By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
- 3 Reasons why Euro Could Hit Fresh Yearly Lows
- Demand for Treasuries and Dollars Remain Intact
- GBP Remains Weak Ahead of Busy Week
- USD/CAD Backs Off 1.10 Resistance Level
- NZD: Holds Near 2-Month Lows as Credit Card Spending Declines
- AUD: Inflationary Pressures in China Remain Muted
- JPY: Lifted by Strong Performance in the Nikkei
3 Reasons why Euro Could Hit Fresh Yearly Lows
This is going to be a tough week for the EUR/USD because chances are the euro will fall to fresh lows against the U.S. dollar. For the past 3 weeks, investors have been selling euros for a variety of reasons that include weakening Eurozone data, geopolitical tensions, safe-haven demand for the greenback and ECB dovishness. Many of these factors could be reinforced by this week's economic reports, giving investors an even stronger reason to press the currency pair lower. ECB President Draghi made it clear on Thursday that the uneven and fragile recovery forces the central bank to step up their preparation for more stimulus. This week, Eurozone GDP numbers are scheduled for release and growth is expected to be anemic. We already know that Italy has fallen into recession and while France is expected to have grown by a modest 0.1% in Q2, Germany may have experienced its first contraction since the fourth quarter of 2012. The problems in Europe are moving north and if German GDP falls by more than 0.1% or Eurozone GDP contracts in Q2, EUR/USD could break its current year to date low of 1.3333. Tuesday's ZEW survey is not expected to lend much support to the currency because it will be hard for investors to be optimistic when Russia has responded to the EU sanctions with their own restrictions. In contrast, U.S. retail sales are expected to have grown at a faster pace in July. According to the International Council of Shopping Centers, same store sales rose 5.4% year over year giving retailers a leg up ahead of the back to school shopping season. Not only are ECB and Fed rates expected to diverge for a long period of time but in the short term, there could also be a widening gap in economic data surprises that will add pressure on the EUR/USD. Finally, even with the rally in stocks, the dollar maintains its safe-haven bid. The market's tolerance for risk has declined significantly with high-yield funds seeing its largest weekly outflow ever. Until there's a more permanent resolution to some of the conflicts around the world or we start to see a steady improvement in global data, it will be difficult to investors to move their demand away from Treasuries and in turn the dollar. So in a nutshell 1) Eurozone data 2) U.S. data and 3) risk aversion could drive the EUR/USD to fresh yearly lows this week but with all of this in mind, it would be remiss not to mention that EUR/USD short positions are at their highest level in 2 years according to Friday's CFTC report. This leaves the currency pair extremely vulnerable to a short squeeze if Eurozone data surprises to the upside or U.S. data miss expectations.
Demand for Treasuries and Dollars Remain Intact
Although geopolitical tensions eased over the weekend investors continued to buy U.S. assets. Both Treasuries and the U.S. dollar held onto their recent gains while stocks edged slightly higher. There were no U.S. economic reports released Monday and investors seemed to take Fed Vice Chairman Stanley Fischer's comments in stride. He expressed concerns about the global recovery, the low participation rate and weakness in the housing market. While the pace of U.S. growth leaves a lot to be desired, the outlook for the U.S. economy is still brighter than the Eurozone and other parts of the world, which explains why the dollar remains bid. There may not be much U.S. data scheduled for release this week but there are many important economic reports due from other parts of the world. Weakness abroad has and could continue to make U.S. assets attractive even if geopolitical tensions subside. Eventually the downtrend in U.S. yields will come to an end but its not over until it is over. We are in the dead of summer, volume and data are light so FX traders should keep an eye on rates this week.
GBP Remains Weak Ahead of Busy Week
It's a big week for the British pound but with no U.K. or U.S. economic reports released Monday, sterling barely budged against the U.S. dollar. Based on the price action of the currency, traders are clearly not positioned for a good employment report or more importantly hawkishness from the Bank of England. At the same time, the CFTC's commitment of traders report shows that speculators are long and not short the currency so anything goes. On a technical basis, the downtrend in the British pound remains intact but the outcome of the employment and the tone of the Quarterly Inflation Reports could easily alter the technical outlook. There's been a lot of talk about division within the Monetary Policy Committee and if the hawkish chatter makes its way into the Quarterly report or the economic forecasts, it could set a bottom for sterling. Some policymakers believe that it would be prudent to raise rates early to ensure that the process is smooth and gradual. Others are more apprehensive with slow wage growth and geopolitical uncertainty giving them good reasons to argue for steady rates. If the Quarterly Inflation Report fails to contain a hint of hawkishness, GBP/USD could easily drop 1.67 with EUR/GBP breaking through 80 cents.
USD/CAD Backs Off 1.10 Resistance Level
For the third time this month, the rally in USD/CAD failed right below the key 1.10-resistance level. On Friday USD/CAD soared after a disappointing employment report and Monday, it retreated on the back of stronger housing starts. Although the increase in housing starts was a pleasant surprise, it is not meaningful enough to offset the weak labor data especially since the housing market is expected to cool further this year. Nonetheless, it was enough to drive USD/CAD away from 1.10, a level that has proven to be extremely difficult to break. There's nothing on Canada's calendar this week that is powerful enough to drive USD/CAD through this resistance level and from the U.S., all we have is retail sales. If USD/CAD trickles lower and breaks below 1.09, there's no support until 1.08. Meanwhile the New Zealand dollar continued to consolidate near its 2-month lows. The decline in credit card spending during the month of July adds to the back-to-back disappointments in New Zealand data that should keep the RBNZ on hold for the rest of the year. No Australian data was released last night but business confidence was due for release Monday evening.
JPY: Lifted by Strong Performance in the Nikkei
The Japanese Yen traded lower against all of the major currencies Monday on the back of gains in equities. The Nikkei performed exceptionally Monday, rising more than 350 points or 2.38%. Unfortunately these gains could be fleeting if Wednesday's second quarter GDP report surprises to the downside. Economists expect a weak release but based on the performance of the Japanese Yen and Nikkei, investors are not prepared for big downside surprise partly because the Bank of Japan remains confident about a recovery. Increasing the sales tax in April took a big bite out of consumer spending with economists looking for GDP growth to fall 1.8% on a quarterly basis and 7% year over year. This would be the sharpest contraction in the economy since the first quarter of 2009. Recent economic reports revived talk of easing by the Bank of Japan and the speculation could gain traction if GDP misses expectations. According to last night's economic reports, even though machine tool orders grew at a faster pace, consumer confidence rose less than expected and the tertiary activity index dropped 0.1%. The BoJ left their monthly economic assessment unchanged. They feel that the economy recovered moderately but there has been a decline in demand following the front loaded increase after the sales tax hike.