Daily FX Market Roundup 09-23-13

Euro Under Pressure as Draghi Talks LTRO
USD – Unfazed by Dovish Comments from Dudley
GBP – Extends Gains on Potential Optimism from UK Policymakers
CAD – Looking for Uptick in Retail Sales
AUD – Lifted by Stronger Chinese PMI
NZD – Rally Seeing Signs of Exhaustion
JPY – Talk of Stimulus Package Gains Momentum

Euro Under Pressure as Draghi Talks LTRO

The combination of weaker economic data and dovish comments from European Central Bank President Draghi drove the euro lower against the U.S. dollar. This morning, we learned that economic activity in the Eurozone accelerated in the month of September, fueling hope that the region is poised for a stronger recovery that could bridge the gap between the European Central Bank and Federal Reserve’s monetary policies. However the PMI numbers were mixed with manufacturing activity slowing and service sector activity accelerating in Germany and the Eurozone as a whole. In response to this weakness in data, Draghi expressed concerns about the outlook for the economy and more importantly said “”W are ready to use any instrument, including another LTRO if needed, to maintain the short-term money market rates at a level which is warranted by our assessment of inflation in the medium-term.” Growth is not his only concern – market interest rates have been increasing and credit volumes have not improved quickly enough. So while the Fed decided not to taper last week, the ECB is considering easing monetary policy further and until ECB and Fed policies are aligned, there’s scope for near term weakness in the EUR/USD.

The German IFO report is scheduled for release tomorrow and based on the drop in manufacturing PMI, decline in industrial production and factory orders, we believe business confidence could surprise to downside. Investors have been more optimistic but businesses cannot ignore the slowdown in activity. If the IFO misses expectations, the EUR/USD could drop towards 1.34. If businesses remain blindly optimistic however, the EUR/USD could retest its 7 month highs at 1.3570. Meanwhile this weekend’s German elections had very little impact on the euro. Angela Merkel received strong support at the polls but did not gather enough votes to avoid forming a coalition. She’s done it before during her first term and after some political wrangling should be able to do so again.

USD – Unfazed by Dovish Comments from Dudley

With no major U.S. economic reports released today, the market was focused on comments from Federal Reserve officials. Of the 3 Fed Presidents scheduled to speak today, NY Fed President William Dudley was the only FOMC voter. Unlike his peers who spoke last week (George and Bullard), Dudley gave us a better look at why the central bank decided to maintain its current level of asset purchases last month. He expressed specific concerns about fiscal uncertainties and the growing questions around the debt ceiling and government spending. It appears that many Federal Reserve officials wanted to wait to see how Republicans and Democrats handled the potential government shutdown on October 1st before deciding to reduce stimulus. Dudley did not rule out the possibility of a reduction this year, which could explain the muted reaction in the U.S. dollar but he downplayed the significance of labor data that masks more modest improvements in the job market. He said changes to QE “need to be anchored in an assessment of how the economy is actually performing, how financial conditions are evolving, and how this affects the longer-term outlook and the risks around it.” While it is clear that Fed President Dudley does not support reducing asset purchases now, if Congress manages to reach a deal on the debt ceiling, come December he could be convinced otherwise. Taper is not off table this year and this notion is preventing a deeper slide in the greenback. Fed Presidents Pianalto and George are speaking tomorrow – George is the only FOMC voter and we know she dissented at the last meeting.

The main risk for the dollar this week will be the ongoing developments in Washington. The House ended last week by passing a stopgap spending bill that would fund the government until the end of the year but it would also withhold all funds for Obamacare. This was widely viewed as the first shot fired in what will undoubtedly be a contentious and long battle in Washington over raising the debt ceiling. With only 8 days to go before the government runs out of cash, the stakes are high as large parts of the government could be shut down on October 1st and this poses the risk of the first ever U.S. default. We’ve been down this road before and an extension or deal has been reached every single time. The stakes are high and the debate will be contentious but we believe that at the end of the day, the impact on the dollar should be small. The last time the government was shut down was between 1995 and 1996 and during this time, the dollar index dropped less than 1%. Of course, if politicians cannot put their differences aside and reach a compromise, the financial markets and the dollar could be big trouble but we think that this unlikely as an 11th hour deal will most likely be reached.

