Will the Fed Breathe New Life into the Dollar?

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Daily FX Market Roundup 04-29-14

Will the Fed Breathe New Life into the Dollar?

EUR Holds 1.38 Ahead of Key Eurozone Data

EUR/GBP Dips as Yields Widen Highest Level Since 1998

CAD Trades Higher as Oil Rebounds

NZD: Supported by Stronger Trade Data

AUD: Shrugs Off Drop in Gold

BoJ Meeting – What to Watch

Will the Fed Breathe New Life into the Dollar?

So far we have had a slow start to a busy week in the foreign exchange market and part of the reason why there has been limited volatility is because the majority of this week’s major U.S. releases are scheduled for Wednesday and Friday. Everyone is hoping that tomorrow’s first quarter GDP report and FOMC rate decision will breathe new life into the dollar but chances are, the outcome for both event risks will be boring. Between the two, the dollar may even have a more pronounced reaction to GDP than FOMC because the Federal Reserve is widely expected to reduce asset purchases by another $10 billion this month. Although this will only be Janet Yellen’s second FOMC meeting as Fed Chair, the surprises will be limited as there will be no press conference or changes to economic projections. For the most part we expect the statement to remain virtually unchanged. Having just shifted to qualitative guidance in March, the central bank is not planning to make any significant alterations in the near future. Expectations for steady taper explain the dollar’s muted reaction to positive and negative data.

Taking a look at the following table, there have been more improvements than deterioration in the U.S. economy since the last FOMC meeting so if the central bank were to alter its tone, a tinge of optimism is expected. Consumer spending rebounded strongly after dipping in the winter and the rise in sentiment suggests that demand increased further in April. Manufacturing and service sector activity also accelerated, contributing to the increase in inflation. Although non-farm payrolls grew at a slightly slower pace in March and average hourly earnings stagnated, the data is consistent with a continued recovery in the labor market. Given the dip in jobless claims, this week’s non-farm payrolls report should show further improvement. The performance of the housing market has been disappointing but low interest rates should keep the sector supported. Although the central bank is in the process of unwinding stimulus, they have done a fantastic job of keeping rates from rising. As it is in the central bank’s interest to maintain a steady stance and avoid rocking the boat, unless the FOMC statement contains a discussion about when to raise rates, we don’t expect the volatility environment to change significantly on the back of the Fed meeting. In other words it may be wishful thinking to hope that the FOMC will breathe new life into the dollar let alone currency volatility.

EUR Holds 1.38 Ahead of Key Eurozone Data

Wednesday is a big day for the euro. In addition to the U.S.’ first quarter GDP report and FOMC rate decision, we expect retail sales and unemployment from Germany, consumer spending from France and Q1 GDP numbers from Spain. The return of investment flows to Spain and Italy after the European Sovereign Debt Crisis is one of the main reasons for the euro’s resilience. This makes Spain’s Q1 GDP report particularly important because in order for the funds to keep flowing to support the euro, GDP growth needs to accelerate. It is not clear whether tomorrow’s German economic reports will help keep the euro above 1.38. While manufacturing and service sector activity accelerated and business confidence improved, which should lead to a decline in unemployment, according to Markit Economics’ Retail PMI report, in the month of March consumer spending grew at its slowest pace in nearly a year. However any pullback is likely to be temporary because expectations for sales in April rose to its highest level in 3 years. Given the big time gap between European and U.S. data, the next 24 hours will be lively one for EUR/USD. The 1.38 level has been rock solid support for the past 3 weeks and whether this level holds may depend more on Eurozone than U.S. data. Today’s sell-off in the EUR/USD was driven by softer Eurozone confidence and a larger decline in consumer prices. Although the European Central Bank won’t be happy to see the 0.2% drop in German consumer prices, on an annualized basis, CPI growth still accelerated to 1.4% from 1.0% which should limit their concerns.

EUR/GBP Dips as Yields Widen Highest Level Since 1998

Slightly weaker than expected first quarter GDP numbers did not stop the British pound from ending the North American trading session higher against the U.S. dollar and euro. Another way to look at this is that sterling refuses to fall because speculators are fighting to sustain their long positions. Of course even with the GDP miss, the data wasn’t all that bad. The U.K. economy expanded 0.8% in the first quarter, lifting annualized GDP growth from 2.7% to 3.1%. Although economists had been looking for a rise to 3.2%, 3.1% growth is still healthy. The gains were primarily in the service sector with hotels and catering expanding at 1.5% rate. However, agriculture, mining and electricity sectors all contracted possibly due to the tough weather conditions during the period. EUR/GBP experienced an unusually large sell-off as the spread between U.K. and German 10 year bonds widen to the largest level since the third quarter of 1998. The ECB’s dovish monetary policy bias drove German yields lower while speculation that the Bank of England will be the next G10 central bank to raise rates drove U.K. yields higher. If this trend continues, EUR/GBP could test 1 year lows.

CAD Trades Higher as Oil Rebounds

The best performing currency today was the Canadian dollar, which is surprising considering that Canadian data surprised to the downside. Average hourly earnings growth dropped to 2.3% from 3% on an annualized basis, a sign of deterioration in labor market conditions. The rise in the loonie was driven entirely by the rebound in oil prices and weakness of the U.S. dollar. Canada’s February GDP report is scheduled for release tomorrow and economists are looking for a slowdown in growth. If they are right, USD/CAD could make its way back to 1.10. While there was an improvement in trade activity in the month of February, weaker consumer spending will subtract from GDP growth. The Australian and New Zealand dollars also rebounded against the greenback thanks in part to healthier New Zealand trade data. The country’s trade surplus rose to NZD920 million from NZD818 million. Imports and exports rose strongly, offsetting the impact of lower dairy prices. Nonetheless it is worth noting that dairy exports dropped 10% that month and with prices falling further since then, the trade surplus could shrink in the coming months. No major economic reports are scheduled for release from Australia over the next 24 hours but New Zealand has business confidence and building permits.

BoJ Meeting – What to Watch

The Japanese Yen traded lower against all of the major currencies today with the exception of the euro and Swiss Franc. USD/JPY was supported by steady U.S. yields and the rise in U.S. equities. Japanese markets reopen tonight after being closed for the Showa Day holiday on Tuesday. Trading kicks off with the Bank of Japan monetary policy decision. The BOJ is widely expected to leave monetary policy unchanged. They have made it clear that stimulus will not be increased until there is clear evidence that the consumption tax is taking a toll on the economy and so far there hasn’t been any sign of that. Nonetheless the BoJ meeting will be worth watching because the central bank will be publishing their Outlook, which will contain their latest GDP and inflation forecasts. This will be followed by a press conference from Governor Kuroda.

Kathy Lien
Managing Director

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