Daily FX Market Roundup 08-21-12
Behind the Dollar’s Slow Reaction to the Fed Minutes
EUR: Trade or Fade Depends on PMI
GBP: Lifted by News of Stronger Manufacturing Activity
CAD: Test of 1.05 Possible if Retail Sales is Weak
AUD: All Eyes on Chinese PMI
NZD: Extends Losses on Weak Data
GBP: Hits 2 Month High
JPY: Fukushima Impact on Japan’s Economy
Behind the Dollar’s Slow Reaction to the Fed Minutes
The broad-based sell-off in the U.S. dollar, rise in Treasury yields and decline in stocks indicate that financial market participants all interpreted the FOMC minutes in the same way – that is there is growing evidence the Federal Reserve will reduce asset purchases this year. In fact, the minutes showed “broad support for Bernanke’s timeline for tapering” and we know that the Fed Chairman wants to begin the process of easing stimulus before he hands over the baton to his successor. However the reaction in the financial markets, particularly in currencies has been slow and the reason is because investors have had plenty of time to position for tapering and the recent jump in bond yields suggests that the move has been priced in. For the past month, it was not a question of if, but a question of when the Fed will taper so while we did see the dollar rise, stocks fall and 10 year bond yields extend to new highs in reaction to the Fed minutes, the moves were restrained. How the Fed will taper, the amount of purchases that will be reduced and the guidance about their plans going forward are all up for discussion and can be used to temper market expectations and potential reaction. Given the recent deterioration in U.S. economic data, we continue to believe that the changes will be incremental.
Nonetheless, the Fed minutes showed the central bank growing more comfortable with the idea of tapering. While a few FOMC members urged patience, others favored QE tapering soon – and that was in July. At the time, policymakers felt that the markets had tightened significantly and they were confidence that a rate rise would not hurt the housing market, which is strengthening. They noted that June payrolls, which increased by 195k represented solid gains and they expected consumer spending to pick up in the second half of the year, leading to a stronger recovery. Fed watcher Jon Hilsenrath felt that the minutes were a tad more pessimistic and that was primarily because some members felt less confident in their outlook for a pickup in economic growth even though the official forecasts call for it. There’s no question that the Fed and the investment community in general should have doubts about the outlook for the U.S. economy but as long as there isn’t a sharp deterioration between now and the September 17th meeting, the central bank is on track to taper. Even if they don’t move next month, they should move in December and while this prospect hasn’t reinvigorated the rally in the dollar, it has and should keep the currency bid.
EUR: Trade or Fade Depends on PMI
The euro may have lost value against the U.S. dollar today but it ended the North American trading session well off earlier lows. The Eurozone’s August manufacturing and service sector PMI numbers are scheduled for release tomorrow and investors are holding out hope that the data will surprise to the upside providing additional fuel to the EUR/USD rally. Despite today’s pullback, 1.35 is still in sight. A large part of the recent strength in the euro can be attributed to unexpected improvements in the Eurozone economy and disappointments in U.S. data. However there is very little confidence on whether these trends can continue which is why currencies have been so sensitive to data. Based on stronger German industrial production, factory orders and investor confidence, we believe that the recovery in manufacturing and services extended into the month of August. If we are wrong, the EUR/USD could drop below 1.33, putting the overall uptrend at risk. The 1.34 level continues to be a significant point of resistance for the currency pair and tomorrow’s report could decide whether the recent sell-off turns into a double top.
GBP: Lifted by News of Stronger Manufacturing Activity
The British pound rose for the sixth consecutive trading day, hitting fresh 2-month highs in the process. Government borrowing numbers were worse than expected in the month of July with public sector net borrowing ex interventions reporting a marginal deficit of 0.1 billion versus expectations for a 2.9 billion surplus. July is usually a month of surplus because of additional tax receipts but this was the first time since 2010 that July was not a surplus month. Public sector net cash requirement on the other hand was better, reporting a surplus of 19.6 billion versus expectations of 8.7 billion. We feel that sterling received its strength primarily from better than expected manufacturing data. According to the Confederation of British Industry’s industrial trends survey, orders rose at the fastest pace in 2 years. The order balance book was flat in August, which was the best reading since 2011 and represents a major improvement from the -12 reading in August. The Director of Economics for the CBI said “UK manufacturers seem to be experiencing a build-up in momentum, but risks in the global economy still mean that it won’t be plain-sailing for some time to come.” No U.K. economic reports are scheduled for release tomorrow and while the June high of 1.5750 could still be tested, the move in GBP/USD has become overstretched and we feel that a retracement is due.
CAD: Test of 1.05 Possible if Retail Sales is Weak
The Australian, New Zealand and Canadian extended their losses against the greenback today as muted economic data leave investors wondering if the Reserve Bank of Australia could cut interest rates again this year. According to the latest economic reports, leading indicators were flat and skilled vacancies rose 0.7%. These numbers show that domestic conditions pose ongoing challenges for Australia’s central bank. The AUD/USD dropped below 90 cents intraday and the outlook now hinges on tonight’s HSBC flash manufacturing PMI report. Part of the weakness in the Australian dollar was caused by concerns about Chinese growth but signs of strength in July gave the market hope that China could be stabilizing. Now economists are looking for further improvements in the manufacturing sector. The HSBC report has been underestimating the government’s official release, which sees manufacturing activity as expanding. Many investors feel that the contraction reported by HSBC is more accurate. The New Zealand dollar on the other hand was hit by a decline in credit card spending. Aside from China’s manufacturing PMI report, Canadian retail sales are scheduled for release tomorrow. USD/CAD has been on a tear over the past 48 hours and given the sharp decline in jobs and the big drop in wholesale sales, a test of 1.05 is possible if spending is weak.
JPY: Fukushima Impact on Japan’s Economy
The only data released out of Japan last night was supermarket store sales, which dropped 0.5% year over year in the month of July. This decline in consumption is consistent with the pullback seen in other reports released this week and is not particularly alarming because it follows a strong month in sales. The bigger story overnight for Japan was the Nuclear Regulation Authority’s decision to raise the Fukushima leak incident to a level 3, the highest since the earthquake and tsunami in in 2011. USD/JPY and the Nikkei initially sold off on the report but eventually recovered. The primary part of Japan’s economy that this impacts is fuel imports. Before the 2011 disaster, Japan imported only Y18 trillion worth of fossil fuel per year. This demand has now increased more than 35% with the country’s annual fossil fuel bill reaching Y25 trillion. This shift has affected Japan’s trade balance as well as the profitability of national utility companies. The Fukushima incident will make it even more difficult to get Japan’s nuclear power generation back to its previous levels. No major Japanese economic reports are scheduled for release tomorrow outside of the Ministry of Finance’s weekly portfolio flow report. The rise in U.S. yields has finally caught the interest of Japanese investors whose latest purchases hit Y1.614 trillion, the largest amount since August 2010. While tonight’s report may not show the same robustness in demand, we still expect Japanese investors to continue to be net buyers of foreign bonds.
