By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
- Euro Hits New 9-Year Lows, More to Come?
- USD/JPY Trades Heavy Ahead of Retail Sales
- Why NZD Was Crushed as AUD Held Steady
- USD/CAD Hits Fresh 5.5-Year Highs
- GBP: Holding Strong on Carney Comments on EUR/GBP Selling
Euro Hits New 9-Year Lows, More to Come?
The euro fell to fresh 9-year lows against the US dollar Tuesday ahead of a key decision by an adviser to the European Court of Justice on the central bank's Outright Market Transaction program. He is set to provide his judgment on whether the ECB overstepped their power when they launched program, responding to complaints out of Germany on the legality of OMT. While the decision is not binding, it could affect the formal decision made by the Court in the middle of this year. It is hard to say whether a negative opinion will be positive or negative for euro. Supporting the legality of OMT would smooth the path to Quantitative Easing but a negative opinion could also hurt the euro by undermining that as well as future programs by the ECB. If OMT is not legal, then QE would be an even greater overstep of the central bank's mandate. Thankfully this is a preliminary decision and therefore not one that will cause immediate turmoil in the markets.
Meanwhile ECB member Nowotny continued to press for a quick decision on QE, calling it a traditional central bank instrument that is sensible with inflation significantly lower than their goal. The prospect of Quantitative Easing has and should continue to keep euro under pressure. The November 2005 low of 1.1640 is a legitimate target for the EUR/USD ahead of next week's central bank meeting and whether the currency pair reaches that level this week hinges on tomorrow's U.S. retail sales report. If consumer spending beats expectations, EUR/USD will extend its slide but if the data misses and there's a good chance it will, EUR/USD will bounce, giving investors an opportunity to sell at higher levels. In the long run, we still see EUR/USD dropping to 1.15. Aside from the OMT judgment, Eurozone industrial production is also scheduled for release and given the decline in German and French production, euro negative news is expected.
USD/JPY Trades Heavy Ahead of Retail Sales
Reversals across the financial markets led to big swings in currencies. USD/JPY traded heavy throughout the day, Tuesday, and extended its losses ahead of Wednesday's U.S. retail sales report. The general performance of the greenback was mixed with the dollar falling against the Japanese yen and rising against the euro. This divergence indicates non-dollar sentiment and flows were dominating currencies Tuesday but that should change Wednesday with the U.S. consumer spending report on the calendar, one of the most important pieces of data scheduled for release this week. While holiday shopping sales were strong, we believe the data will surprise to the downside because of lower gas prices and the decline in wages. The market anticipates the negative contribution from gas but not necessarily the impact of lower wages. If spending ex autos and gas fails to rise as much as economists expect, the dollar will extend its losses quickly. We believe that USD/JPY will eventually make a run back to its 121.85 December high but not before a deeper near-term pullback toward the 116.75 to 117.50 range. In the long run, it will be very difficult for the Fed to justify holding interest rates at current levels with the unemployment rate at 5.6% but in the short term, the dollar is overbought. As the year progresses the unemployment rate will fall further putting greater pressure on the Fed to normalize monetary policy. Fed fund futures are currently pricing in a 50% chance of a rate hike by September and a 79% chance by December. Aside from retail sales, the Beige Book report is also scheduled for release.
Why NZD Was Crushed as AUD Held Steady
The drop in oil prices continues to be the biggest story in the financial markets Tuesday but the move that investors are most confused about is the divergence between the performance of AUD and NZD. The Australian dollar held steady against the greenback while the New Zealand dollar dropped 0.8%. Both countries benefit from the upside surprise in Chinese data and are affected in a similar way by the movement of commodities but yet they have traded very differently over the past 48 hours, which was due to yen short covering. As oil prices continue to fall, investors either sought safety in the Japanese Yen or liquidated out of their short yen bets to cover the losses in commodities. NZD/JPY was a bigger beneficiary of long yen trades between November and December than AUD/JPY. NZD/JPY rose from 85.50 to 93.50 from the beginning of November to end of December while AUD/JPY dropped from 99 to 98 during that same period with a brief visit below 95.50 during the last month of the year. More investors were long NZD/JPY than AUD/JPY and based on Tuesday's 1.25% drop in NZD/JPY and 0.4% drop in AUD/JPY, commodity yen pairs are clearly driving flows. Meanwhile USD/CAD soared to fresh 5.5-year highs as oil prices sank to new lows. The currency pair came within a whisker of the 1.20 level while oil prices steadied above $45 a barrel. In the long run, oil could head lower but in the short term, the intraday bounce in oil points to a potential near-term bottom. Oil is a crowded trade and $45 is an attractive level to take profits on both the commodity and USD/CAD.
GBP: Holding Strong on Carney Comments on EUR/GBP Selling
The British pound held up fairly well considering the big downside surprise in consumer prices thanks to Bank of England Governor Carney's confidence in their abilities to get inflation back to target. Annualized CPI growth dropped to 0.5% from 1% in December, its lowest level in 14 years. Carney admitted that inflation is lower than they anticipated and could drift down in coming months, suggesting a "more gradual" rate path but he said slow inflation is good news in the short term. His admission that "deflation" is possible and that the central bank must avoid a more generalized decline in prices suggests that they are less eager to raise interest rates as a result. Nonetheless they haven't wavered from their commitment to do so. An exodus out of euros into sterling is another reason why the currency is holding up so well. Lower oil prices have a more direct impact on ECB policy than BoE policy at this stage. As reported by our colleague Boris Schlossberg:
UK price levels have essentially collapsed as declines in energy costs, food and clothing have all led to greatly diminished inflation expectations. This is a far cry from several years ago when UK economy was running the highest inflation levels in the G-7 universe and then Governor Mervyn King was forced to write a letter to Chancellor of Exchequer explaining why the BoE missed its inflation targets to the upside.