Daily FX Market Roundup / Asia Preview 06-21-12

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management

USD: Rising on Weak Data
EUR: German Growth Concerns Overshadow Potential Progress on Economic Union
GBP: Stronger Data Does Not Remove Risk of QE
CAD: Major Disappointment in Retail Sales
AUD: Hit by Weaker Chinese Manufacturing Data
NZD: Faster First Quarter GDP Growth
JPY: 2 New BoJ Members are Dovish

USD: Rising on Weak Data

It is always interesting to see how the market behaves. When the Federal Reserve admitted that further stimulus could be needed, the dollar sold off across the board as traders adjusted their expectations and positions for QE3. However, a round of weak economic data that hardened the case for Q3 turned out to be positive and not negative for the U.S. dollar. We can tell by from price action in equities that traders were disappointed by the reports, which triggered a sell-off in risk. Yet rather than weaken, the dollar appreciated against every major currency including the Japanese Yen. For many traders, handicapping the main driver of currency movements can be very difficult, especially if it changes day by day. However on a day such as today, trouble in the U.S. economy was not the only thing that investors were worried about. Speculation of downgrades of U.S. and U.K. banks kept traders on toes. Slower economic activity in China and Germany also posed a risk to global growth with weaker U.S. data adding salt to the wound. The concern is that even if the Eurozone manages to cobble together a larger safety net for the region, demand is still a serious problem. In the U.S., manufacturing activity in the Philadelphia region contracted by the largest amount since August 2011. Economists had anticipated a small improvement but instead, the pullback deepened. Existing home sales also dropped 1.5 percent in May after rising 3.4 percent the previous month. Although the average price of a home sold increased, the amount sold was the lowest this year. Not all news was bad however – leading indicators rose 0.3 percent while jobless claims dropped slightly to 387k from an upwardly revised 389k. In our note yesterday, we said today’s reports would not make the Federal Reserve any less dovish but the weak numbers have hardened the case for QE3.

EUR: German Growth Concerns Overshadow Potential Progress on Economic Union

The euro sold off sharply against the U.S. dollar today, erasing all of the past week’s gains in the process. As Eurozone Finance Ministers continue to meet behind closed doors, comments out of the meeting seem to confirm that progress is being made. With this in mind, no major announcements are expected as the 2-day meeting is aimed at preparing for the EU Summit at the end of the month. The same is true of tomorrow’s four way summit between German Chancellor Merkel, French President Hollande, Italian Prime Minister Monti and Spanish Prime Minister Rajoy. We are hopeful that all of the meetings will yield results but based on the price action in the EUR/USD and the financial markets today, investors are concerned about the desire and ability of EU leaders to make the politically tough decisions that are needed to end the crisis. More specifically, everything is up to the Germans who do not want add further burden on their taxpayers and form a tighter political union that forces them to cede control on areas that are normally decided by national governments. So far we haven’t heard concessions by the Germans directly, but the G20 statement and the scheduling of important meetings suggest that they could finally be warming up to the idea.

With the near term risk of Greece leaving the euro eliminated, the focus is on Spain and on growth. Ten year Spanish bond yields declined today thanks to 2 small but strong auctions. However weaker German PMI numbers raised concerns about the ability of the Eurozone’s largest nation to provide cover for the rest of the region. With manufacturing activity contracting and service sector activity grinding to a halt, Europe needs not only an economic union to fortify the region but also stimulus to promote growth. While Eurozone Finance Ministers are meeting behind closed doors to find a way to form a more integrated fiscal and monetary union, investors are once again growing concerned about their ability to end the crisis. With Moody’s expected to downgrade U.K. banks today and S&P expressing concern about the ability of Spain’s bank bailout to cure the country’s short term funding needs investors realize there is no easy way out of the crisis. We agree and continue to believe that any rally in the EUR/USD should be looked at as an opportunity to sell at higher levels.

GBP: Stronger Data Does Not Remove Risk of QE

Despite stronger consumer spending numbers, the British pound weakened against the U.S. dollar for the second day in a row. The minutes from the most recent monetary policy meeting made it clear that the Bank of England is getting ready to ease and could do so as quickly as next month. Stronger spending weakens the case for more stimulus but the data also shows that the rebound in sales was due primarily to weakness in the prior month. Retail sales rose 1.4 percent in May after falling 2.4 percent in April. Excluding autos, spending still grew by 0.9 percent. This rebound was much needed to offset the drag that consumer spending in May would have had on second quarter GDP. The good news doesn’t just stop there – the Confederation of British Industry reported a sharp improvement in factory orders in June. However this may matter little to the Monetary Policy Committee whose primary motivation for easier monetary policy is the growing threat that the euro area’s debt crisis poses to the U.K. economy. Given the recent downtick in inflation, if the Bank of England wanted to ease, they certainly have room to do so without stoking inflationary pressures. According to BoE monetary policy committee member Weale, falling CPI creates “appreciable more rom” for stimulus. He voted for more QE this month because he was dissatisfied with the U.K.’s economic performance and believed that CPI may fall more in 2012 than the central bank forecasted in May.

CAD: Major Disappointment in Retail Sales

Weaker Chinese PMI numbers and the sell-off in the equity markets drove the Australian, New Zealand and Canadian dollars sharply lower against the greenback today. Manufacturing activity in China shrank at a faster pace for the second straight month according to HSBC. For countries such as Australia who counts China as its number one trading partner, the slowdown in activity has hit the currency hard. In fact the Australian dollar is one of the day’s worst performing currencies despite the lack of Australian data. The Canadian dollar was the second worst performing. Consumer spending was surprisingly weak in the month of April. Given the strength of the labor market and the improvement in demand on the wholesale level, most economists had been looking for a rise. Demand for clothing and shoes experienced the sharpest decline but spending on discretionary items such as sports goods, hobby, books and music also fell while purchases of alcohol and healthcare items increased. Excluding autos, sales dropped 0.3 percent, which was slightly less than the headline number, which dropped 0.5 percent but motor vehicle and parts sales also contracted. For the Bank of Canada, the pullback in spending raises questions about their plans to tighten monetary policy. The BoC has been the only central bank talking about raising interest rates but with consumers cutting back on spending and the possibility of Europe’s debt crisis spreading, the BoC will need to rethink their plan to raise interest rates. Consumer prices are scheduled for release tomorrow and softer inflationary pressures would support the case for steady rates for the rest of the year. While the New Zealand dollar also weakened against the greenback, it held up the best among the 3 commodity currencies thanks to stronger GDP numbers. The economy grew 1.1 percent in the first quarter, which was nearly 3 times stronger than Q4.

JPY: 2 New BoJ Members are Dovish

It was a mixed day for the Japanese Yen, which traded lower against the U.S. dollar and higher against the euro, Swiss Franc and Australian dollar. Final machine tool orders were the only piece of Japanese data on the calendar overnight and orders were revised slightly lower for the month of May. Supermarket sales are due tomorrow but this release will not have any impact on the Yen. More importantly, the Bank of Japan now has 2 new board members. Last night both houses of Parliament confirmed Prime Minister Noda’s nominations to the BoJ – Takahide Kiuchi of Nomura Securities Co. and Takehiro Sato of Morgan Stanley MUFG Securities Co. It is believed that these two private sector economists are more bearish on the economy and inflationary conditions than the Bank of Japan which means come July, there could be 2 additional members voting in favor of additional easing. The only respite for Japan is the impact that the possibility of QE3 from the Fed has had on the dollar. USD/JPY is hovering around 80, a level that Japanese policymakers are much more comfortable with.