Will the Dollar Extend its Losses into End of Feb?

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Daily FX Market Roundup 02-21-14

Will the Dollar Extend its Losses into the End of Feb?
EUR Benefits Ukraine Peace Deal
GBP: Prospect of M&A Flow Offsets Weaker Retail Sales
USD/CAD Backs Off Highs on CPI
AUD: Extends Losses to End Week Lower
NZD: Gold Up, Oil Down
Fresh February Highs for USD/JPY

Will the Dollar Extend its Losses into the End of Feb?

By all counts, February has been a tough month for the U.S. dollar. The greenback lost value against all of the major currencies with the exception of the Japanese Yen which performed slightly worse. What makes the sell-off interesting is the fact that U.S. equities are closing in on record highs while Treasury yields have bounced back sharply after the decline in January. While disappointments in U.S. data have discouraged traders from buying dollars, the price action in the fixed income and equity markets suggest that other investors are looking beyond the weather distortions. Every Federal Reserve official that spoke in the past few weeks including Fisher and Bullard who spoke today sound committed to tapering. Fisher is a voting member of the FOMC this year and he called the unanimity on QE tapering a good sign. Like many of his peers, he wants the central bank to drop their Quantitative guidance and shift to a more Qualitative measure. Fed Presidents are out in force next week speaking about the economy and monetary policy. If they stick to script and downplay the recent weakness in U.S. data, the dollar could recover. However in order for the greenback to enjoy a strong recovery, U.S. data needs to start improving and unfortunately we do not expect that to happen for another few weeks when we finally move past January and February releases. Today’s larger expected decline in existing home sales continues to show how much pressure the brutal winter has had on the U.S. economy. We don’t expect much in the way of upside surprises in next week’s reports. House prices, consumer confidence, new home sales, durable goods, Chicago PMI index and pending home sales are scheduled for release. While none of these are tier 1 reports, they should still have an impact on the dollar. As for this weekend’s G20 meeting, no surprises are expected. U.S. monetary policy has made life difficult for many countries but official criticism is not expected to make its way onto the communiqué.

EUR Benefits Ukraine Peace Deal

For the past few weeks, the turmoil in Ukraine weighed on risk appetite and the euro. Today, news that opposition leaders have a signed a deal with the President to call for early elections, a new constitution and unity government raises hope that the deadly crisis will finally come to an end. With no economic data to curtail a rally, the EUR/USD reacted positively to the news. Next week will be a busy one for the euro with a number of market moving economic reports scheduled for release. This past week we learned that manufacturing and service sector activity slowed while investor confidence weakened. Germany’s IFO report, unemployment rate, retail sales and final Q4 GDP numbers are due for release along with consumer prices and confidence from the Eurozone. For the most part, we expect mixed releases that will show the Eurozone recovery on shaky ground. EUR/USD is trading firmly above 1.3700 and as long as the currency pair holds above this level, a test of 1.38 is likely.

GBP: Prospect of M&A Flow Offsets Weaker Retail Sales

Despite all of the reasons that we provided yesterday about how consumer spending could surprise to the upside, retail sales fell more than expected driving the British pound slightly lower against the U.S. dollar and euro. Economists had been looking for a 1% decline in spending but sales fell 1.5% in January. Excluding autos, the magnitude of the decline was the same, which means that the contraction in spending was not affected by items whose demand can be volatile. A pullback after a strong December is not unusual, but the magnitude of the downside surprise was unexpected. Yet investors appear to have taken the news in stride with sterling weakening only slightly against other major currencies. The currency’s resilience can be attributed in part to the month-to-month volatility of retail sales. If you average the last 3 reports, consumer spending is actually rising at a healthy 0.4% pace. Also, the Vodafone / Verizon deal is expected to create a large cross border U.K.-U.S. M&A flow in favor of the GBP. Having started the week at a 4-year high, back-to-back disappointments in U.K. data shaved 200 pips off GBP/USD. While we don’t expect the Bank of England to be overly concerned about these recent releases because the recovery’s foundation remains solid, the 1.66 support level in GBP/USD is key. If M&A flows keep the currency pair above 1.66, a slow climb upwards is possible. However if the support level gives way, we could see a steeper slide down to 1.64.

USD/CAD Backs Off Highs on CPI

Based on the sharp decline in Canadian retail sales in the month of December, USD/CAD should be trading at a fresh 4 year high. Yet rather than extend its gains, the currency pair dropped below its pre-retail sales levels because consumer prices increased more than expected. While the rise in CPI reduces the chance of easing by the Bank of Canada, the 0.2% surprise should be easily overshadowed by the -1.4% disappointment in retail sales. Consumer spending dropped 1.8% at the end of the year, 4 times more than economists anticipated. Excluding autos, sales also fell 1.4%, which happens to be the largest decline in 5 years. The contraction in spending was broad based with consumers cutting their demand for furniture, electronics, building materials, clothing and sporting goods. As usual we can blame the weakness on Mother Nature as Eastern Canada was hit by a nasty winter storm that cut power to homes throughout the region. With a 1.8% drop in retail sales and a significant increase in the trade deficit at the end of the year, we are looking for a steep contraction in GDP growth in the month of December. The latest growth numbers from Canada are due for release next week and the data should confirm that Canadian growth slowed significantly in the last 3 months of the year. While consumer spending is extremely important, it is clear that the market is placing greater weight on the increase in consumer prices. CPI was expected to rise 0.1% and instead increased 0.3% in January, pushing the annualized pace of growth to 1.5%, the highest level since June 2012. Core prices also rose 0.2% on a monthly basis and 1.4% annualized. The upside in CPI was small and year over year growth remains well within the Bank of Canada’s 1-3% band. Inflation is an extremely important input into the central bank’s rate decision and the rebound in price pressures after the decline in December will make the BoC more comfortable with the current level of monetary policy. However housing, trade and spending are still big problems and with the country only releasing December and early January data, we could still be looking at another month of weather related data disappointments before there is evidence that the economy has turned a corner. Lets not forget that Canada is heavily reliant on U.S. growth so aside from their own troubles, they will also be vulnerable to weaker U.S. demand at the start of the year. So while CPI has taken some steam out of USD/CAD’s rally, we continue to believe that further gains are likely.

Fresh February Highs for USD/JPY

Thanks to the nearly 3% rally in the Nikkei overnight and rise in U.S. yields, USD/JPY rose to its strongest level this month. The strength of USD/JPY helped to lift all of the Yen crosses and with 103 in sight, we could see fresh 1-month highs for the pair in the coming week. Last night the Bank of Japan released the minutes from its January meeting and there was no impact on the Japanese Yen. Monetary policy was left unchanged and no additional details were provided in the statement. The recent disappointments in Japanese data, most notably the record trade deficit has many investors wondering if the central bank will increase stimulus in the second quarter. Most economists are looking for rate hike in the third quarter. According to the minutes, the majority of monetary policy members believe that the economy will continue to grow after the sales tax hike. While they expect a slowdown in Q2, they are looking for stronger growth in the second half of the year. We will get a better sense of how the economy fared at the start of the year from next week’s economic reports. Manufacturing PMI, the jobless rate, overall household spending, consumer prices, industrial production and retail trade are among the key reports scheduled for release.

Kathy Lien
Managing Director

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