Daily FX Market Roundup 07-27-12

EUR: Are EU Policymakers Prepping for Something Big?
Will USD Receive Help from FOMC and NFP?
GBP: BoE Won’t Rain on the Party
AUD: Hits 2 Month Highs
NZD: Best Performer Against the USD
CAD: Oiland Gold Up
JPY: Hit by Weaker Data

EUR: Are EU Policymakers Prepping for Something Big?

The euro soared against the U.S. dollar today after German Chancellor Merkel, Finance Minister Schaeuble and French President Hollande joined ECB President Draghi’s pledge to do everything within their power to protect, save and secure the euro. While no policy actions have actually been announced, all this talk creates expectations for greater activism by European policymakers in the coming weeks. Investors around the world will now be looking to Thursday’s European Central Bank monetary policy meeting for potential stress relieving measures. There’s a number of things that the ECB could do to help the euro but the real question is whether they will hold back given the recent decline in Spanish bond yields.

We know that the German Finance Minister supports the idea of using the EFSF to buy government bonds and the French paper Le Monde claims that coordinated action is being planned by the ECB and European bailout fund to lower borrowing costs by buying Spanish and Italian debt. As a result, the most likely decision by European policymakers would be to allow the EFSF/ESM to purchase bonds on the primary and secondary market and to reactive the Securities Market Programme which would help reduce sovereign yields and funding pressure. The Germans oppose the idea of giving the rescue fund a banking license and until they concede, it cannot become a reality. Taking the deposit rate to negative levels and introducing a third round of long term refinancing operation (LTRO) are also options but Europe probably needs another near death experience for either of these to become reality.

While today’s decline in Spanish and Italian bond yields have bought policymakers more time to come up with a long term solution to Europe’s problems, it also reduces the political will to get things done. Spanish 10 year yields are now much closer to 6.5% than 7% and Italian yields are back below 6%. As long as Spanish yields remain below 7%, we don’t expect Spain to make a formal request for a full scale bailout. Deputy Prime Minister Saenz confirmed that the government would not seek a rescue because it “isn’t an option” but there have been reports by Reuters that a discussion about a sovereign bailout occurred between Spain and Germany. Aside from the ECB meeting next week, German retail sales and unemployment numbers are also scheduled for release along with Eurozone final PMI reports.

Will USD Receive Help from FOMC and NFP?

The U.S. dollar traded lower against every major currency except for the Japanese Yen. Better than expected U.S. GDP numbers helped to drive the greenback higher and take QE3 completely off the table as an option for the Federal Reserve next week. When the central bank last met in June, they expressed skepticism about the weakness of U.S. data. Since then, U.S. economic reports have been mixed, giving them very little motivation to change their stance. The latest GDP number gives the Fed the luxury of time, which is part of the reason why we expect the Fed to remain ambiguous about their plans for future monetary policy. The absence of a clear sign of QE3 should be positive for the dollar. Based on the level of jobless claims, Friday’s non-farm payrolls report should also help the greenback. The 4 week moving average of jobless claims is consistent with above 100k non-farm payroll growth. Over the last 3 weeks, there were 2 weeks where jobless claims were at its lowest level since March 2008. In terms of this morning’s GDP number, the U.S. economy expanded by 1.5% in the second quarter. Economists had only been looking for a 1.4% rise and not only did the data beat expectations but growth in Q1 was also revised higher. Given the significant weakness in retail sales and the decline in trade, we had anticipated a sharper contraction in growth but the slowdown in Q2 was nominal. Private investment, exports and imports grew at a stronger pace in Q2 while personal consumption slowed less than expected. The better than expected GDP number comes at a very good time for the U.S. dollar because it reinforces the strong possibility that the Fed will forgo QE3 next week. If Q2 GDP was less than 1%, the Fed might have felt compelled to discuss the idea of more QE but now they have reasons to shelve the discussion until more data is released. This could be bullish for USD/JPY especially if the ECB sweeps in with more support next week.

GBP: BoE Won’t Rain on the Party

The London Olympics has officially begun and after 7 years of preparation, the U.K. is ready to celebrate. No U.K. economic reports were released today and we don’t expect the Bank of England to ruin the mood next week either. After increasing asset purchases last month, the BoE will leave monetary policy unchanged on Thursday. The British pound ended the week higher against the greenback and lower against the euro. The shift in risk appetite has been caused by optimism about Europe, which explains why the euro rebounded against the U.S. dollar. What will be more important than the monetary policy announcement next week are the PMI numbers. The manufacturing, service and construction sector reports will provide the market with an updated look at how the U.K. economy is performing. With many economists downplaying the contraction in GDP, the PMI numbers will be particularly important in shedding light on the current state of the U.K. economy. Good numbers could help the GBP/USD break above its 1 month high of 1.5790.

AUD: Hits 2 Month Highs

The Canadian, Australian and New Zealand dollars extended their gains against the greenback with the AUD/USD and NZD/USD rising to its highest level in 2 months. Of the 3 commodity currencies, the New Zealand dollars continues to be the best performer. Drought conditions in the U.S. have worsened and the recent increase in prices should have boosted the profits of New Zealand’s agriculture industry. No economic data was released overnight and a decline in Chinese industrial profits did not seem to have an impact on these currencies. Chinese manufacturing and service sector PMI numbers are due for release next week and unlike the industrial profits report, these numbers will certainly have an impact on the commodity currencies. Canada also has GDP numbers on the calendar and while Australia has service and manufacturing PMI reports along with retail sales. While these releases are important, the fate of the comm dollars lies in the hand of risk appetite.

JPY: Hit by Weaker Data

The Japanese Yen weakened against all the major currencies. The yen declined after Japan’s retail trade and national CPI numbers surprised to the downside and the rally was compounded by the better than expected US Q2 GDP numbers. Retail trade declined to 0.2% against expectations for a drop of 1.1%. Deflationary conditions exacerbated as national CPI dropped 0.2% missing expectations of 0.0%. This is the first time in 11 months that the CPI performed worse than anticipated. Should more deflation arise the BOJ may be more likely to expand its monetary policy which would curb the strengthening yen. Recently, the Japanese government anti-deflation panel called on the BOJ to continue easing monetary policy strongly until the economy rises out of deflation. On July 24th, one of the newly appointed BOJ policy members, Takehiro Sato, noted that the BOJ may be willing to implement fresh forms of monetary easing should it prove difficult to raise inflation to the 1% target.