Central-Bank Mania: The Busy Week Ahead

FX: Importance of Chinese NPC, US NFP Next Week

At the beginning of this week, we said the euro would have a bullish bias and USD/JPY would range trade. It took 5 trading days for EUR/USD to break out but the move finally happened and despite a testimony from Janet Yellen, USD/JPY was fined within a 115 pip trading range. Generally speaking, it has been a quiet week in the forex market but all of that will change with next week's busy economic calendar. We have 4 major central banks making monetary policy announcements (RBA, BoC, ECB and BoE), PMIs from the U.K. and Australia along with employment reports from the U.S. and Canada. China will also kick off the National People's Congress (NPC), the annual 9 day meeting in which more than 3,000 delegates will convene to approve laws, policies and the budget. For the financial markets, the focus will be on the government's growth targets, which will be shared by Premier Li Keqiang on Wednesday. The government is expected to leave its 7.5% GDP target and 3.5% inflation target for 2014 unchanged. However the question will be whether 7.5% will be the minimum or maximum growth rate that the government expects. If they downplay the growth target, it would suggest that China would not be troubled by slightly slower growth. If they say 7.5% is the "bottom line," it suggests that the government expects stronger growth. Given the recent sell-off in the Yuan, FX policy will also be of interest but no changes are expected.

The dollar will be particularly active this week with non-farm payrolls scheduled for release. After 2 months of subpar job growth, the U.S. economy desperately needs to create more jobs to keep the Fed on track to reduce asset purchases by another $10 billion in March. If fewer than 110k jobs were created this month, not only does Janet Yellen need to drop the unemployment rate threshold, but she may be forced to seriously consider a smaller amount of tapering. Yellen will also be delivering her very first quarterly monetary policy statement. While she has shared her views on the economy and monetary policy often in February, it is very difficult for her to make a proper assessment without seeing the March NFP report. We would be surprised if the storms in February did not affect payrolls but a reading below 110k would be hard for the Fed to ignore.

Meanwhile U.S. Treasury yields rose for the first time this week but the rise in interest rates provided very little benefit to the U.S. dollar. Yields in other parts of the world are up by an even larger amount due to stronger data, reducing the significance of the move in U.S. rates. The EUR/USD climbed to a 2-month high in large part because German 10 year bund yields rose more than Treasury yields. Friday's economic reports were mixed with a lower Q4 GDP number and weaker pending home sales offset by stronger manufacturing activity in Chicago and an upward revision to consumer confidence.

EUR Soars as Chance of Rate Hike Sinks

Better than expected economic data drove the euro to its strongest level against the U.S. dollar in nearly a month. The European Central Bank has a monetary policy announcement next week and while we had been skeptical on the chatter about possible easing, there was certainly a subset of investors who went into this week thinking that the ECB could ease. However between the larger than expected rise in Eurozone consumer prices this month and jump in retail sales, the chance of more stimulus has fallen significantly. While optimism from the central bank is a possibility, traders should not expect the ECB to give up on the idea completely and shift their bias to neutral because at 0.8% inflation is still very low. Our colleague Boris Schlossberg summarized it well. He said "The ECB, which has been hampered in its attempts at a more active monetary policy by opposition from German courts, is loathe to act at this juncture as the interest rate cut option may be its only policy choice left. Mr. Draghi and company would no doubt like to reserve any such action for a more critical need. Therefore, the markets outsized reaction to Friday's data release is understandable as it virtually removes the possibility of a rate cut this month." Aside from the ECB rate decision on Thursday, final PMI numbers, Eurozone retail sales, revisions to Q4 GDP and German industrial production numbers are also scheduled for release.

GBP: Busy Week Ahead

Despite the lack of U.K. data, the British pound traded higher against the U.S. dollar Friday. Part of the move can be attributed to the large M&A cash distribution set for next week. We actually expect quite a bit of movement in sterling in early March with the PMI numbers scheduled for release. Although it is premature to start pricing in tighter monetary policy, it is not too early for U.K. policymakers to start thinking about what the exit will look like. Based on all of the comments from Bank of England officials this past week, we know that they want interest rates to rise gradually. How quickly they kickoff the process will partially depend on this week's economic reports. If manufacturing, service and construction sector activity accelerate, optimism from the BoE could push forward rate hike expectations. However judging from the consensus forecasts for each of these releases, economists are not looking for a significant change in February. Slower growth in many parts of the world could have hampered economic activity in the U.K. The BoE also has a monetary policy decision on the calendar but no changes are expected.

USD/CAD Nosedives on Stronger Q4 GDP

Like many other risk currencies, the Canadian and New Zealand dollars traded higher against the greenback but the Australian dollar bucked the trend by extending its recent losses. According to the latest economic report from Canada, the economy contracted 0.5% in December, slightly more than the consensus forecast. However on a quarterly basis, GDP growth accelerated to 2.9% from 2.7%, which catapulted USD/CAD higher. The improvement was a bit surprising given the weakness in the monthly retail sales and trade numbers. The details of the Q4 GDP report shows that the expansion was driven by stronger consumer spending, business investment and exports. If next week's IVEY and employment reports surprise to the upside, USD/CAD could extend its losses. However the Bank of Canada's monetary policy bias will also be important - any concerns about the outlook for the economy would weigh on the loonie. A sharp rise in business confidence drove the New Zealand dollar to a 1 month high. The last time New Zealand businesses were this optimistic was in 1994. Confidence has been gradually improving over the past few months and this trend boosts the chance of a rate hike by the RBNZ next month. As for the Australian dollar, the continued slide in the Chinese Yuan is catching up to the currency. USD/CNY rose to its strongest level since June 2013, reducing the purchasing power of the Chinese. The RBA also has a monetary policy announcement. Having only shifted to a neutral bias this month, we do not expect any major changes in their outlook.

USD/JPY: Struggling to Hold 102

Given the lack of market moving U.S. data this week, the chance of a breakout in USD/JPY was slim. The currency pair traded within a very tight 113-pip range between 102.65 and 101.55. Lower highs and lower lows suggest USD/JPY could extend its losses in the coming week but given the narrow range and the abundance of important U.S. data, the technical outlook could easily shift. Better than expected U.S. data drove USD/JPY above 102 but the weakness in Japanese stocks overnight kept USD/JPY under pressure. Thankfully this underperformance did not stop the other yen pairs from rallying - EUR/JPY, CHF/JPY and CAD/JPY all enjoyed nice gains Friday. A number of Japanese economic reports were released overnight and most of the data beat expectations. Overall household spending, inflation, retail sales and industrial production increased in the month of January. We said that industrial production was one of the most important releases and while economists were already looking for a sharp 2.8% rise, IP increased a whopping 4%, the strongest pace of growth since June 2011. However last night's reports were not overwhelmingly positive - the manufacturing PMI index declined in the month of February and housing starts fell short expectations. It may be early but based on these numbers, there is a possibility that the manufacturing sector slowed further this month. There are no major Japanese economic reports scheduled for release next week which means the Yen will take its cue from risk appetite.

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