Daily FX Market Roundup 07-02-12

USD: Weaker ISM Keeps QE3 Expectations Alive
EUR: The Challenge of Implementation
GBP: Supported by Stronger PMI
AUD: Don’t Expect the RBA to Ease
CAD: Oil Down 1.5 Percent
NZD: Shrugs Off Weaker Chinese Manufacturing Data
JPY: Political Upheaval

USD: Weaker ISM Keeps QE3 Expectations Alive

With near term risks in the euro neutralized by the announcements made during last week’s EU Summit, investors have shifted their focus from fiscal to monetary policy. There are 3 main central bank rate decisions this week in Australia, U.K. and the Eurozone but speculation about what the Federal Reserve could do is also having an impact on the markets. Surprisingly weaker economic data drove the U.S. dollar lower against the Japanese Yen on concern that the case is building for QE3. For the first time in nearly 3 years, the manufacturing sector contracted. The ISM index dipped below the 50 mark that separates expansion from contraction in June with the index falling to 49.7 from 53.5. While the employment component or the amount of hiring only dropped slightly, prices paid fell to a 3 year low and new orders experienced a steep decline. The U.S. is a service based economy but the drop in manufacturing cannot be ignored and if service sector activity also slows, the Fed could be forced to pull the trigger on additional stimulus. Non-farm payrolls are also scheduled for release this week. After 2 months of subpar NFP numbers, the labor market market should go a long way in confirming whether the slowdown in job growth has become a trend. If payrolls fail to rebound in June, we could see QE3 on August 1st.

When the Federal Reserve last met, they had nothing positive to say about the U.S. economy. Unlike previous months, Bernanke did not downplay the weakness in the U.S. labor market and instead admitted that the Fed was too optimistic about the economy and that their outlook has changed. They extended Operation Twist, downgraded their growth forecasts and upgraded unemployment forecasts. Throughout the post monetary policy meeting press conference, Bernanke said repeatedly the Fed is prepared to take further action, which was a strong signal that QE3 is in play. To hammer this point in further, Bernanke said the Fed still has ammunition, would consider further asset purchases and can provide additional support for the economy with an intention to do what they can. If economic data continues to weaken, the Fed would have its case for another round of stimulus. Although the U.S. central bank will not meet for another 4 weeks, with ISM and non-farm payrolls on the calendar this week, U.S. monetary policy will still be on the minds of investors. The only piece of U.S. economic data on the calendar tomorrow will be factory orders which we do not expect to have a meaningful impact on the U.S. dollar.

EUR: The Challenge of Implementation

The challenge of implementing some of the decisions made at the EU Summit caused the EUR/USD to retreat and give up more than 25 percent of Friday’s gains. This morning, Finland and Netherlands said they would vote against secondary market bond purchases by the European Stability Mechanism or ESM for short. While these two countries do not command enough of ESM capital to completely block the decision, the lack of unanimity shows the amount of struggle and time it will take to implement any decisions made by the European Union. Germany will be holding its vote on the ESM next Tuesday and other countries will do the same over the next few weeks. According to Spiegel Online, the German Constitutional Court will decide next week “whether to grant a temporary injunction against German laws on the fiscal pact and the permanent euro rescue fund, the ESM, both of which the German Parliament narrowly approved on Friday.” We expect the complaints and requests for an injunction to be dismissed, preventing politics from holding back progress. Meanwhile Swiss National Bank President Jordan reiterated their commitment to defending the Swiss Franc. He said the Franc is still very highly valued and if the crisis worsened, the SNB would not exclude the possibility of negative interest rates. The reason why we bring this up is because the SNB will release its foreign currency reserves on Friday, which will tell us whether there has been any stealth intervention in the Franc. Swiss retail sales jumped 6.2 percent year over year in June while manufacturing activity contracted at a slower pace – these positive reports validate the central bank’s intervention efforts.

GBP: Supported by Stronger PMI

Thanks to better than expected economic data, the British pound ended the day higher against the euro and unchanged against the U.S. dollar. UK manufacturing activity contracted for the second month in a row, but the pace of contraction was not as significant as the previous month. In fact investors interpreted the report as good news for the British pound ahead of this week’s Bank of England meeting. At 48.6, the index still signals shrinking manufacturing activity but with the reading moving closer and not further away from the 50 mark that separates expansion from contraction, the latest release should make the central bank less likely to ease. This month’s BoE rate decision will be a very close one that could be largely determined by all of the important economic reports scheduled for release ahead of the rate announcement. We look forward to construction sector and housing market numbers on Tuesday followed by service sector PMI on Wednesday. As for today’s release, a recovery in output volumes was offset by a big decline in inflationary pressures that gives the central bank the flexibility to ease if they choose to do so.

AUD: Don’t Expect the RBA to Ease

The Australian and New Zealand dollars ended the day slightly higher against the greenback ahead of the Reserve Bank of Australia’s monetary policy announcement. The Canadian dollar did not join the rally and instead held steady against the greenback. While the RBA has been extremely aggressive with easing monetary policy over the past 2 months, reducing rates from 4.25 to 3.5 percent, don’t expect the RBA to ease again. The 50bp move followed by the 25bp rate cut earlier this year was aimed at inoculating the economy against Europe’s debt crisis and slower global growth. While there hasn’t been a significant amount of data released since the last monetary policy meeting (many key reports are due this week), recent improvements in data and the support provided by EU Leaders gives the RBA enough reason to pause in July. Job growth was particularly strong in the month of May while manufacturing activity contracted at a much slower pace in June. Stocks also rebounded and bond yields ticked higher. There are still areas of weakness, particularly in confidence and the housing market but with retail sales, service and construction sector activity reports scheduled for release after the RBA meeting, the central bank does not have enough inputs this month to make a decisive decision about further rate cuts. When the central bank last met, the decision to cut interest rates by 25bp was also a very close one because the domestic economy was performing better than they had anticipated. Most of their concerns centered on the uncertainty about the future of Europe but a lot has changed since their June meeting. There is no longer the risk of a Greek euro exit and the decisions made at last week’s EU Summit neutralized the risks in Europe for the time being. Even the comments from central bank officials have been relatively optimistic. Earlier this month RBA Governor Stevens said Australians have become overly pessimistic and that an objective investor from the outside world would feel that “Australia’s glass is at least half full.” Deputy Governor Debelle added last week that the Australian economy is in a “good place,” confirming that there is very little urgency within the RBA for another rate cut. We expect neutral comments from the RBA, which should have minimal impact on the Aussie.

JPY: Political Upheaval

The Japanese yen traded higher against other major currencies today as the US produced unexpectedly weak ISM data. The Tankan manufacturing and non-manufacturing index improved despite the strength of the Yen which has crippled exports. Former DPJ leader Ichiro Ozawa officially announced his leave from the ruling bloc to create his own political group. Lawmaker Kenji Yamaoka submitted a letter of resignation on behalf of 50 lawmakers, 38 from the lower house of parliament, and 12 from the upper chamber. Back on June 26 when the bill was getting passed to lower parliament, Ozawa and 56 other members voted against the bill. The resignations could interfere with Prime Minister Yoshihiko Noda’s effort to pass legislation to double the consumption tax if he loses a majority of the votes. Polls surveyed showed the bill as being hugely unpopular. With Ozawa forming a new party, he could gain a lot of supporters because of his opposition to the bill. Be prepared for the year to year labor cash earnings tonight which are forecasted to increase to 0.6%. There are no data scheduled for release tomorrow.