Daily FX Market Roundup 03-22-13

FX: Is Cyprus Just a Road Bump?
EUR: Intensive Weekend Ahead for Europe
GBP: Further Short Squeeze Possible
NZD Outperforms, Could Extend Gains on Good Trade
CAD: GDP and CPI Next Week
AUD: One Month Highs
JPY: Expect Consolidation and Profit Taking Until April 4th

FX: Is Cyprus Just a Road Bump?

Currencies and equities traded higher today on the hope that the problems in Cyprus will prove to be only a minor road bump in the long road to recovery for the Eurozone and the global economy. Whether that becomes true remains to be seen and we’ll let you decide if a tax on deposits in Cyprus will make investors nervous about depositing more than 100,000 euros in the Eurozone as a whole. We should never underestimate the power of sentiment, especially when it comes to the forex market. If investors feel that this is an isolated problem, then good news from this weekend’s negotiations could lead to a nice short squeeze in the EUR/USD (see EUR portion of our commentary for more). According to the latest CFTC IMM data on speculative positioning in the futures market, traders added to their short EUR/USD positions this week. Once the dust settles, it will be back to fundamentals and there were plenty of important developments that will be important to remember when that happens.

First and foremost, the Bank of England is not as eager to push the GO button on additional Quantitative Easing as the market had expected. Combined with stronger retail sales, we could be at the cusp of a new uptrend in the GBP/USD. In the U.S., we learned that Fed Chairman Ben Bernanke is not as worried about the country’s fiscal finances or the latest troubles in Europe. With the House of Representatives approval of a budget and stop-gap measure to fund the government through this fiscal year, the near term risk is lifted. The debt ceiling is the next battle in Washington but for the time being, Bernanke’s optimism should be interpreted as positive for the U.S. dollar especially as we look beyond Cyprus to the recent economic reports from the Eurozone. If Cyprus is just a road bump, then the underlying performance of the Eurozone economy is what matters and unfortunately the outlook is not promising. Bernanke will be speaking next week – so keep an eye out for that but overall, the economic calendar is quiet with only secondary economic reports on the calendar. Both GDP reports from the U.S. and U.K. are final and not initial numbers. As a result, developments in Cyprus will drive trading in the FX market in the front of the week but as time progresses, relative fundamentals should come back into play.

EUR: Intensive Weekend Ahead for Europe

In the words of the Cyprus government, “the next few hours will determine the fate” of the country and unfortunately hours could now turn into days. At the end of the North American trading session, which is very late in Cyprus (11pm), the Parliament had just convened to vote on a new legislation to raise funds for a bailout. They have said yes to capital controls and a solidarity fund to pool state assets but still need to vote on the big issue such as restructuring their second and maybe even first largest bank and a deposit level. The EUR/USD has traded extremely well today on the hopes that Parliament will approve their latest plan to avoid bankruptcy and immediate withdrawal of liquidity support from the European Central Bank. Talks with Russia failed and the latest proposal involves restructuring Laiki Bank, the country’s second largest lender, nationalizing pension funds, conducting an emergency bond sale and taxing deposits over 100,000 euros (the word is a one time 15% tax on deposits over this amount). Originally, angry demonstrations in Cyprus led the President to take the deposit levy off the legislation but the Germans criticized the government for their dangerous plans to raid pension funds of state owned businesses. The first test is whether this deal passes Parliament. If it does, it still needs to have the full endorsement of the Troika. According to Bloomberg, Eurozone Finance Ministers want Cyprus to restructure its 2 largest banks, freeze uninsured deposits of funds over 100,000 euros and tax them at a rate that could be as high as 40%. This is a continually evolving situation and for this reason we are surprised by the resilience of the EUR/USD because the stakes are high and the odds are stacked against Cyprus. Even if they reach a deal, their banking sector has been killed. Nonetheless Europe’s currency along with its stocks and bonds are taking the developments in stride and we can’t ignore that. Investors clearly feel that with the ECB holding their liquidity line hostage, Cyprus has no choice but to reach a deal by Tuesday. Eurogroup Finance Ministers are holding an in person meeting on Sunday with the hopes that they will have a deal to from Cyprus to discuss. If they like the deal, the EUR/USD will soar in relief but if they don’t it could drop to fresh year to date lows.

GBP: Further Short Squeeze Possible

The British pound has finally broken above the 1.52 level against the U.S. dollar. For the past month, the currency pair has consolidated below this level and now better than expected economic data along with renewed concern from the Bank of England about inflation has shifted the outlook for the British pound. If next week’s U.K. economic reports show further improvement in the economy, the recent rally could turn into a new trend. The reason is because the primary driver of sterling weakness this year was an increasingly dovish bent from the Bank of England. Lets not forget that it was only last month that Bank of England Governor King joined Fisher and Miles in voting for more Quantitative Easing. However the central bank’s recent concerns about inflation mean there is less willingness to ease. Before the minutes were released, short GBP positions had risen to their highest level since October 2011 which means the currency is vulnerable to a broader short squeeze in the coming week, especially if economic data continues to improve. Fourth quarter current account numbers are due for release along with revisions to GDP and consumer confidence. It is also worth mentioning that Fitch has put the U.K.’s sovereign debt rating on negative watch which means a downgrade is likely but the market is taking the news in stride as Moody’s cut the U.K.’s rating last month.

NZD Outperforms, Could Extend Gains on Good Trade

An improvement in risk appetite and better than expected economic data helped commodity currencies extend their gains against the U.S. dollar. The NZD was the best performer as higher job ads and net migration in the month of February fueled hope that the solid growth New Zealand enjoyed in the fourth quarter can be sustained. We are certainly beginning to see consistent improvements in New Zealand data and if next week’s trade numbers also surprise to the upside the rally in NZD/USD could extend to 84 cents. The AUD/USD rose to a 1 month high this week and since there isn’t much in the way of Australian economic data next week, AUD traders will need to keep an eye on comments from central bankers and overall risk appetite. In contrast, CPI and GDP are expected from Canada. The recent improvement in manufacturing activity and consumer spending points to stronger releases, which could help renew the rally in USD/CAD.

JPY: Expect Consolidation and Profit Taking Until April 4th

The Japanese Yen extended its gains against all of the major currencies as profit taking and consolidation continue to the limit the upside in USD/JPY. While additional Quantitative Easing from the Bank of Japan is a near certainty, unimpressive comments from Bank of Japan Governor Kuroda and the lack of fresh developments expected on the monetary policy front next week could lead to further consolidation and possibly additional profit taking on short Yen trades. Concerns over Europe is making investors weary of increasing risk until Cyprus reaches an agreement with the Troika and Italy finally decides on a Prime Minister. What we have to appreciate is that USD/JPY has enjoyed a very nice rally over the past 4.5 months. There have been bumps in road, most notably in late February but the recovery was quick. The rally was fueled by speculation that the BoJ will ease aggressively and we still believe that they will but the longer investors have to wait, the wearier they will grow about being overly exposed. With a week and a half to go before the next Bank of Japan meeting, that may be a long time in the eyes of some investors who know that there’s only a 50-50 chance that the BoJ will ease on April 4th versus April 26th. There are a number of Japanese economic reports on the calendar next week including retail sales, PMI and labor market numbers – while important we don’t expect these reports to cause any big moves in the Yen.