Daily FX Market Roundup 09-04-12

EUR: Number One Goal of the ECB
USD: Shrugs Off Weaker Data
GBP: Service Sector Activity Expands
CAD: What to Expect from the Bank of Canada
AUD: RBA Remains Neutral
NZD: Hits Fresh 1 Month Low
JPY: A Look at China

EUR: Number One Goal of the ECB

The lazy days of summer have finally come to an end and while volatility in the foreign exchange market was at a minimum today, September promises to be an extremely active month for EUR/USD. Between the ECB monetary policy announcement on Thursday, the German Constitutional Court’s ruling on the European Stability Mechanism September 12th and the Federal Reserve’s monetary policy decision on September 13th, the next 2 weeks could set the stage for how currencies trade the rest of the year. There will be a lot of euro and ECB related items to talk about as the week progresses and we start by discussing ECB President Draghi’s primary objective on Thursday. The central bank’s number one goal is to get investors to buy and hold the stocks and bonds of Portugal, Ireland, Italy, Greece and Spain. If the equity and bond markets in high risk nations stabilize, it will help to reduce uncertainty and funding pressures in the region. The latest price action in the EUR/USD suggests that investors are treading carefully ahead of the central bank’s rate decision because they are unsure about whether the ECB will meet the high bar set by the market.

Economists are looking for a 25bp rate cut from the ECB, which would take interest rates down to 0.5% and details on a new framework for asset purchases. Mario Draghi is also expected to deliver on the promise he made in early August to provide an outline for bond purchases – the only question is the amount of details that he will provide. The best case scenario would be an explicit euro denominated target for bond purchases and a numerical yield cap as they give investors unambiguous and tangible targets. Unfortunately central banks rarely like to be so explicit because they want to leave themselves flexibility in case more or less needs to be done. As a result, we expect the ECB to announce a new framework for bond purchases that includes an expansion in tenors or maturities of bonds purchased with an open ended and flexible quantity target. By pledging to purchase short term bonds, the ECB hopes to achieve their number one goal of driving yields lower. However this will only be effective if investors believe that the ECB’s efforts won’t come up against any roadblocks. This leads to the question of whether the ECB will hinge finalization of the new program on the ratification of the ESM by the German government. With many questions still to be answered, it is no surprise to see the EUR/USD trade in a narrow range ahead of the ECB rate decision. Eurozone retail sales and final service sector PMI numbers are scheduled for release on Wednesday. While interesting, these reports are not expected to have much impact on the EUR/USD.

USD: Shrugs Off Weaker Data

The U.S. dollar traded higher against all of the major currencies despite weaker economic data. While the strength of the dollar reflects risk aversion, the intraday recovery in U.S. equities suggests that investors have not ruled out the possibility of further gains this week. Manufacturing ISM and construction spending were the only U.S. economic reports released this morning and unfortunately both surprised to the downside. Manufacturing activity contracted slightly more in August than in July. The index dropped to 49.6 from 49.8 – the market was looking for a rise to 50. New orders and employment both declined which is consistent with the Beige Book report that found demand in manufacturing weakening over the past 6 weeks. While the ISM number is interesting, the agency’s report on service sector activity will be far more important. This month’s non-farm payrolls report carries particular significance because it could be the metric that decides whether the Federal Reserves eases on September 13th. On Thursday, we’ll gain greater insight into which direction the non-farm payrolls could move vis a vis the ADP and Challenger reports. Meanwhile construction spending also fell 0.9 percent in July after rising 0.4 percent the prior month. Lackluster housing market activity has constrained new developments. These 2 reports give the Fed a stronger case to ease next week.

GBP: Service Sector Activity Expands

The British Pound held onto its recent gains against the U.S. dollar and remained steady against the euro. Better than expected economic data failed to lend much support to the single currency. PMI Services was suppose to be released on Wednesday but came out early after being leaked by Reuters accidently. According to the report, service sector activity expanded at its fastest pace in 5 months. Growth in incoming business and activity helped to lift the index while job growth accelerated slightly as companies keep on top of workloads. While Markit Economics, the agency that publishes the report did not mention it specifically we believe the Olympics in London played a big role in the increase seen in manufacturing and service sector activities. Since this event was only temporary in nature, there’s a good chance that its stimulative impact could fade as well. Unlike the manufacturing and service sectors, construction activity contracted last month. Overall, the Bank of England will want to keep monetary policy steady until they get a chance to see how the economy performs without the contribution from the Olympics. As a result, don’t expect much from the BoE this week as the British pound will most likely follow the lead of the euro.

CAD: What to Expect from the Bank of Canada

The Bank of Canada has a monetary policy announcement on Wednesday and the Canadian dollar has traded quietly on the eve of the rate decision. No one expects the central bank to cut interest rates but everyone will be watching to see if the BoC shifts their tone. As the most hawkish G7 central bank, the BoC has said that, “some modest withdrawal of the present considerable monetary policy stimulus may become appropriate.” Investors interpreted this to mean that the central bank is gearing up to raise interest rates, a position that is unique to the BoC. However economic data has not supported their hawkish monetary policy stance. Consumer spending has been anemic, inflationary pressures have eased and job growth slowed. Additionally, the U.S. economy has been struggling along, providing very little promise for Canada. Yet the recent increase in oil prices has proven to be very supportive for the Canadian dollar. Since the beginning of August, oil prices have already climbed from a low of $87.13 a gallon to a high of $97.25 a gallon. If Hurricane Joyce, Kirk or Leslie turn into big storms, we could see oil prices rise above $100 a gallon. If the BoC moves to neutral, USD/CAD could finally find a bottom but if the central bank reiterates their view that withdrawal of stimulus could be needed, USD/CAD could extend lower. The Australian and New Zealand dollars traded lower against the greenback despite the RBA’s relatively neutral monetary policy stance. According to our colleague Boris Schlossberg, the central bank “offered no hints that it was looking to lower rates anytime in the near future. The RBA repeated many of it prior points noting that global growth has slowed, the commodity prices important to Australia have fallen sharply and that weaker recent indicators point to uncertainty on Chinese growth going forward. However, the central bank also stated that, ” interest rates for borrowers are a little below their medium-term averages. The impact of those changes is still working its way through the economy, but dwelling prices have firmed a little and business credit has picked up this year.” Overall the RBA has essentially reaffirmed its stance that “monetary policy remained appropriate,” disappointing the doves who had expected a more accommodative posture from Australian monetary officials.” Australian GDP and service sector PMI numbers are scheduled for release this evening.

JPY: A Look at China

It was a mixed day for the Japanese Yen which traded higher against all of the major currency pairs with the exception of the U.S. dollar and British pound. There was very little in the way of Japanese data released overnight and nothing significant is expected this evening. The only report was labor cash earnings, which continued to fall in the month of July. In Asia, the focus this week is on China. On Sunday, China released their official non-manufacturing PMI number and the HSBC Manufacturing PMI report. According to the government’s reading, service activity accelerated last month. HSBC will be releasing its version of services PMI tonight and a similar uptick is expected because the service sector has been holding up better than the manufacturing sector. We continue to believe that supportive monetary policies will prevent the soft landing from turning into a hard one but we can’t ignore the fact that economic momentum remains soft. After tonight’s HSBC report, there will be no more data from China until next week when we have inflation, industrial production, retail sales and trade numbers. If the People’s Bank of China were to increase monetary stimulus, they would probably opt to wait for these reports to be released before making any decisions.