USD, EUR and JPY Outlook This Week

The USD lost more ground last week extending its drop from the early October. Interestingly its latest drop has occurred despite an uptick in risk aversion suggesting other factors are at work. Mixed US data and earnings have not given the USD much direction with a downbeat Beige Book counterbalanced by a firmer Philly Fed manufacturing survey and housing starts.

The data have not been sufficiently weak to fuel expectations of more Fed quantitative easing but some Fed officials including Yellen, Tarullo, Evans and Rosengren in indicating that further QE could be considered. The USD has therefore been somewhat undermined but will take its cue from data releases and events in Europe this week.

This data slate will be mixed but on balance will not support more Fed QE. In particular, Q3 Real GDP is expected to come in sharply higher than in Q2, with a 2.5% annual rate expected to be revealed. Other indicators will be less positive, with October consumer confidence set to slip further and remain at a recessionary level, while September durable goods orders will decline by around 1%.

Despite an expected increase in new home sales in September the overall picture of the US housing market will remain very weak. Overall, the USD may find some respite from the GDP report but the data will be seen as backward looking, with the jury still out on the issue of more quantitative easing.

The EUR struggled to make any headway last week amid a barrage of rumors about the outcome of Sunday’s EU Summit. In the event the summit failed to deliver concrete details although there appeared to be some progress in key areas. Attention will now turn to Wednesday’s summit but once again the risk of disappointment is high. EUR/USD will only extend gains if markets are satisfied at the result but this is by no means guaranteed.

Data releases will not be supportive for the EUR this week, with a further deterioration in ‘flash’ eurozone purchasing managers indices (PMIs) and European Commission confidence surveys expected in October but hopes of a concrete resolution at Wednesday’s EU Summit will keep the EUR/USD supported early in the week although it will find strong resistance around 1.3915.

The sensitivity of the JPY to risk aversion has actually fallen over the last three months while the influence of bond yield differentials also appears to have slipped. The fact that USD/JPY continues to remain in a very tight range with little inclination to break in either direction despite gyrations in risk and yield differentials almost appears if the currency pair has been pegged.
Obviously this is not the case but a break out of the current range does not look imminent.

Speculative JPY positioning has dropped over recent weeks while equity and bond flows have overall been negative but this has not been reflected in JPY weakness resulting in increased frustration by Japanese officials. We continue to look for the JPY to weaken over coming months but much will depend on a widening in US / Japan yield differentials and easing risk appetite as both will regain their hold on the currency. In the meantime, the currency will continue to offer little to get excited about.

ECB to Hike, BoJ, BoE & RBA on Hold

The better than expected March US jobs report will likely help to shift the debate further towards the hawkish camp in the Fed. There is little this week to match the potency of payrolls in terms of market moving data this week. Instead attention will focus on a raft of Fed speakers over coming days as well as the minutes of the March 15 FOMC meeting.

This week’s Fed speakers include Lockhart, Evans, Bernanke, Kocherlakota, Plosser and Lacker. Of these only Lockhart and Lacker are non voters. Given the intense focus on recent Fed comments FX markets will be on the lookout for anything that hints a broader Fed support for a quicker hike to interest rates and/or reduction in the Fed’s balance sheet.

In any case the USD may struggle to make much headway ahead of an anticipated European Central Bank (ECB) rate hike of 25 basis point on Thursday. Much will depend on the press statement, however. If the ECB merely validates market expectations of around 75bps of policy rate hikes this year the EUR will struggle to rally.

It may also be possible that once the ECB meeting is out of the way the EUR may finally be susceptible to pressure related to ongoing peripheral tensions. Last week the outcome of the Irish bank stress tests, and political vacuum in Portugal ahead of elections set for June 5 were well absorbed by the EUR but it is questionable whether the dichotomy between widening peripheral bond spreads and the EUR can continue.

The Tankan survey in Japan released today unsurprisingly revealed a deterioration in sentiment. The survey will provide important clues for the Bank of Japan (BoJ) at its meeting on April 6 & 7th. Although a shift in Japan’s ultra easy monetary policy is unlikely whilst strong liquidity provision is set to continue, pressure to do more will likely grow. This will be accentuated by a likely downward revision in the economic outlook by the BoJ.

The JPY will not take much direction from this meeting. Nonetheless, its soft tone may continue helped by foreign securities outflows (particularly out of bonds), with USD/JPY eyeing the 16 December high around 84.51. Speculative positioning as reflected in the CFTC IMM data reveals a sharp deterioration in JPY sentiment as the currency evidence that finally the currency maybe regaining its mantle of funding currency.

It is still too early for the Bank of England to hike rates despite elevated inflation readings and MPC members are likely to wait for the May Quarterly Inflation Report before there is decisive shift in favour of raising policy rates. Even then, members will have to grapple with the fact that economic data remains relatively downbeat as reflected in the weaker than expected March manufacturing purchasing managers index (PMI) data.

Today’s PMI construction data will likely paint a similar picture. The fact that a rate hike is not expected by the market will mean GBP should not suffer in the event of a no change decision by the BoE this week but instead will find more direction from a host of data releases including industrial production. GBP has come under growing pressure against the EUR since mid February and a test of the 25 October high of 0.89415 is on the cards this week.

Finally, congratulations to the Indian cricket team who won a well deserved victory in the Cricket World Cup final over the weekend. The celebrations by Indians around the world will go on for a long while yet.

