Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Will Euro Break 1.35?
- Gains in Dollar Supported by Optimistic Beige Book
- Why Dovish BoC Statement Failed to Drive USD/CAD Higher
- NZD Crushed by Weak CPI
- AUD Shrugs Off More Jawboning and Decent Chinese Data
- GBP: Mixed Labor Means Back to Range Trading for Sterling
- Yen Crosses Underperform on Weakness of High Beta Currencies
Will Euro Break 1.35?
The 1.35 level is very significant for the EUR/USD. Despite numerous attempts to test this level over the past 8 months, EUR/USD only closed below 1.35 on one occasion and that was on January 31. If we look back all the way back to September, we see even more instances where the currency pair tested and failed to break 1.35 in a meaningful way. The only time that a sustained break occurred was after the European Central Bank surprised with a 25bp rate cut in November and while the sell-off extended to 1.33, less than 2 weeks later, EUR/USD was trading back above 1.35. So now that we are once again within 30 pips of this key level, many traders are wondering if 1.35 will hold. From a technical perspective, 1.35 is less significant than the February-3rd low of 1.3477. However taking a look at the chart below, Wednesday’s decline has taken EUR/USD below trend line support. If the pair breaks its 2014 low of 1.3477, the next stop could be the November low of 1.3295. On a fundamental basis disappointing Eurozone data and a faster decline in European yields drove the sell-off in EUR/USD. The region’s trade surplus rose to 15.3B from 15.2B in May, which was less than expected and yesterday, the Eurozone ZEW survey dropped to its lowest level in 11 months. While Treasury yields declined Wednesday, the 1.6bp drop in 10-year yields paled in comparison to the 2.1bp drop in French yields, 2.7bp drop in Italian yields and 5bp decline in Spanish yields. However it is important to recognize that there are also fundamental reasons why the euro refuses to break 1.35. The Eurozone has a massive current account surplus, U.S. yields are still in a downtrend and the currency is benefitting from reserve diversification. Therefore without a significant rally in U.S. yields or a strong signal from the ECB that further easing is imminent a move below 1.35 could be fake-out instead of a breakout. Eventually 1.35 will give way but that may not happen until the fall when the Fed ends Quantitative Easing and shares its exit strategy.
Gains in Dollar Supported by Optimistic Beige Book
The US Dollar traded higher against all of the major currencies Wednesday with the exception of the USD/CAD. The strength of the greenback had less to do with the market’s optimism about the U.S. economy and more to do with weaker economic data abroad. While the Beige Book reported a general improvement in the economy, the latest pieces of data were mixed. Producer prices increased at a faster pace but on an annualized basis growth slowed. Builder confidence increased in July but industrial production weakened in June. Foreign investors increased their exposure to U.S. Treasuries in May but total net Treasury International Capital Flows slowed from April. These second tier economic reports reinforce the ongoing challenges for the Federal Reserve who sees an improvement in the labor market but not much more beyond that. According to the Beige Book, modest to moderate growth in consumer spending was seen in the month of June with labor market conditions improving, manufacturing activity increasing and loan volumes rising across the nation. Most Fed districts were also optimistic about the economic outlook but none of this is enough to convince the Fed that earlier tightening is necessary. Housing starts and building permits are scheduled for release Thursday and a small rebound is expected after the sharp decline in May. While the housing data is important, the Philadelphia Fed manufacturing survey should be a bigger mover for the dollar – don’t forget that the surprise jump in the Empire State survey on Tuesday overshadowed the smaller increase in retail sales. However even if all of Thursday’s economic reports surprise to the upside, the impact on the greenback should be nominal.
Why Dovish BoC Statement Failed to Drive USD/CAD Higher
The Bank of Canada’s decision to downplay the recent rise in inflation should have been positive for USD/CAD and initially it was but shortly after the monetary policy announcement, the currency pair gave up its gains. This reversal left many traders confused because the BoC felt the CPI rise was temporary, not tied to any change in the economy and attributed to “the temporary effects of higher energy prices, exchange rate pass-through and other sector-specific shocks.” Combined with their decision to lower their 2014 GDP forecast, the overall tone of the BoC meeting was dovish. However USD/CAD gave up its initial gains because there was significant pre-positioning ahead of the BoC announcement. Recent disappointments in Canadian data led many traders to correctly anticipate that the central bank would place less emphasis on inflation and more emphasis on the weak activity indicators so when the comments were actually made, they were not a big surprise. At the same time, the Bank of Canada maintains a neutral monetary policy stance, which means they are not considering tighter or looser monetary policy. While the recent decline in oil prices and the prospect that the BoC will lag behind the Fed is still positive for USD/CAD, right now profit taking appears to be the primary driver of USD/CAD flows. Meanwhile the New Zealand dollar has been hit hard by lower consumer prices and the lingering impact of yesterday’s weak dairy auction. The general belief is that while the Reserve Bank is widely expected to raise interest rates next week, they will slow or pause their pace of tightening thereafter. Like the Canadian dollar, the Australian dollar ended the day unchanged against the greenback. The currency has become immune to jawboning – Tuesday night RBA board member Edwards described the AUD as overvalued but judging from his comments they don’t plan to intervene at this time. He said “We might have to wait until global markets are more convinced that the U.S. is actually about to move on the overnight rate” before AUD/USD sees a more meaningful decline.
GBP: Mixed Labor Means Back to Range Trading for Sterling
The British pound ended the day unchanged against the U.S. dollar GBP/USD on the back of mixed labor market data. Sterling needed an unambiguously positive jobs report to hit 1.72 versus the dollar and unfortunately that did not happen. While jobless claims fell -36.3k, versus a -27k forecast and the unemployment rate dropped to 6.5% from 6.6%, average weekly earnings growth slowed to 0.3% from 0.8%. If we exclude bonuses, earnings growth slowed to 0.7% from 0.9%. Inflation is on the rise and employment conditions are improving but Bank of England Governor Carney made it clear a few weeks ago that low wage growth will impact the timing of a rate hike. On countless occasions, he has spoke of the slack in the economy and his concerns that wage growth has been weaker than expected. If wages do not rise alongside inflation, it becomes very difficult for the central bank to act on rising price pressures. Still, Wednesday’s report was decent enough to limit the losses in GBP/USD and keep sterling bid versus the euro. As there are no additional major U.K. economic reports scheduled for release this week, the 1.7060 to 1.7191 range in GBP/USD should remain intact. The next opportunity for a breakout in sterling will be when the Bank of England minutes are released next week.
Yen Crosses Underperform on Weakness of High Beta Currencies
Despite the rally in U.S. stocks and the steadiness of USD/JPY, nearly all of the Japanese Yen crosses traded lower Wednesday on the back of weakness in high beta currencies. No major Japanese economic reports were released overnight but according to the Bank of Japan’s monthly report, “Japan’s economy has continued to recover moderately as a trend, although the subsequent decline in demand following the front-loaded increase prior to the consumption tax hike has been observed.” As this assessment was exactly the same as the past 2 months, the impact on the Yen was limited. Stronger growth in China also failed to drive USD/JPY or Japanese equities higher, which suggests that the market has completely discounted stabilization in China’s economy. GDP rose 2% in the second quarter at a time when economists were only looking for a 1.8% rise and this helped to lift the annualized pace of growth from 7.4% to 7.5%. While it can be argued that investors were disappointed by slightly weaker retail sales growth, stronger GDP and a larger increase in industrial production should have made up for the difference. At the end of the day, China’s economy is improving and in the long run, it will be positive for Japan. The Ministry of Finance’s portfolio flow report was scheduled for release Wednesday evening along with the Cabinet’s assessment of the economy.