Daily FX Market Roundup 10-10-13

Currency Traders Have it Right
EUR: Weighed Down by Weak Data and Comments from ECB Draghi
GBP Consolidates after BoE Leaves Policy Unchanged
Commodity Currencies Lag on Weaker Data
CAD: Employment Numbers on Tap
AUD: Drop in Unemployment Rate Masks Underlying Weakness
JPY: Bank of Japan Expresses Confidence in Monetary Policy

Currency Traders Have it Right

The price action in the equity markets today tell us that investors are excited about the prospect of a temporary increase in the US borrowing limit. However currency traders don’t feel as enthusiastic because they believe the short-term reprieve does not reduce the risk of owning U.S. assets. The dollar was bought against the Japanese Yen but it saw virtually no gains against other major currencies. Instead, the improvement in risk appetite encouraged investors to buy high beta currencies, leading to strong gains in Japanese Yen crosses. As the prospect of a temporary spending agreements nears, we expect a further improvement in risk appetite that could drive USD/JPY above 99 but additional gains for the dollar beyond that level and in general should be limited.

For the past month, the financial markets have been held hostage by the U.S. debt crisis and investors are cheering the first signs of progress. However the gains are not expected to last because the government will be kicking the can down the road, leaving U.S. debt troubles to cripple the markets a month forward. The government is expected to remain closed during the extension and despite less dovish FOMC minutes, we believe this will handcuff the Fed from tapering asset purchases this year. Each week the government remains shutdown, U.S. GDP growth is shaved by a minimum of 0.1%. Even if furloughed government workers receive back pay, the shutdown will still have a negative impact on consumer and business sentiment / spending. Between the drag on the economy and the nomination of Janet Yellen as Federal Reserve Chairwoman, the chance that the central bank will taper asset purchases this year has dropped to almost zero. The lack of reliable U.S. data also makes the Fed’s decision more difficult and this is another reason why we feel the gains in the dollar will be limited. U.S. jobless claims surged to 374k from 308k to its highest level since March but according to the Bureau of Labor Statistics the data was distorted by the recent computer upgrade and dismissal of U.S. government employees because of the shutdown. The delay in other economic reports and the distortion in jobless claims means no action from the Fed in October and if the government shutdown extends into December, the central bank won’t have enough reliable information to taper asset purchases at the end of the year.

U.S. retail sales was scheduled for release on Friday but it has been delayed with other reports, leaving the University of Michigan’s consumer sentiment index as the only piece of U.S. data on the calendar tomorrow. The fiscal debt crisis is expected to have weighed on sentiment in the month of October. When the euphoria fades, the market will realize that delaying a resolution for 6 weeks means that fiscal troubles will remain a risk for the U.S. economy and the financial markets until November 22nd. So while we may see a further relief rally in the markets, we expect the gains to be limited because the problem are not resolved, only pushed forward, extending the period of uncertainty for the U.S. and global economy. At best we expect no more than a 2% rally in the U.S. dollar with gains in USD/JPY capped below 100.

EUR: Weighed Down by Weak Data and Comments from ECB Draghi

While the U.S. dollar ripped higher again the Japanese Yen today, it was unchanged against the euro. Economic data from Europe was disappointing with industrial production falling short of expectations in France and Italy. Accordingly, ECB President Draghi who spoke in NY, the Eurozone’s recovery is expected to be subdued, uneven and fragile. He highlighted the downside risks and said any positive economic reports only show the recovery at its infancy. This explains why the central bank is comfortable with the current level of monetary policy and along these lines, Draghi reaffirmed their plans to keep rates low for an extended period of time. Like many other central banks around the world, they are worried about the U.S.’ fiscal debt troubles. Draghi in particular warned that a protracted U.S. standoff could cause severe damage to the global economy. For the time being, it appears that the next step for the ECB could still be easier and not tighter monetary policy. With no major Eurozone data expected on Friday, it is worth noting that the ECB and the PBoC have agreed to establish a bilateral currency swap line that would facilitate euro and yuan transactions. Swap agreements such as these are aimed at minimizing the impact and exposure to U.S. dollars. This is a trend that we expect to grow with time but in the near term, there’s no question that the U.S. debt problems was a motivation for the central banks to initiate the 350 billion yuan, 45 billion euro swap.

GBP Consolidates after BoE Leaves Policy Unchanged

The Bank of England’s decision to leave monetary policy unchanged today limited the British pound’s movements against the euro and U.S. dollar. We suspect that the decision was unanimous considering the wake of recent economic reports from the U.K. Signs of slower growth in the service, manufacturing and construction sectors validate the central bank’s decision to keep asset purchases unchanged but past strength should also keep most policymakers optimistic. Central bank Governor Mark Carney made it clear last month that they do not see any reason to expand its Quantitative Easing program so the next move for the central bank should be tighter and not looser monetary policy. For sterling, the key is the market’s expectations – the central bank said it will not increase interest rates until late 2016, but the market is looking for a move in 2015 and these expectations will only change if there is a prolonged period of data disappointments. The central bank will be comfortable with the current level of monetary policy for the time being as they monitor the ongoing developments in Washington and its impact on the global economy.

Commodity Currencies Lag on Weaker Data

Typically when stocks rise as much as they have today, we expect to see a strong rally in commodity currencies. Unfortunately that was not the case as the AUD edged only slightly higher versus the greenback while the CAD and NZD were virtually unchanged. The problem was weaker economic data. New Zealand reported a drop in manufacturing activity that raised concerns about the sustainability of the country’s recovery. Canada reported a smaller increase in house prices in the month of August and while the unemployment rate in Australia improved last month, the level of job growth fell short of expectations. In fact the drop in the jobless rate looked better than what it was only because of rounding. The actual decline in the jobless rate was closer to 0.1% than 0.2% and when combined with the drop in the jobless rate, Australian labor market conditions remained weak. The recovery from net job losses in July and August has been sluggish and based on the drop in business confidence, the potential for a strong recovery before the end of the year is slim. Canada’s employment report is scheduled for release tomorrow and unlike Australia, the country recovered quickly from net job losses in June and July. Since August was a very strong month for jobs, employment is only expected to rise 10k in September versus 59.2k in August. USD/CAD is currently trading at a 1 month high and a weaker number could drive it above 1.04.

JPY: Bank of Japan Expresses Confidence in Monetary Policy

The Japanese Yen traded lower against all of the major currencies today on the back of rising U.S. yields and strength in the Nikkei. The performance of these instruments reflects the hope for progress on U.S. fiscal debt talks. Considering that USD/JPY is moving in lockstep with equities and Treasuries, this strength helped to drive all of the Yen crosses higher. Japanese data also continued to improve with machine orders rising 5.4% in the month of August and consumer confidence rebounding in September. These consistent upside surprises in data have made Japanese investments increasingly attractive to foreign investors. According to the latest report from the Ministry of Finance, foreigners bought 322.7B yen worth of Japanese bonds last week. Unfortunately Japanese demand for foreign bonds dropped by more than 2 trillion yen, the largest net sales ever since the publication began in 2005. These sales can be largely attributed to concerns about the U.S.’ fiscal position. Looking ahead, we expect further recovery in the Yen crosses as investors look forward to a short term debt fix announcement.