Daily FX Market Roundup 06-29-12

FX: Prepare for Short but Busy Week
EUR: Making Sense of the EU Summit Announcements
GBP: Close Call for BoE Next Week
CAD: Stronger than Expected Rise in GDP
AUD: RBA Expected to Keep Rates on Hold Next Week
NZD: Sharp Gains in Oil and Gold
JPY: Mostly Weaker Data Points to Need for More Stimulus

FX: Prepare for Short but Busy Week

For North American traders, it will be a shortened trading week broken up by July 4th or Independence Day on Wednesday. The mid-week nature of this holiday means that most U.S. traders will either take the entire week off or come into work for only 2 days. Although our desks will be manned the entire week, if we were to take time off, it would certainly be Monday and Tuesday and not Thursday and Friday. The reason is because it’s a busy trading week filled with market moving events and economic data, the most important of which are due at end of the week. The agreement by European leaders to directly recapitalize banks helped to restore confidence in European assets and prevented an exacerbation of Europe’s debt crisis. Without today’s announcements, currencies and equities would be trading at much lower levels, putting us in a very different position as we head into the new trading week.

The outcome of the European summit has global ramifications not only for asset markets but also policymakers around the world. Three central banks have monetary policy announcements next week and each one of them have attributed part of their dovish monetary policy statement to the Eurozone’s debt crisis. Now that there has been some relief, there is also less pressure on these central banks to cut interest rates or increase their asset purchase programs. The Reserve Bank of Australia, the Bank of England and the European Central Bank will have a lot more breathing room this week and could very well reserve their stimulus for a more desperate time in the global economy.

The past week has been focused on Europe but this should change to some degree with non-farm payrolls and other important pieces of U.S. data on the calendar. Job growth is expected to remain weak but economists are looking for a small uptick after 2 months of particularly bad NFP reports. In addition to payrolls, manufacturing and non-manufacturing ISM reports are scheduled for release along with factory orders and the usual leading indicators for NFPs. This morning’s U.S. economic reports were mixed. Personal incomes grew by 0.2 percent in May, same pace as the previous month while personal spending remained flat. The PCE, a measure of inflation dropped 0.2 percent while core prices rose a mere 0.1 percent. Consumer confidence was revised lower according to the University of Michigan report but manufacturing activity in the Chicago region accelerated slightly. As with most of this week’s U.S. economic reports, the changes are not significant enough to alter the Federal Reserve’s outlook for monetary policy.

EUR: Making Sense of the EU Summit Announcements

The euro ended the day sharply higher against the U.S. dollar thanks to concessions from Germany and details for a broader plan to bring down bond yields and restore confidence in Europe. Expectations were extremely low going into the Summit with investors expecting nothing more than a growth pact and the formation of a single banking supervisor. When Van Rompuy delivered more, the EUR/USD soared in approval. We attempt to explain to you in plain English what was delivered during the EU Summit and what is still missing.

Four Key Announcements:

1. EUR120 billion Growth Pact – While the growth pact was preannounced on Thursday, it was the bargaining chip used by the Spanish and Italian Prime Minister to get Merkel to cave on debt issues. The money will come from existing EU funds and will be used for short term growth boosting measures such as building highways, railways and air links in the same spirit as the Franklin D Roosevelt’s economic programs to promote growth during the Great Depression.

2. Quasi Banking Union and Direct Rescue of Banks – A banking union is one of the core solutions to Europe’s debt crisis that the market did not expect so quickly from Europeans Leaders. However the Italians got the Germans to relent on allowing the European Stability Mechanism (ESM = Europe’s rescue fund) to give money to banks directly without adding to the debt burden of individual governments. What is wonderful about this is that it helps to cap the rise in European bond yields and hopefully prevent further downgrades by providing a bailout for banks without adding to the total debt sovereign owed by countries like Spain and Ireland. U Leaders aim to start allowing direct rescues of banks as quickly as year end instead of 3 years from now, when the crisis will probably be behind us. This is the short term rescue that the market desperately wanted and the main catalyst for the EUR/USD rally. The ECB will also become the sole supervisor of banks and any loans will be attached with strict rules.

