. We have already seen Treasury yields move higher today and a further rise is likely if Tuesday’s retail sales report beats expectations. Economists are looking for sales growth to slow after a strong March but based on surveys conducted by the International Council of Shopping Centers and Johnson Redbook, consumer spending continued to move higher in April. Gas prices also increased an average of 10 cents last month, which should drive up gas station receipts. If U.S. yields start to respond positively to U.S. data, it would create the perfect backdrop of a broader recovery in the dollar. At the same time, the monetary policy bias of other central banks is drifting further away from the Fed. The European Central Bank said they could ease, the Bank of Canada will most likely increase its level of dovishness after Friday’s surprisingly weak jobs number and Reserve Bank of New Zealand could pause their tightening cycle in response to their concern about a strong currency. The dollar will benefit as this shift in bias is expected to put pressure on these currencies.

EUR – Potential Move to 1.36

After 2 days of steep losses, the euro consolidated near one month lows against the U.S. dollar. With no U.S. or Eurozone economic reports were released over the past 24 hours, the lack of volatility is not unusual. EUR/USD will be on the move again tomorrow with the German ZEW survey and U.S. retail sales scheduled for release. Investor confidence is expected to deteriorate which would be bad news for the euro especially if retail sales in the U.S. beat expectations. By signaling that they are prepared to ease monetary policy in June, European Central Bank President Mario Draghi has completely shifted the near term outlook for the currency. We now expect the currency pair to drop to at least 1.3650-1.3600. If the central bank eases next month, their most likely course of action will be a combination of small moves that include a cut to the refi rate, a mildly negative deposit rate and end to SMP sterilization. Unfortunately with interest rates already at very low levels, these measures may have only a limited impact on the euro, which is part of the reason why we think the sell-off in EUR/USD will be limited to another 1 to 2 cents. Nonetheless buying euros right now is not a good idea because the ECB has put themselves into a unique situation of being the only major central bank planning to ease. The next ECB meeting is also 2 weeks before the next FOMC meeting, allowing investors to focus on positioning for the move by European policy makers.

Will the Federal Budget Hurt AUD?

While the Australian, New Zealand and Canadian dollars held steady against the greenback, tonight will be a busy one for AUD/USD. The Australian government releases its 2015 Budget in which significant spending cuts and new taxes are expected. With a deficit of 3% of GDP, Australia’s fiscal finances are far healthier than the U.S. and much of Europe but it is a major area of concern for a country that is use to running a surplus. Tony Abbott pledged to rebuild fiscal discipline and deflate the country’s ballooning deficit through higher taxes, welfare cut and an increase to the retirement age. As the toughest budget in the past 2 decades, Abbott’s measures pose a threat to recovery in an environment where growth is slow and prices of iron ore have hit a 20 month low. According to some local economists, fiscal tightening could shave as much as 0.5% off GDP growth. The Australian dollar’s reaction to the Budget will be based upon the government’s latest GDP forecasts and of course the extent of new measures- the risk is to the downside for AUD/USD. However tonight’s Chinese economic reports could lend support to the currency. Between retail sales and industrial production, IP should have the bigger impact on the currency. Based on recent releases from China, tonight’s report should show further stabilization in the world’s second largest economy. While business conditions deteriorated according to last night’s NAB index, business confidence increased, a positive sign for Australia’s economy.

Sterling: Testing the Waters Before Inflation Report

The British pound fell to a 1 year low against the U.S. dollar ahead of this week’s Bank of England Quarterly Inflation Report. The overall strength of the currency reflects the market’s expectations for a less dovish and more hawkish outlook from the central bank. Their sentiment will play a big role in determining whether 1.70 in GBP/USD will be broken. Investors are hoping the BoE will reinforce their belief that they will be the next major central bank to raise interest rates. While there have been improvements in the economy, low inflation and the slack in the labor market has given the central bank very little desire to rush into tightening monetary policy. However if they were to move closer to doing so, they would most likely telegraph their intensions in the Quarterly Inflation Report. This week, the BoE reminded us in their monetary policy statement that their economic forecasts would be updated so even if the monetary policy committee does not provide any insight into their plans for tightening, traders will be able to look at their forecast changes to get a gage of how close they are to tightening. Unless no changes are made to the forecasts, the Quarterly Inflation Report will determine whether GBP/USD breaks 1.70. We think that the BoE will upgrade their economic projections, providing additional upside momentum to sterling. Labor market numbers are also scheduled for release but considering that the data comes out an hour before the Inflation Report, the impact on the currency should be limited.

JPY: Takes Weaker Current Account Balance in Stride

With the rise in U.S. equities, the Japanese Yen traded lower against all of the major currencies. Softer than expected economic data from Japan also weighed on the currency. The country’s trade deficit ballooned to Y1.1 trillion from Y533 billion in month of March while the current account surplus dropped to Y116 billion from Y612 billion. On an annualized basis, the current account balance hit a record low for FY2013, which ends in March in Japan. This weakness has been driven by softer demand from abroad and low return on foreign investments. The current conditions component of the Eco Watchers survey, which measure the confidence of waiters, taxi cab drivers and barbers also fell steeply for the month of April but there was very little reaction in the Yen because the improvement in the outlook component of the report indicates that workers in Japan grew more optimistic about the economic outlook despite the potential drag from the consumption tax. Overall investors are taking the recent economic reports with a grain of salt because they realize March and April data will be distorted by the tax and instead the 3-month trend from April onwards will be most important. The main focus for Japan this week will be Q1 GDP and Bank of Japan Governor Kuroda’s speech on Thursday.

Kathy Lien
Managing Director

Leave a Reply

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