No News Is Bad News For FX

No News is Bad News for FX

No news was bad news for the financial markets Tuesday. After pressing to fresh record highs on a near daily basis last week, the lack of U.S. data prevented the S&P 500 from extending its gains. In fact, U.S. stocks experienced their largest one-day decline in a week. Profit taking near record levels is not unusual especially when there is no catalyst for additional momentum. That will change later this week with the U.S. retail sales report but for the next 24 hours, there could be more consolidation and liquidation in the financial markets. Profit taking in equities also spilled over to currencies with the EUR/USD, GBP/USD and USD/JPY off their highs. While Tuesday’s trading ranges were wider than yesterday’s there was very little consistency in the performance of the greenback. The dollar strengthened versus the euro, British pound and Australian dollar, lost value against the Japanese Yen and held steady versus the Swiss Franc, Canadian and New Zealand dollars. It may seem that investors are more risk averse Tuesday but there hasn’t been any news to explain the deterioration in sentiment. With the Federal Reserve poised to reduce asset purchases by $10 billion later this month, the Chinese economy expected to slow further, Japan preparing to increase the consumption tax and Russia still testing the world’s patience in Crimea, there are plenty reasons for investors to be cautious. Unless Thursday’s retail sales reports from the U.S. and China surprise to the upside in a meaningful way, we could see a further pullback in currencies and equities.

NZD: Rate Hike Expected from the RBNZ

In less than 24 hours, the Reserve Bank of New Zealand is poised to raise interest rates for the first time in more than 3 years. The New Zealand dollar is hovering near 4-month highs in anticipation of the big announcement. Recent economic data has been very encouraging and suggests that the RBNZ could not only raise rates but also lay the foundation for a longer period of tightening. The latest reports show a significant rebound in house prices last month along with a sharp rise in credit card spending. House prices rose 2.1% in February, erasing the past month’s decline. Credit card spending rose 0.9%, a sign that household spending is starting the year strong. We will be publishing a more detailed RBNZ preview in the morning but the main question at hand will be how much detail the central bank provides on future monetary policy. It is no secret that the RBNZ expects to bring rates from their current level of 2.5% to 4.75% by 2016 but it is not clear how much of that increase will happen this year versus next. If the central bank expresses a strong commitment to normalizing monetary policy, NZD/USD could make a run for its 2-year high of 0.8675. If they sound noncommittal, emphasizing their concerns about a strong currency and growth of their trading partners, NZD/USD could succumb to profit taking and drop back below 84 cents. Unlike New Zealand, Australian data continues to surprise to the downside, sending the Australian dollar sharply lower. Business confidence and business conditions tumbled in the month of February. Consumer confidence was scheduled for release Tuesday evening and with business confidence weakening, it seemed difficult for consumers to feel overly enthusiastic. No Canadian economic reports were released Tuesday, leaving USD/CAD unchanged.

EUR: Shrugs Off German Trade Data

Although the euro ended the day slightly lower against the U.S. dollar, by the end of the North American trading session, it recovered nearly all of its early Euro session losses. Healthy German trade numbers failed to offset the selling that began right at the European open. Thanks to a sharp 2.2% rise in exports, Germany’s trade surplus increased from 13.9B to 15.0B in the month of January. The current account surplus beat expectations but shrank from the previous month. These reports reinforce the notion that Germany continues to be primary source of growth for the Eurozone. Industrial production is scheduled for release on Wednesday and despite a contraction in France, IP is expected to rebound thanks to the sharp increase in activity in Germany. The sell-off in U.S. stocks also added pressure on EUR/USD but as long as the currency pair holds above 1.38, the uptrend remains intact.

GBP: Twists and Turns

The British pound has been one of the worst performing currencies this week. Of course that doesn’t say much when most of the majors have been quietly consolidating. The combination of weaker economic data, post M&A flow hangover and extreme positioning has made it difficult for the currency to rally and has instead encouraged profit taking near 2.5 year highs in the GBP/USD. Although manufacturing production accelerated in the month of January, industrial production growth slowed to 0.1% from 0.5%. On a year over year basis, IP still expanded by 2.9% versus 1.9% expected. With the Verizon – Vodafone M&A deal no longer providing support to sterling, the currency is vulnerable to additional profit taking this week. According to the CFTC speculative long positions in the British pound hit a 1-year high last week. Current positions are near their 5-year extremes, which makes GBP/USD particularly vulnerable to a sharp sell-off. In this chart, we highlighted points of reversal in positioning and how they have corresponded with nasty reversals in the GBP/USD. Coincidently, positioning topped out not far from current levels in past years. With only the trade balance report scheduled for release this week, additional profit taking could drive GBP/USD below its 3-week low of 1.6585, which would pave the way for a move down to 1.64. Trade numbers are scheduled for release on Wednesday.

JPY: No Surprises from BoJ

Last night’s Bank of Japan monetary policy decision contained absolutely no surprises. The BoJ reiterated its pledge to expand the monetary base by Y60 to 70 trillion yen per year. Although Governor Kuroda said the central bank will “adjust policy without hesitation if achieving 2% inflation becomes or problematic or if smooth progress isn’t made toward the goal,” he also expects the “overall positive economic mechanism” to continue and he does not anticipated a repeat of the contraction seen after the 1997 tax hike. He even believes there’s scope for growth to exceed potential after the initial shock of the tax increase fades. These optimistic comments indicate that the central bank is confident about the economy’s ability to bounce back from the tax increase. Nonetheless, they downgraded their assessment of exports, citing concerns about slower growth in developing nations but this was offset by an upgrade to their expectations for capital expenditures and industrial production. Only time will tell whether the central bank’s optimism is warranted because all signs point to consumer confidence weakening. They BoJ could be looking to engineer a stronger recovery by boosting stimulus shortly after the tax is increased and not before.

Kathy Lien, Managing Director of FX Strategy for bkassetmanagement.com.