Daily FX Market Roundup 12-12-13
Re-loading Long Dollar Trades Ahead of FOMC
AUD Killed by Verbal Intervention from RBA
NZD Hits 5 Year Highs Versus AUD
CAD: Commodity Prices Hit by Stronger Dollar
EUR Succumbs to Weaker Data and Dovish ECB
GBPUSD: Near Term Top?
Rise in U.S. Yields Lifts Yen Crosses
Re-loading Long Dollar Trades Ahead of FOMC
As the most important piece of U.S. data this week and the only report that could have altered the market’s expectations for tapering, U.S. retail sales successfully united the movements in U.S. assets. The dollar traded higher against all of the major currencies as Treasury yields increased and equities weakened. Even commodity prices were driven lower by the rise in the dollar. All of this price is consistent with increased expectations for Fed tapering and is a breath of fresh air after a long period of divergence. Investors across different asset classes interpreted the U.S. retail sales report in the exact same way – which is that the Fed could realistically taper asset purchases this month. It is a very close call but with USD/JPY trading back above 103, traders are re-loading their long dollar positions ahead of next week’s FOMC meeting. USD/JPY ended the day at a fresh 6 month high and if the Nikkei rebounds overnight or U.S. yields extend their gains on Friday, it could test its 2 year high of 103.74.
The dollar’s initial reaction to retail sales was tempered by the sharp rise in jobless claims. Consumer spending rose at its fastest pace in 5 months but jobless claims hit its highest level since March. While the market may be worried about the implications of higher claims on December non-farm payrolls, the correlation between claims and payrolls have been very weak. Also, the surge is most likely a short-term distortion because of the seasonal volatility usually seen around the Thanksgiving and Christmas holidays. Between the 2 releases, the retail sales report is always more important. With spending rising by 0.7% in November from an upwardly revised 0.6% in October, the odds of tapering this month have increased and in response U.S. Treasury yields and the dollar edged higher.
However investors quickly realized that the Federal Reserve would be please to see that spending increased. Both the upward revision in the October figures and the improvement in November indicate that the economy is moving in the right direction. Consumer spending provides the backbone for growth and the sharp rise over the 2 past months means that retail sales will contribute positively to GDP growth in the fourth quarter. Advance retail sales rose 0.7% and excluding gas and autos, spending still increased 0.6%. Many Federal Reserve officials sounded open to the possibility of reducing bond purchases this month before they saw today’s report and their confidence will only be hardened by the stronger spending numbers. Some economists were worried about the decline in clothing sales but consumers spent more on pricier items such as furniture, building materials and motor vehicles. Online shopping also surged, leaving Americans with more time and money to dine out. As these are positive developments for the U.S. economy, they support a further rally in USD/JPY pre-FOMC. The rise in jobless claims shouldn’t be too much of a concern because the seasonal distortion should reverse in the coming weeks with jobless claims falling back from its current level of 368k to below 330k.
AUD Killed by Verbal Intervention from RBA
Hands down, the worst performing currency this week is the Australian dollar. Since Monday, the currency pair has lost over 2% of its value against every major currency and since the beginning of the month, it is down over 3% versus the euro, New Zealand dollar and Swiss Franc. Weaker Chinese imports initially drove the currency lower but the selling intensified when investors learned that consumer confidence fell sharply in the month of December. The rise in the unemployment rate left investors unimpressed by the larger increase in jobs and today, the A$ came crashing down after Reserve Bank of Australia Governor Stevens said the currency needs to be closer to 85 cents compared to its current level of 89 cents to spur growth. With limited capacity to lower interest rates, Stevens’ comments basically amounts to verbal intervention and he is hoping that tapering by the Fed will help drive the currency to his targeted rate. If it fails to do so, the RBA may have to resort to another rate cut. Either way, the RBA is clearly dovish and want to see the currency lower. As such, we not only expect the AUD/USD to break below its 3 year low of 0.8846 but we expect it slide to extend to down to 85 cents. In contrast, the New Zealand dollar is performing very well thanks to the hawkishness of the RBNZ. The monetary policy divergence between the RBA and RBNZ has driven AUD/NZD to fresh 5 year lows. Our near term target for the move continues to be 1.05. The Canadian dollar was also hit by risk aversion.
EUR Succumbs to Weaker Data and Dovish ECB
After rising for 7 consecutive trading days, EUR/USD is stalling right below its 2 year high. Industrial production in the Eurozone dropped more than expected but this deterioration wasn’t a major surprise after similar declines were seen in Germany and France. Weaker economic data contributed to today’s move but the currency pair has also reached levels of exhaustion. The sell-off in U.S. stocks is finally catching up to EUR/USD while dovish comments from ECB President Draghi added pressure on the currency. Draghi describes the Eurozone recovery as weak and reiterated that they stand ready and able to act, a line repeated later by ECB Governing Council Liikanen. Draghi is also not opposed to another LTRO once the current one ends but said that it would be geared to lending to the economy. Liikanen said the central bank’s monetary policy capacity is not exhausted and warned that rates will remain at present or lower levels for a long period of time. The central bank may not be serious about dropping interest rates to negative levels but the monetary policy committee as a whole is very serious about ensuring that the market understands they are dovish and won’t be tightening monetary policy anytime soon. As such, gains in the EUR/USD will be limited by the divergence between Eurozone and U.S. monetary policies.
GBPUSD: Near Term Top?
For the second day in a row, the weakness in global equities drove the British pound lower against the U.S. dollar. While no data was released from the U.K., the GBP/USD’s recent price action leads many investors to wonder if the currency pair is carving out a top below 1.65. From a fundamental perspective we have seen improvements on both sides of the Atlantic and they have made the Bank of England and the Federal Reserve more optimistic. Sterling is one of our favorite currencies for 2014 and we even believe the U.K. will be one of next year’s the fastest growing G-10 economies. However the BoE is comfortable with the current level of monetary policy and while they said that their first move would be to raise rate, they are in no rush to do so. We expect the Bank of England to grow more optimistic in the first quarter but stop short of making any changes. In contrast the recovery in the U.S. may not be as strong as the U.K. but the Federal Reserve is widely expected to reduce stimulus over the next 2 to 3 months. With one central bank looking to hold policy steady and the other taking action, even if the longer term outlook for U.K. is brighter than the U.S., GBP/USD could extend its losses if the Fed tapers this month. This leaves buying sterling more attractive against the euro and Australian dollars. Both the ECB and RBA remain dovish and could ease monetary policy in 2014.
Rise in U.S. Yields Lifts Yen Crosses
Despite the sell-off in Japanese and U.S. stocks, the rally in USD/JPY lifted most of the Yen crosses higher. The only laggard was AUD/JPY, which extended its losses on the back of dovish comments from the RBA. With 10-year U.S. bond yields climbing to its highest level since early September, the pressure is to the upside for USD/JPY. The 103.74 year to date high is now in sight and traders could make a run for this level before next Wednesday’s FOMC announcement. However without a rally in U.S. or Japanese stocks, gains in the yen crosses could be limited. The consistent rise in U.S. yields also attracted investment from the Japanese. According to the Ministry of Finance’s latest weekly portfolio flow report, Japanese investors were net buyers of foreign bonds for the ninth week in a row. Purchases last week rose from 65.5B to 413.2B. While Japanese investors are selling domestic stocks ahead of the steep increase in capital gains tax, foreign investors bought Japanese stocks for the sixth week in a row. Final Japanese industrial production numbers are due for release this evening and no revisions are expected. Next week’s fourth quarter Tankan report will be a very important release for Japan and we expect the report to show stronger manufacturing and non-manufacturing activity.