Eurozone peripheral tensions

The USD index remains under pressure but will likely continue to consolidate. The USD continues to be undermined by adverse interest rate differentials and is gaining little support from rising risk aversion. One factor that will help dictate USD direction over coming months is the prospects for further quantitative easing once QE2 ends.

Fed officials offered varied views on the subject. Dallas Fed President Fisher hinted he would support cutting short asset purchases before the end of June, whilst Atlanta Fed President Lockhart noted he was “very cautious” about further asset purchases. Meanwhile Chicago Fed President Evans noted that he believes the hurdle for altering the asset purchase plan is “pretty high”.

Although there is a lack of first tier data releases in the eurozone this week there is certainly plenty for markets to chew on in terms of peripheral country issues, which may just prevent the EUR from extending its gains. Eurozone peripheral debt spreads have undergone a renewed widening over recent weeks as debt fears have increased and worries that Portugal may follow Ireland and Greece in needing a bailout have risen.

Meanwhile news that Ireland’s incoming government will introduce legislation allowing the restructuring of some senior bank bonds, will add to tensions. Meanwhile, the downgrading of Greece’s government bond ratings to B1 from Ba1 dealt another blow sentiment following hot on the heels of Fitch’s downgrade of Spain’s outlook to negative although the EUR proved resilient to the news. EUR/USD continues to look as though it will consolidate around the 1.4000 level, but worsening sentiment towards the periphery may open up downside as the EUR’s resilience fades.

Upward revisions to eurozone growth and inflation forecasts and of course a hawkish shift in eurozone interest rate expectations may have justified the EUR move higher over recent weeks. However, there does not seem to be much that will provide the stimulus for further gains from current levels.

The market has already priced in an interest hike as early as next month’s European Central Bank (ECB) meeting and further tightening thereafter. The risk now appears asymmetric skewed to the downside especially if tensions between the eurozone core and peripheral countries deepen. How long the EUR can ignore such tensions?

It’s not only the eurozone periphery that should worry about ratings. Japan’s ratings agency R&I has warned that it may be forced to cut Japan’s sovereign ratings before April’s local elections due to current political problems. R&I’s concern revolve around the potential for political problems to delay fiscal reforms. As usual the JPY remains unmoved by political issues and is moving to the stronger side of its recent range against the background of elevated risk aversion.

Although the JPY has not been particularly sensitive to risk over recent months shorter-term correlations shows that its sensitivity has increased. Given that Middle-East tensions do not appear to be easing the JPY will remain well supported. Indeed, speculative positioning data reveals the highest JPY net long position since November 2010. As risk appetite improves JPY positioning will be pared back but this is unlikely to be imminent, with USD/JPY set to remain close to support around 81.10.

What to watch this week

The 85k drop in US non-farm payrolls in December was obviously disappointing given hopes/expectations/rumours of a positive reading over the month.  There was a small silver lining however, as November payrolls were revised to show a positive reading of +4k, the first monthly gain in jobs since December 2007.  Overall, the US labour market is still gradually improving as the trend in jobless claims and other indicators show. 

The fact that the market took the drop in US payrolls in its stride highlights the fact that recovery is becoming more entrenched despite the occasional set back.  More significantly weaker US jobs disappointment has been countered by strong Chinese trade data, which showed both strong imports and exports growth in December.  Whilst the data, especially the strength in exports, will support calls for a stronger CNY, it also highlights China’s growing influence on world trade and the important role that the country is providing for global economic recovery.

Market resilience in the wake of the drop in US payrolls and positive reaction to Chinese trade data will maintain a “risk on” tone to markets this week.  In particular, the USD is set to start the week on the back foot and despite data last week showing that Eurozone unemployment reached an 11-year high of 10% and growing evidence that the Eurozone economy is falling behind the pace of recovery seen elsewhere, EUR/USD held above technical support (200 day moving average) around 1.4257, and is setting its sights on the 16 December 2009 high of 1.4591 helped by renewed Asian sovereign interest.  

The main event in the Eurozone is the ECB meeting on Thursday no surprises are expected, with the Bank set to keep policy unchanged whilst maintaining current liquidity settings.  The bigger concern for European markets is ongoing fiscal woes in the region, with press reports warning of a ratings downgrade for Portugal and still plenty of attention on Greece and its attempts at deficit reduction.  Fiscal concerns are not going to go away quickly and will clearly act as a restraint on market sentiment for European assets. 

In a holiday shortened week in the US as markets close early on Friday ahead of the 3-day MLK holiday, there are a number of data this week that will shed further light on the shape of US recovery. The main event is the December advance retail sales report on Thursday, which is expected to record a reasonable gain, helped by firm autos sales. 

Preceding this, tomorrow there is expected to be a renewed widening in the US trade deficit in November whilst on Wednesday the Fed’s Beige Book as well as various Fed speakers this week including Bullard, Lockhart, Fisher, Plosser, Evans and Lacker, will give important clues ahead of the January 27 Fed FOMC meeting.  Bullard sounded dovish in his comments in Shanghai, as he highlighted that US interest rates will remain low for some time. 

At the end of the week there will be a heavy slate of releases including December CPI, industrial production, capacity utilization, January Empire manufacturing and Michigan confidence. The outlook for these data is generally positive, with gains expected in both manufacturing and consumer confidence, whilst hard data in the form of industrial production is likely to record a healthy increase and CPI is set to reveal another benign reading.

%d bloggers like this: