What are the Potential Surprises in FX this Week?

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It may be a quiet morning in the foreign exchange market but the lack of liquidity due to the July 4th holiday in the U.S. could mean an increase in volatility this week. With 3 central banks holding monetary policy announcements, 2 countries releasing employment reports and a number of Chinese economic data on the calendar, there’s certainly no shortage of catalysts for big moves this week. Central bank interest rate decisions do not always mean large volatility for currencies particularly when it comes to Bank of England meetings because they have remained on hold for so long and very little details are provided when there are no changes to monetary policy. Economists are looking for the ECB and the BoE to ease but their decisions will be a close one and action OR inaction could surprise FX traders. After 2 months of subpar non-farm payrolls reports, this week’s labor market number will confirm whether the slowdown in job growth has become a trend. If payrolls did not rebound in June, the Federal Reserve will have no choice but to ease next month.

According to the latest U.S. economic report, the Federal Reserve still has a lot to be worried about. 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 the sharp sell-off in USD/JPY could continue if service sector activity slows as well.

Meanwhile the challenge of implementing some of the decisions made at the EU Summit caused the EUR/USD to give up part of its 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. Stronger than expected U.K. PMI manufacturing numbers helped the British pound hold onto its gains and rise against the euro while the commodity currencies shrugged off softer Chinese manufacturing activity.

Kathy Lien
Managing Director

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