3. Give Spanish Bondholders Seniority Over the EU – EU Leaders promised to not subordinate Spanish bondholders, giving creditors the confidence that they will not lose their place in the debt restructuring line to the ESM. As the second groundbreaking announcement from European Leaders this morning, loans from the rescue fund will now be on equal footing with loans from private investors, giving them the reassurance they need to buy Spanish bonds again.

4. Allow EFSF/ESM To Buy Bonds Directly – Allowing the EFSF/ESM to buy bonds in the secondary market is also a big deal because it is an aggressive and quick way to prevent the crisis from worsening by allowing the EFSF/ESM to control bond yield.

What was missing however are guaranteed deposit insurance and a roadmap for a fiscal union, which EU Leaders have tasked EC President Van Rompuy with delivering by the October summit. While there is no question that EU Leaders have announced more aggressive measures today than investors had anticipated, without fiscal changes or anything directly targeted at Italy, everything now rests on the hope of lower bond yields. In light of this, we are skeptical about whether steps taken today are enough to turn things around for Europe and end the crisis.

GBP: Close Call for BoE Next Week

Like the euro, the British pound benefitted significantly from the decisions made at the EU Summit. It was a full risk on rally today with money flowing out of safe haven currencies into high beta currencies. While the latest U.K. economic reports showed service sector activity grinding to a halt in the month of April, the data is backwards looking and paid little attention to by market participants. Despite the recent weakness in U.K. economic data and the uncertainty surrounding Europe’s debt crisis in June, consumer confidence held steady. PMI numbers are scheduled for release next week ahead of the Bank of England’s monetary policy announcement. This month’s decision by the BoE will be a close one. When monetary policy committee members last met, they voted by a slim 5-4 margin to keep asset purchases unchanged. Since then we have seen evidence of weaker economic conditions in the U.K. but with the relief from the EU Summit, central bank officials may vote to hold off another month. Nonetheless economists are looking for a GBP50 billion in asset purchases. The PMI reports could help to shape the central bank’s decisions. If the BoE eases, the British pound will weaken across the board, especially if the U.K. is the only central bank that eases this month.

CAD: Stronger than Expected Rise in GDP

The Canadian, Australian and New Zealand dollars traded higher against the greenback today while commodities jumped the most in 39 months in response to the EU Summit. There was no economic data from New Zealand and Australia but Canada released GDP, Industrial Product Price, and Raw Materials Price Index figures. Industrial Product Price remained unchanged at 0.0%, while the GDP and Raw Materials Price Index increased to 0.3% and -1.0% respectively. The Canadian GDP was surprisingly strong after two months of sluggish data. Mining, oil and gas were responsible for the unexpected turn of events. Oil and gas rose 2.4% in April after declines in February and March. Mining grew 3.1% after an 8.4% drop in February. Expected for next week is Australian data for Manufacturing PMI on Sunday night. The Reserve Bank of Australia will meet on Tuesday and might avoid further lowering its rates as its country had a strong month in terms of GDP, and employment data. The RBA dropped its rate by 25 basis points to 3.5% on June 5th. Had the markets responded poorly to the EU Summit, the RBA may have been motivated to ease again but when they last met, their tone was decidedly neutral and for this reason, we are practically certain that they will keep policy unchanged next week.

JPY: Mostly Weaker Data Points to Need for More Stimulus

The Japanese yen traded lower against all of the major currencies today as money moved out of safe haven and into riskier currencies. It was a busy night for Japan but the data was not meaningful enough to make a big dent in the Yen. The jobless rate decreased from 4.6% to 4.4% and household spending increased from 2.6% to 4.0%. This month’s housing starts decreased from 10.3% to 9.3%. Japan’s industrial output fell the most since March 2011 and CPI declined which may mean the need for stimulus to sustain the nation’s economic recovery. The growth forecast for the second quarter is expected to slow to 2% from 4.7% and the third quarter is forecasted to decline to 1.3% according to economists. The yen has risen 5.4% since March which causes concern for exports. Several central banks had increased their yen-denominated reserves to the highest level in at least a decade, according to the BoJ, which is an indication that the Eurozone crisis has favored the safe haven currency’s appeal. The European leaders came to an agreement at their two-day summit to create a permanent bailout fund to recapitalize troubled banks. The Nikkei 225 leaped 1.50% in response to this surprising news. In the new week, expect Japan to release Tankan Large Nonmanufacturing and Manufacturing Index and Outlook.