What Drove EUR/USD to a Fresh 2-Year Low?

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Daily FX Market Roundup 07-06-12

What Drove EUR/USD to a Fresh 2-Year Low?
US: Another Month of Disappointing Payrolls
Why the GBP is Outperforming the EUR
CAD: Sharp Pullback in IVEY PMI
AUD: Deeper Contraction in Construction Sector
NZD: Sharp Decline in Oil and Gold Prices
JPY: Quiet Trading, Positive Comments from Japan

What Drove EUR/USD to a Fresh 2-Year Low?

The broken up holiday week in the U.S. did not stifle the volatility in currencies or equities. With 3 central banks easing monetary policy and the U.S. reporting another month of weak job growth, the euro hit a fresh 2-year low against the U.S. dollar, 3 year low against the euro and a record low against the Australian and New Zealand dollars. While the euro was hit the hardest, the Swiss Franc also experienced steep losses, falling to a 1 year low against the U.S. dollar and British pound. There are 2 main reasons for the euro’s weakness and the first is risk aversion. Weak economic data and pessimistic comments from the central banks of Europe have made investors extremely nervous about the outlook for the global economy. If things were bad in the first and second quarter, it now appears that central bankers believe the outlook will worsen in the third and fourth quarters. For this reason, every piece of bad news, including today’s non-farm payrolls report has made investors more risk averse.

The second reason why the EUR/USD experienced such a large decline is because investors believe that the ECB will expand its balance sheet at a faster pace than the Federal Reserve. In plain English, this means that they expect the ECB to be more aggressive than the Fed in easing monetary policy. Whether this is true remains to be seen but there is no question that this sentiment is contributing to the weakness in the euro. The next question is then how much lower can the EUR/USD go. At this point, there is no major support in the EUR/USD until the psychologically significant 1.20 level.

Next week’s Eurozone economic calendar is light but the region’s Finance Ministers will be convening on Monday to follow up on decisions made at the EU Summit. More specifically, EU Leaders have challenged this group to come up with a more detailed plan to lower Spanish and Italian borrowing costs in the near term and to lay out a plan for banking supervision before the end of the year. None of these are easy tasks and therefore no major decisions are expected on Monday. However one of the meeting’s goals is to outline the conditions for Spain’s bank bailout. For the time being, the money will still go directly to the sovereign until the Finance Ministers agree on the best way to recapitalize the banks and bypass the sovereign.

US: Another Month of Disappointing Payrolls

The price action in the currency and equity markets tell us that investors were disappointed by this morning’s non-farm payrolls report. However the rally in the dollar against the euro and commodity currencies suggests that not everyone believes the NFP report is terrible enough to cause the Fed to launch QE3. We beg to differ and believe there is a 75 percent chance of QE3 in August but with more than 3.5 weeks to go before the Fed meeting, there’s plenty of time for traders to place their QE3 trades. In the meantime what we know with certainty is that the outlook for the global economy is grim. Every action taken by central banks this week and every piece of major economic data points to tougher times ahead in the third and fourth quarter. This will necessitate more action from central banks before the end of the year, the Federal Reserve included. Everyone was hoping that job growth would exceed 100k but unfortunately American companies added only 80k jobs in June. After the small upward revision to the May report, non-farm payrolls were virtually unchanged. Federal Reserve officials hoped that today’s jobs number would allow them to coast on the monetary easing of other central banks and spare them from QE3. Unfortunately this won’t be the case. Even though job growth accelerated, the sluggish pace of improvement in the labor market means there is a good chance the Fed will need to keep up with the ECB and BoE in August and even if they pass next month prepare for some action in the fourth quarter. After the move from other central banks this week, QE3 won’t be as politically controversial. For President Obama, the lack of improvement in the unemployment rate means a tougher battle for reelection in November. The biggest problem in the U.S. economy is the lack of job growth and while the unemployment rate in the U.S. has fallen from its high of 10% it has refused to break below 8%. The details of the report show non-farm payrolls revised slightly higher in May from 69k to 77k and private sector payroll growth slowing to 84k from 105k the previous month. The unemployment rate remained unchanged at 8.2 percent but the U-6 unemployment rate increased to 14.9 from 14.8%. The only good news was average hourly earnings, which increased to 0.3 from 0.2 percent and average weekly hours, which rose to 34.5 from 34.4. When the Federal Reserve last met, Bernanke pledged to provide additional stimulus if the U.S. economy slowed further and come August, they will be looking for Bernanke to deliver on this pledge. We expect further losses in USD/JPY ahead of next week’s FOMC minutes, which should confirm that the central bank is moving closer to increasing stimulus.

