EUR: Big Gap in ECB and Fed Exit Strategy Views

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Daily FX Market Roundup 02-27-13

EUR: Big Gap in ECB and Fed Exit Strategy Views
USD: Big Ben Dovish but Not Dovish Enough
GBP: Holds Steady in Europe and North America
NZD: Trade Surplus Turns into Deficit
CAD: Stalls After 7 Straight Days of Losses
AUD: Struggling to Hold Above 1.02
JPY: Expect BoJ Nomination Within 48 Hours

EUR: Big Gap in ECB and Fed Exit Strategy Views

Given all of the problems in Italy, forex traders may be surprised to hear that the best performing major currency pair today is the EUR/USD. There’s been no additional clarity on the Italian elections and if anything, Grillo’s refusal to support Bersani could put Italy on track for new elections if Bersani fails to form a coalition with Grillo or Berlusconi. Prolonged political uncertainty makes Italy a major source of risk for the euro this year. After yesterday’s sharp sell-off in Italian stocks and rise in Italian bond yields, investors appear to have calmed a bit with stocks recovering 1.7% and bond yields retreating. Today’s successful bond auction in Italy certainly helped because it indicates that the election results have not completely scared investors away from Italian assets. Eurozone confidence numbers also surprised to upside lending support to the currency. However, as long as the makeup and policies of Italy’s government is unclear, the euro will have a tough time recapturing 1.33 let alone 1.34 or 1.35. Investors may be dipping their toes back into the water but they won’t be rushing back into the European assets until they know what type of coalition is formed and whether new elections will need to be held.

The euro also shrugged off the comments from ECB President Draghi who reminded us that the central bank is “far from having exit in mind.” He said with the euro area economy still weak, policy accommodation is needed to stimulate growth. The markets are improving but inflation is expected to be significantly lower than 2% next year, giving the central bank plenty of room to keep monetary policy easy. The ECB and the Federal Reserve couldn’t be further apart when it comes to exit strategies. Today, Bernanke said the central bank will need to start reviewing their exit strategy while the Draghi completely brushed off the idea. These differing views should be bearish for EUR/USD but as we have seen in today’s price action, currency traders are not focused on the issue. Instead, the EUR/USD has followed U.S. equities higher.

USD: Stronger U.S. Data Bolsters Risk Appetite

The strong rally in U.S. stocks and improvement in risk appetite eased safe haven flows out of the greenback and lifted the currency higher against the Japanese Yen. Durable goods orders fell 5.2% in the month of January but the majority of the decline was in transportation orders because excluding transportation, durable goods rose 1.9%, which was the strongest rise since October 2011. Pending home sales also beat expectations, rising 4.5% in the month of January. The data is consistent with what we have seen in new home sales and indicative of a steady recovery in the housing market. Even Bernanke believes that the housing market has hit a bottom and is currently recovering. On Day 2 of his testimony to Congress, the Fed Chairman sounded a bit more optimistic about the economy. In addition to his housing market comments, he also said that the rise in interest rates is “indicative of a stronger recovery.” However getting back to a 6% unemployment rate could take another 3 years. When asked about an exit, Bernanke said the central bank will have to start reviewing their strategy which may suggest that has not completely ruled out the idea of tapering asset purchases. This was also our main takeaway from Day 1 of his testimony. Revisions to Q4 U.S. GDP are due for release tomorrow along with jobless claims and the Chicago PMI report. Economists are looking for a sharp upward revision to fourth quarter growth (from -0.1% to +0.5%) and if they are right, the dollar should rally. Meanwhile the Sequestration is scheduled to happen at the end of the week and so far it seems that the House and Senate has yet to reach an agreement. According to Fitch, “implementation of the spending cuts – sequester- and government shutdown would not prompt a negative rating action,” however “failure to raise the debt ceiling in a timely fashion could prompt a review and likely downgrade of the U.S. debt rating.”

GBP: Marginal Growth in 2012

The British pound weakened against the euro and rebounded against the U.S. dollar today. On a headline basis, GDP in the fourth quarter was left unrevised at 0.3%. However on an annualized basis, GDP was revised up to 0.3% from 0%. In other words, instead of stagnating in 2012, the U.K. economy expanded by a mere 0.3%. This improvement came primarily from the construction sector, as manufacturing output was revised up slightly and service output was revised lower. Overall the data confirms that the recovery in the U.K. economy is very sluggish and more monetary stimulus is needed if the government wants to reinvigorate activity. We knew where MPC member Fisher stood before he delivered his speech yesterday but Bean on the other was more of a centrist. In his speech today he said the U.K. recovery is likely to remain “somewhat subdued” but “there’s danger of expecting too much from monetary policy.” The only piece of data due from the U.K. tomorrow is consumer confidence and given the drop in the CBI retail trade index, we are not expecting any improvement in consumer confidence.

AUD: 1.0148 is Key

The Australian dollar recovered nicely today after dropping below 1.02 against the greenback for the first time in 4 months. While 1.0200 is an important round number, the real support level for the AUD/USD is 1.0148, a level that it tested but failed to break on numberous occasions over the past 7 months. If the AUD/USD closes below 1.0148, there’s a very good chance that it could break below parity. The latest round of AUD weakness was triggered by weaker economic data and S&P’s comment about Australia’s credit rating. While S&P said Australia has “several robust credit fundamentals” to support its AAA rating, their comment that Australia faced the prospect of a downgrade if demand from China slowed materially or if the country’s housing sector saw a sharp fall in prices was enough to send investors rushing out of the AUD. In terms of data, Construction Work Done showed a surprising contraction of -0.1% versus 1.5% eyed. The New Zealand dollar stabilized after surprisingly weak trade numbers. Australian new home sales and New Zealand business confidence numbers are due for release this evening. After rallying for 7 straight trading days, USD/CAD is showing signs of exhaustion. We see this as nothing more than a technical move since there has been no economic data out of Canada. Current account, raw material and industrial product prices are due for release tomorrow. Recent improvement in trade points to the possibility of a stronger report, which could trigger a deeper reversal in USD/CAD.

JPY: Cabinet Upgrades Economic Assessment for Second Straight Month

The Japanese Yen recovered its earlier losses to end the day higher against the U.S. dollar. Better than expected consumer spending numbers provided very little support for the Yen as traders focused on the long term prospect of additional Quantitative Easing from the Bank of Japan. Retail sales increased 2.3% in the month of January but the Yen failed to benefit because on an annualized basis, sales declined 1.1%, down from 0.3% in December. That did not stop the Cabinet from upgrading its outlook for on the economy for the second month in a row. Industrial production picked up in February and could improve further going forward as the global economic upturn lifts exports. According to the Cabinet, “the Japanese economy is bottoming out.” The more than 15% decline in the Yen over the past 3 months combined with the prospect of additional monetary stimulus brightens the outlook for Japan significantly but it will still be a long road to recovery. In the meantime, we continue to wait for Prime Minister Abe’s nomination for BoJ Governor. His government previously said the decision needs to be made this week otherwise it would be too late to elicit support for the candidate before the current BoJ head leaves office on March 19th. Until the announcement is made, which we expect to be within the next 24 to 48 hours, USD/JPY may have a tough time recovering. It is clear that Yen traders are desperate for a fresh catalyst and we believe that nomination of Kuroda as BoJ Governor and uber dove Iwata as one of his Deputies could be enough to renew the rally in USD/JPY. Japanese industrial production and manufacturing PMI numbers are also due for release this evening.

Kathy Lien
Managing Director

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