Is Euro Headed For 1.30?

EUR: Headed for 1.30?

I was on CNBC Squawk Box Tuesday morning talking about currencies (see video) and the first question Joe Kernen asked me was whether euro was headed to 1.30 against the U.S. dollar. Of all the major currencies, the EUR/USD was in focus Tuesday because its continued losses have driven the pair below its pre-ECB levels.  During the European trading session, the slide in European yields and rise in U.S. yields put the currency pair on a downward course that extended when European officials described the region's recovery as fragile and repeated Mario Draghi's warning that they haven't finished easing. The sharp sell-off in EUR/USD led many investors to wonder if the ECB's policy changes are finally catching up to the euro and while there's no question that the initial enthusiasm post ECB has faded, we do not expect the slide in EUR/USD to extend to 1.30.  In this low volatility environment, we continue to see the decline in the currency pair limited to 1.34/1.35. The EUR/USD may have held onto its losses but European bond yields recovered sharply with 10-year French, Spanish and Italian yields, rising more than Treasury yields.  Although German bond yields increased only 2.5bp compared to the 3.3bp rise in U.S. 10-year yields, on an aggregate basis, European yields are not providing less value to investors.  While this could change, especially if the ECB decides that Quantitative Easing is necessary, we don't expect the central bank to seriously consider more stimulus until the economy has at least 1 to 2 months to absorb their latest changes. So while it may be tempting to view the break below 1.3585 as the beginning of a new downtrend, chances are the breakout will turn into another fake out for the EUR/USD.  However with this in mind, traders looking to position for further euro weakness should look to the crosses.  EUR/AUD fell to its lowest level in 6 months and if the RBNZ raises interest rates Wednesday, EUR/NZD could extend its losses.  

NZD: Potential for RBNZ Rate Hike

 The Reserve Bank of New Zealand does not meet until Thursday local time but by then we'll be commenting on their decision and not our expectations for their monetary policy announcement. The New Zealand dollar traded higher against all of the major currencies Tuesday in the lead up to the decision, which suggests that some traders think the RBNZ will raise interest rates Wednesday. According to a survey conducted by Bloomberg and a report by the shadow board of the RBNZ, which consists of a 9 personal panel at the NZ Institute of Economic Research, there's an 85 to 95% chance that the central bank will raise interest rates.  The market is pricing in 75bp of tightening.  For the analysts who believe that rates will rise, the majority also expects the RBNZ to pause in July. How the New Zealand dollar reacts will depend not only on the action taken by the central bank but also their forward guidance.  If the RBNZ raises rates and suggests that more could come, NZD/USD will soar. If they leave rates unchanged, NZD/USD could fall to and through 84 cents but if they raise rates and signal plans to pause NZD could still weaken.  We continue to believe there's a good chance that rates will remain unchanged and this discrepancy is where we see the opportunity to sell the NZD/USD.  Since the last monetary policy meeting on April 24, New Zealand economic data has taken a turn for the worse. Commodity prices have fallen significantly, consumer confidence declined, spending fell, manufacturing activity slowed, the trade surplus narrowed and house price growth slowed. The only area of strength is the service sector and the labor market but unfortunately labor data is for the first quarter and chances are hiring slowed in Q2. The biggest problem for New Zealand is the collapse in dairy prices. Dairy accounts for approximately a third of New Zealand's exports by value and since February, prices have fallen more than 23%.  This prompted Fonterra to lower their payout forecast this year and the expectation for less income should weigh on economic activity.  Under this backdrop it will be very difficult for the RBNZ to continue tightening.  A pause would not only help the economy but would also drive the New Zealand dollar lower, an ideal outcome for a central bank that threatened to intervene in the foreign exchange market to weaken their currency in April.

Dollar: Inconsistent Performance Despite Continued Rise in Yields

While U.S. Treasury yields continued to recover, the performance of the dollar was mixed. The greenback strengthened versus the euro, Swiss Franc and British pound but weakened against the Japanese Yen, Australian and New Zealand dollars.  No major U.S. economic reports were released Tuesday and nothing was scheduled for the next 24 hours.  If U.S. Treasury yields continue to rise, it should only be a matter of time before the U.S. dollar follows suit. Having been burned by the Treasury market for most of this year, currency traders are reluctant to believe that the rise in yields will last especially since Friday's non-farm payrolls report was good but not good enough to accelerate the Federal Reserve's plans for tightening. We also do not expect much from this week's economic reports.  The only piece of data worth watching is retail sales and unless spending rises or falls by more than 2%, the impact on Fed policy and in turn the greenback will be nominal. However even with the certainty in Fed policy, if 10-year yields break 2.65%, a former resistance level, USD/JPY could make a run for its 1-month high.   

EUR/GBP Hits Fresh 1 Year Lows

The British pound traded lower against the U.S. dollar despite relatively healthy industrial production numbers.  Manufacturing activity grew by 0.4% in the month of April after rising 0.1% in March.  Although the data was right in line with expectations, the upward revision made the overall report stronger than forecast. Yet the big test for pound this week will be Wednesday's employment report.  For the most part, the labor market is expected to remain unchanged with jobless claims falling at a consistent pace. However based on the latest PMI numbers, we believe that the risk is to the upside. The service sector reported the strongest pace of employment growth in 17 years and in the manufacturing sector, jobs continue to be added.  Stronger data could not only renew the rally in GBP/USD but also drive sterling to fresh 1-year highs versus the euro.  In addition to the absolute amount of job growth and the unemployment rate, wage growth will be particularly important because how quickly the Bank of England raises rates will depend in large part on the pace of wage growth. 

Yen Crosses Retreat as Equity Rally Stalls

The Japanese Yen traded higher against all of the major currencies Tuesday with the exception of the Australian and New Zealand dollars. The slight pullback in the Nikkei overnight and the slowdown in machine tool orders also weighed on yen pairs. China reported its latest inflation report and the uptick in CPI failed to have much impact on Asian currencies. For the most part, risk appetite and the market's demand for dollars continues to drive the daily movements of USD/JPY.  Despite Tuesday's deterioration, Japanese data has been relatively positive which means that anyone banking on USD/JPY rising on a decline in the Japanese Yen will have to wait.

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