Why the GBP is Outperforming the EUR

Although risk aversion drove the British pound lower against the U.S. dollar, sterling performed extremely well against the euro and Swiss Franc. In fact the GBP hit a 3 year high against the EUR and 1 year high against the CHF today. What was most interesting about this move was the fact that it came on the heels of weaker inflation numbers. The Bank of England eased monetary policy alongside the European Central Bank this week, but the euro has fallen far more significantly than the pound. The reason why this has occurred is because the euro is being punished for being the source of the region’s problems. Both the BoE and the ECB are expected to ease again this year and inflation is a big reason for why they can. According to this morning’s producer price report, input prices dropped 2.2 percent in June while output prices fell 0.4 percent and core prices fell 0.2 percent. Inflation is on a downtrend and it won’t be long before consumer prices slip back to the BoE’s 2 percent target from its current level of 2.8 percent. In the coming week, industrial production and the Visible trade balance are the only pieces of U.K. data on the calendar. With the rebound in the manufacturing PMI report, there’s scope for an upside surprise.

CAD: Canada Releasing Employment Numbers on Friday

The Canadian, Australian and New Zealand dollars ended the North American trading session lower against the U.S. dollar today. Canadian economic data was mixed with marginally stronger job growth met by significantly weaker manufacturing activity. Canada’s unemployment rate unexpectedly dropped 10 basis points to 7.2% marking the fourth consecutive month Canada has been adding jobs. A total of 7,300 jobs were added compared to a forecast of 5,000. With the rise in full time jobs more than offsetting the decline in part time work, the employment data shows a modest improvement in labor market conditions. However, the contraction in manufacturing activity will raise red flags for the central bank especially with oil prices dropping 20 percent since May. While the Bank of Canada has previously signaled the possibility of a rate hike, it will be difficult for them to pull trigger in light of slowing global growth and falling commodity prices. No major economic reports are due from the Bank of Canada next week but employment numbers will be released from Australia along with Canada’s trade balance.

JPY: Risk Off Means Yen On

The Japanese Yen strengthened against all of the major currencies today. IMF Managing Director Christine Lagarde suggested in a speech in Tokyo today that Japan should intervene in the Yen “provided that it’s duly concerted with other colleagues and is justifiable.” Japanese Prime Minister Yoshihiko Noda told Lagarde that the strong yen was hurting its economy especially the export sector which is its main source of growth. Lagarde said, “If there was a further deterioration arising out of the Eurozone, it might have an unwelcoming currency effect on the yen, which would be used as a safe haven and therefore would become further overvalued.” Japan is having trouble sustaining its recovery from natural disasters as the strong currency deters exports. Lagarde reiterates the IMF’s stance that the yen is “moderately overvalued and that if the crisis was to worsen, “it would certainly be very unwelcoming for Japanese growth.” The Eurozone crisis is currently one of the biggest economic movers and is driving up the yen which Noda notes that the strong yen is not a good reflection of the real state of Japan. Lagarde praises Noda for his proposal to double the tax on consumption and noted that it was an essential step to the nation’s recovery. In other news, the Japanese Finance Minister, Jun Azumi, noted that Japan’s government is on the verge of running out of money to fund this fiscal year’s budget by the end of October. Azumi plead to the two largest opposition parties to pass the deficit financing bill which would allow the government to sell bonds required to fund almost half its budget. If there are signs that the bill will not be passed then the Finance Ministry may have to cut tax grants to local governments. The first batch of data expected next week is on Sunday with the release of machine orders, currency accounts, and trade balance. The BoJ is meeting on Thursday and there are mixed forecasts on whether it will ease monetary policy further, having done so already this year.

Kathy Lien
Managing Director

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