Daily FX Market Roundup 08-20-12

Dollar: What to Look for in the FOMC Minutes
What Drove EUR to 6 Month Highs
NZD Plunges after RBNZ Imposes Lending Restrictions
AUD: RBA Leaves Door Open to More Rate Cuts
CAD: Wholesale Sales Plunge
GBP: Hits 2 Month High
JPY: Yen Strength Weighs on Stocks

Dollar: 2 Things to Look for in FOMC Minutes

The most important event risk for the U.S. dollar this week will be tomorrow’s FOMC minutes. The central bank will releasing the minutes from its June meeting and given the heightened sensitivity to anything that could shed light on the timing for Fed tapering, the minutes could have an unusually significant impact on the U.S. dollar. The recent surge in Treasury yields provided zero benefit to the greenback and today with yields declining ahead of the Fed minutes, the dollar retreated against all the G3 currencies (EUR, GBP and JPY). In all likelihood, the FOMC minutes may not provide much clarity of Fed policy but with the next meeting only a month away, investors will be going over the report with a fine-tooth comb for any fresh insight into the Fed’s plans. In terms of how the dollar could react, the market expects the Fed to begin tapering this year with a small majority anticipating a move in September vs. December and even for those who favor earlier tapering, the size and scope that bond purchases will be reduced remains an open question. Of course we don’t expect the FOMC minutes to have all of the answers, if any at all.

Nonetheless, we along with the financial market community will be looking for 2 specific details in tomorrow’s release. The first is the level of conviction for easing in September. Most Federal Reserve Presidents that we have heard from support some type of action over the next 3 months with more leaning towards a sooner vs. later move. If the minutes emphasize the progress made in the U.S. economy and the need to act quickly, the dollar could resume its rise as yields extend higher. However if the minutes contain an overall air of caution with more members wanting to wait for further improvements before changes are made, the dollar could fall sharply as U.S. yields give up recent gains. We will also be looking for details on which assets the Fed will taper. The choice is between Treasuries and mortgage backed securities and if the Fed opts for only one and it would be Treasuries, the dollar should slide as this would represent a smaller initial move. If the minutes reveal plans to taper both, it would be positive for the dollar because it gives hope for a more aggressive reduction. As for how much the Fed will taper, this will be a decision made in September but the central bank could drop some hints on a preferred range.

What Drove EUR to 6 Month Highs

European currencies are testing the top of their recent ranges today with the euro hitting a 6-month high against the U.S. dollar and the Swiss Franc reaching a 2-month high. We can’t attribute the move to data because the only economic report released from Europe was German producer prices, which declined in the month of July. Economists had been hoping for an uptick in price pressures but unfortunately weak demand is keeping a lid on price growth, which eases the ECB’s concerns about inflation. At the same time, no U.S. economic reports are scheduled for release today. We believe it’s the combination of a decline in U.S. yields and optimistic German growth forecasts that has driven the euro higher. Ten year Treasury yields are poised for their first decline in 4 trading days, which put pressure on the dollar against many of the major currencies. In a speech this morning in Northern Germany, Finance Minister Schaeuble said he sees 2013 GDP growth of 0.5% to 0.7%. This range is slightly higher than the government’s official forecasts and more optimistic than what most economists and investors had anticipated. Yet most of his speech was centered on Greece and the need for another aid program but according to a Greek Finance Ministry official, additional aid would be much smaller. Last month, Greece received an aid tranche of 5.8 billion euros and is scheduled to get another 1 billion euro payment in October. Schaeuble’s optimistic outlook for Germany will spur expectations for stronger August PMI numbers, expected on Thursday. A healthier Eurozone recovery and uneven U.S. economy has allowed EUR/USD to rally despite the threat of Fed tapering and the support that it may provide for the U.S. dollar. If EUR/USD manages to hold the breakout above 1.34, the next level of resistance will be 1.35.

NZD Plunges after RBNZ Imposes Lending Restrictions

The worst performing currency today was the New Zealand dollar, which was hit hard by new lending measures introduced by Reserve Bank of New Zealand Governor Wheeler. In a speech that was suppose to “Explain the role of macro-prudential policy,” Wheeler announced loan to value restrictions that will limit low deposit loans to 10% of new mortgages made by banks. Low deposit or high LVR is assumed to be loans where 80% or more of the home value is mortgaged. The goal is to “slow house price growth” and support monetary policy. While the central bank is not looking to raise interest rates this year because of concerns about Australian, Chinese and global growth, today’s announcement represents tightening of monetary conditions. First time home buyers will find it much more difficult to attain financing with a deposit of less than 20% and this could affect home prices in the medium term. Wheeler’s comment that the exchange rate is overvalued also weighed on the currency. Meanwhile the Australian dollar declined but not as steeply as the NZD or CAD. According to the RBA minutes, the central bank is still open the idea of additional easing but they are in no rush to reduce rates. A “run of generally weak economic data,” soft consumer spending and the view that “China was unlikely to pick up much, if at all, in the coming quarters,” prompted the downgrade in GDP forecasts and the rate cut. However the outlook is unclear because the central bank ended the minutes by saying the Board “neither close off the possibility of reducing rates further, nor signal an imminent intention to reduce rates further”. As a result, the main takeaway is that the central bank still maintains a bias to ease. The Westpac leading index is scheduled for release this evening and we do not anticipate any significant improvements. The Canadian dollar also rejected the 1.04 level after wholesale sales dropped 2.8% in the month of June, nearly 5 times more than expected and a sign that consumer demand may have weakened significantly.

GBP: Hits 2 Month High

The British pound hit a 2-month high against the U.S. dollar and snapped a 9-day losing streak to end the day up against the euro. No U.K. economic reports were released today but recent upside surprises in U.K. data continues to lend support to the currency. The markets are pricing in an earlier rate hike by the monetary policy committee, which means they expect the central bank to reach its unemployment rate target sooner. Before last week’s data surprises, investors expected the first rate hike to occur at the end of 2016 but now tightening could happen as early as February 2015. This is still a long time from now but the dramatic shift in expectations is part of the reason why sterling has performed so well this month. Tomorrow’s public sector finances report isn’t expected pose a threat to MPC expectations. Public sector net borrowing is actually expected to decline in the month of July thanks to stronger growth and spending cuts. This would represent an improvement in Britain’s budget. The number that we are more interested in is the factory orders index from the Confederation of British Industry. We believe that this data has a good correlation with the more closely followed manufacturing PMI report because it measures the same sector. Economists are looking for an improvement and if the increase is large enough, it could drive the GBP/USD to its June high of 1.5750.

JPY: Yen Strength Weighs on Stocks

The Japanese Yen traded lower against all of the major currencies today with the exception of the euro and Swiss Franc. The decline in U.S. bond yields contributed to the weakness in USD/JPY but softer Japanese data also pushed the Nikkei down 2.63% adding pressure to the Yen crosses. Nationwide department store sales dropped 2.5% year over year in the month of July. Softer spending was also seen at convenience stores in Japan and department stores in Tokyo. Yet the decline in demand is not alarming because part of it is a payback after last month’s sharp rise. The all industry activity index also declined -0.6% in June after rising 1.2% the previous month. While the volume of trades in the Nikkei has been low, the fact that the Yen has refused to decline despite a widening gap between U.S. and Japanese interest rates is weighing heavily on sentiment in Japan. It has been a challenge to remain bullish USD/JPY but fundamentals continue to support a rally but at this stage, it may be better to wait for some upside momentum before getting into the trade. There is quite a big of resistance between 98 and 99 in USD/JPY.