Housing market numbers, the Richmond Fed manufacturing index and consumer confidence are scheduled for release tomorrow. Given the drop in the U.S. Markit manufacturing PMI index and the University of Michigan consumer sentiment report, we see scope for a downside surprise that could keep pressure on USD/JPY.

GBP – Extends Gains on Potential Optimism from UK Policymakers

No economic data was released from the U.K. overnight but that did not stop the British pound from trading higher against the U.S. dollar and euro. Weaker Eurozone economic data and the Fed’s hesitancy about tapering asset purchases has made sterling the shining star of the forex market. The currency continues to hold above the key 1.60 level against the U.S. dollar and tonight’s housing market report should confirm the effectiveness of Bank of England’s policies. It’s a light week for U.K. data with final Q2 GDP and current account numbers being the most important releases on the calendar. We however are more interested in the speeches from U.K. officials – Monetary Policy Committee members Miles, Broadbent and Tucker will be speaking this week. So far we have heard more optimism from most policymakers and if this sentiment is shared by any of these officials, sterling could extend higher. Miles will be the first to speak tomorrow and we know from the latest BoE minutes that he dropped his call for additional Quantitative Easing because he sees signs of stronger growth. Miles is known for his dovish stance and his dissent from the majority vote. If his comments are optimistic, it could lend additional support to the currency.

CAD – Looking for Uptick in Retail Sales

Better than expected Chinese data drove the Australian dollar sharply higher against the greenback. The New Zealand and Canadian dollars also benefitted from the report but not to the same extent as the AUD. According to HSBC, Chinese manufacturing activity continued to expand at a stronger pace in the month of September, which is good news for the region and the countries that rely on Chinese demand. Considering that many view the private sector survey as a more conservative assessment of the health of China’s manufacturing sector, the uptick in PMI fuels hope that the much-needed recovery in China is gaining momentum. The biggest beneficiary of the upbeat view of China should be the Australian dollar. We have already seen a significant reduction in AUD/USD short positions and according to Friday’s CFTC IMM report, in the past week short positions have been cut more than 50%. NZD/USD should have also benefitted from the news but given how strong the recent rally has been, the currency pair failed to extend much beyond its current levels. With no economic data expected from Australia or New Zealand tonight, the Canadian dollar will be in focus because retail sales are due for release tomorrow. The latest employment report from Canada was 3 times stronger than economists had anticipated and this uptick in job growth should translate into stronger spending.

JPY – Talk of Stimulus Package Gains Momentum

With no major Japanese or U.S. data released today, the Yen continued to trade higher against most of the major currencies. Talk of another stimulus package is gaining momentum in Japan with local newspapers reporting over the weekend that an announcement will be made on Tuesday October 1st. Government officials apparently “leaked” the details of the package that is aimed at stimulating growth and offsetting concerns about the negative impact of the 3% consumption tax hike which will probably be announced at the same time. The stimulus program, widely known as the “third arrow” of Abenomics is a 5 trillion yen program that includes a reduction in the corporate tax rate, which may come in the form of a removal of the surcharge added in 2011 to help the economy recover from the earthquake. There could also be increased incentives for capital expenditure and higher wages, which the government hopes will boost household income and spending. These programs are expected to be financed by the supplementary budget and the main budget. The official announcement of the stimulus package should be good for stocks and given the relationship between the Nikkei and USD/JPY, potentially negative for the currency pair in the near term. Meanwhile according to the latest CFTC IMM data, speculators reduced their yen short positions slightly last week but overall, traders are still very short yen.