It’s Time For A Little FX Action

Time for Action in GBP and CAD

Many U.S. economic reports have been released this week, but we have not seen any big moves in the U.S. dollar. The reason is because none of the reports change the near term outlook for the U.S. economy or the Federal Reserve’s plans to taper asset purchases gradually. While Mother Nature has not been kind this winter, investors are beginning to discount her impact on the economy and with the Northeast enjoying unseasonably warm weather everyone is looking forward to seeing the flowers bloom and the recovery strengthening in the spring. The one currency that has seen a big move this week is the Canadian dollar and with retail sales scheduled for release on Friday, USD/CAD will be in play over the next 24 hours. Given the weakness in recent economic reports, there is a very good chance the currency pair will make a run for 1.12 (more on Canadian retail sales in the next section).

In addition to the Canadian dollar, we also expect to see increased volatility in the British pound. This week’s disappointing U.K. economic reports have made investors weary of any potential strength in U.K. data. However we have a number of reasons to believe that Friday’s retail sales report could surprise to the upside. Earlier this month, the British Retail Consortium reported the strongest increase in consumer demand in more than 2.5 years. The BRC retail sales monitor rose a whopping 3.9% in January, which compares to a 0.4% increase the previous month. Despite the rise in the unemployment rate, jobless claims dropped more than expected last month while average weekly earnings increased at a faster pace – both of which have positive implications for consumer demand. Consumer confidence also improved significantly, rounding out our reasons for expecting an upside surprise in retail sales on Friday. Since the details of the recent economic reports are not nearly as discouraging as the headline release, we continue to believe that sterling could head higher especially after hawkish comments from Bank of England monetary policy member Weale. He said interest rates could rise next spring, sooner than the central bank’s current projections. The only tricky part of buying sterling is positioning. According to the latest CFTC IMM report, speculators already hold a significant amount of long GBP/USD positions and this means unambiguously positive data may be needed to encourage fresh longs in the pair.

USD/CAD Extends Gains Ahead of Retail Sales

After yesterday’s sharp rally, USD/CAD extended slightly higher ahead of Friday’s retail sales report. Based on recent economic reports, the Bank of Canada has every reason to be cautious and if Friday’s consumer spending numbers drop as much as wholesale sales, they may have to seriously revisit the idea of additional stimulus. Wholesale sales fell a whopping 1.4% in the month of December and unfortunately in our experience, this report has a strong correlation with the broader retail sales release. Economists are looking for a soft number and expect retail sales to fall by 0.4%. The end of the year was extremely tough for Canada with job growth and manufacturing activity contracting significantly. Therefore we would not be surprised if retail sales dropped more than 0.4% and if we are right, it would trigger a stronger rally in USD/CAD. Canadian consumer prices are also scheduled for release and inflation is expected to rise in January after falling the previous month. While there have been signs of stronger economic activity in the beginning of the year, if this does not eventually translate into stronger spending, Canada’s economy will have a tough time recovering. Meanwhile the Australian and New Zealand dollars traded sharply higher. AUD was initially hit by weaker Chinese manufacturing activity but recovered as risk appetite improved North American trading session. HSBC’s flash PMI index dropped to its lowest level since July 2013, confirming the slowdown in Asia’s largest economy. A sharp increase in job ads in New Zealand in the month of January offset a decline in producer prices. No economic reports are scheduled for release from either country over the next 24 hours and for this reason, we expect the AUD to continue to underperform NZD.

Dollar: Starting to Grow Immune to Weaker Data

Based on the price action in the foreign exchange market Thursday FX traders are starting to become immune to weaker U.S. data. Nearly every U.S. economic report released over the past month has been distorted by the brutal winter weather. Temperatures will rise eventually and economic data will normalize but we still have at least another month worth of softer economic data ahead. The news that manufacturing activity in the Philadelphia region contracted at its fastest pace in 12 months sent the dollar tumbling against the Japanese Yen but losses in USD/JPY and U.S. equities were short lived as buyers looking forward to the end of winter swoop back in for bargains. The glass half full view of the economy was supported by a separate survey from Markit Economics that found manufacturing conditions improving significantly in the month of February and while we are skeptical of this strength, it provides hope that it won’t be long before the U.S. economy regains momentum. The other economic reports release Thursday was in line with expectations – consumer prices rose 0.1%, jobless claims dropped to 336k from 339k and leading indicators rose 0.3%. The Philly Fed survey did very little damage to the U.S. dollar this morning with the greenback quietly consolidating against other major currencies. For the time being we expect the 101.50-103 range in USD/JPY to remain intact and EUR/USD to hold below 1.3800. The increasingly narrow range in USD/JPY points to an imminent breakout but with no major U.S. economic reports scheduled for release on Friday, we can’t see a breakout occurring within the next 24 hours. Existing home sales is the only piece of U.S. data scheduled for release Friday. While USD/JPY is struggling to rally, if investors continue to discount weaker U.S. data, the currency pair could crack above 103 on the first sign of strength. In the meantime FX traders should keep an eye on Treasuries and equities. If yields continue to rise and stocks extend higher USD/JPY could hit its monthly high of 102.75.

EUR: Weak Data Raises Risk of Further Losses

While the euro traded lower against the U.S. dollar on the back of weaker economic data, it continues to flirt with its pivotal 1.37 former resistance turned support level. The currency pair’s resilience reflects the influence of risk appetite, which improved significantly Thursday despite weaker U.S. data. According to the Eurozone PMI index, both manufacturing and service sector activity slowed in the month of February. As our colleague Boris Schlossberg noted, “Germany continues to be the locomotive that is keeping the Eurozone from slipping into a recession” with France as the weak link. While the decline in the composite index was only 0.2 points, the recent disappointments in key economic releases signals the potential for additional losses in the EUR/USD. With the economic recovery in the Eurozone tenuous as best, the European Central Bank will be forced to maintain an extremely accommodative monetary policy stance. The odds of a rate cut are low but we expect continued cautiousness from Mario Draghi especially in light of muted inflationary pressures. German producer prices were expected to rise 0.2% in January but instead fell 0.1%, pushing the annualized pace of growth down to -1.1% from -0.5%. Eurozone consumer confidence also tumbled in February, which is consistent with other economic reports. The lack of Eurozone economic reports on Friday means risk appetite should drive EUR/USD flows.

USD/JPY Recovers From Record Trade Deficit

The news that Japan’s trade deficit hit record highs in the month of January sent the dollar tumbling against the Japanese Yen. The Nikkei dropped more than 2%, dragging USD/JPY down to a low of 101.67 intraday. However as the European and North American trading session progressed, USD/JPY recovered all of its earlier losses. Still, Japan’s trade data was very weak with exports falling 3.5% month over month. Imports rose 4.7% but this was primarily caused by a rise in energy prices. Consumer demand increased but the contribution was small compared to the increase in energy cost caused by the combination of a weaker Yen and rising commodity prices. The main concern was the weakness in exports particularly to the Asia Pacific region because the deficit with China hit its largest amount ever. The Lunar New Year may have contributed to the weakness in demand that caused Japan’s trade deficit to double from –Y1.3 trillion to –Y2.79 trillion. If the balance does not improve soon, the Bank of Japan may have to increase monetary stimulus. According to Bloomberg, 25 out of 34 economists surveyed expect the Bank of Japan to raise stimulus by the end of September with only 13 of those projecting action by the end of June.

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