USD/JPY – First Test or Failed Attempt At 90?

USD/JPY – First Test or Failed Attempt at 90?
Fate of AUD and all FX Hinges on China GDP
NZD: Hit by Weak AU Employment Numbers
CAD: Demand for C$ Securities Slow
USD: Uneven US Data will keep Fed Cautious
GBP: Watch for Potential Disappointment in U.K. Retail Sales
EUR Continues to Power Higher Against the CHF

USD/JPY – First Test or Failed Attempt at 90?

We’re mixing things up today and starting our daily piece with the Japanese Yen and not the U.S. dollar or euro. The Yen is on the move and USD/JPY’s test of 90 is the biggest story of the day. Throughout the European and North American trading sessions, USD/JPY gradually powered higher to its strongest level since June 2010. This rally also pushed most of Yen crosses to new highs but the milestones reached today are only slightly higher than previous levels. While the Japanese Yen resumed its slide, it still ended the NY session below 90, leaving traders wondering whether today’s rally is a first test or failed attempt to break above a key technical level.

From a fundamental perspective, there are a few factors supporting a continued rally in USD/JPY. The Bank of Japan is widely expected to adopt a higher inflation target next week and will make this announcement on Monday evening NY time (Tuesday morning in Japan). While we don’t know whether the central bank will provide a convincing plan to achieve that goal, either tonight or on the Friday and Monday before the BoJ meeting, we expect USD/JPY to make break above 90 once again. Today’s rally in USD/JPY was also supported by stronger U.S. economic data and a rise in U.S. yields. USD/JPY has a strong correlation with Treasury yields which means that as long as U.S. data continues to improve or investors have a reason to believe that the Fed will grow more serious about phasing out asset purchases, USD/JPY could continue to rise. Also we have to mention that the correction in USD/JPY earlier this week may have happened under false pretenses because Economics Minister Amari retracted his caution against a weak Yen last night by saying that he regrets his comments on Tuesday.

From a technical perspective, 90 is a very important level but the key resistance is between 94.50 and 95. When the currency pair broke above 87.50, the 23.6% Fibonacci retracement of the 2007 to 2011 sell-off and a level that coincided with the 2008 low, it officially broke its downtrend and initiated what should become a stronger move higher in USD/JPY.

Fate of AUD and all FX Hinges on China GDP

Over the next 24 hours, the main focus of the foreign exchange market will be on China’s GDP numbers. The outcome will not only impact how the AUD/USD trades but also risk appetite and in turn, all other major currencies. It should also cause a reaction in the financial markets that carries through from Asia into Europe and North America. The reason why China’s GDP numbers are important should be not a surprise to most investors. China and the U.S. are the 2 pillars of global growth and if tonight’s economic reports show that the Chinese economy grew less than expected in the fourth quarter, a wave of concern could sweep across the financial markets. Economists are looking for GDP to rise by 2.2% in the fourth quarter, which would bring the annualized pace of growth to 7.8% from 7.4%. Compared to 2011, when the Chinese economy expanded by 9.3%, growth last year was significantly weaker. Europe’s sovereign debt crisis took a bite out of Chinese exports and forced the government to seriously consider overhauling its export-driven growth model. Based on the upside surprise in Chinese trade numbers, GDP growth is expected to improve in Q4 from Q3 levels but the risk is to the downside and if GDP growth falls short of expectations, we could see a continued slide in the AUD/USD. Aside from GDP, industrial production and retail sales are also scheduled for release. Improvements are expected in both production and consumer spending. The Australian dollar was hit hard last night by the surprise 5.5k drop in employment that drove the unemployment rate up from 5.3% to 5.4%. The New Zealand dollar also lost value while the Canadian dollar held steady despite a smaller increase in foreign purchases of Canadian assets during the month of November.

USD: Uneven US Data will keep Fed Cautious

It was a mixed day for the U.S. dollar, which traded higher against the Japanese Yen, Swiss Franc, Australian and New Zealand dollars but lower against the euro. To the Federal Reserve’s relief, the latest round of economic reports confirm that the U.S. economy is gradually improving. Jobless claims dropped to 335K last week to its lowest level in 5 years. While the labor department said the data could be distorted by the difficulty of adjusting for seasonal changes around the holidays, the sharp improvement in claims is unambiguously positive for the U.S. economy and the U.S. dollar. Even if jobless claims rise back above 350k, on average claims are in very good shape and consistent with a continued recovery in the U.S. labor market. Continuing claims dropped to 3.214 million from 3.127 million and the less volatile 4 week moving average also fell to 359k from 366k. But the good news didn’t just end there – housing starts jumped 12.1% to a four year high of 954k. Permits rose by only 0.3% but the disappointment was offset by the rise in starts. Unfortunately one area of the U.S. economy is deteriorating and its the manufacturing sector. Earlier this week we learned that manufacturing conditions in the NY region contracted at a faster pace in the month of January and today the Philadelphia Fed manufacturing index dropped to -5.8 from 4.6. The surprise contraction indicates that the manufacturing sector is losing momentum, a condition that also reported in the Beige Book. The question now is whether these improvements are enough to convince more FOMC voters that it is time to start considering phasing out asset purchases this year and the answer is no. While the drop in jobless claims will make the Fed less worried about rising unemployment, the unevenness of the U.S. recovery will keep the central bankers cautious about removing stimulus prematurely. For the currency market, the weaker Philly Fed index stripped away some of the gains that the dollar achieved after the jobless claims report. The University of Michigan Consumer Confidence report is scheduled for release on Friday and a small improvement is expected.

GBP: Watch for Potential Disappointment in U.K. Retail Sales

With no economic data on the calendar, the British pound ended the day unchanged against the U.S. dollar. Overall, sterling remains weak and we believe that further losses could be likely on the back of Friday’s retail sales report. Economists expect spending to rebound slightly in the month of December. Over the past 3 months, consumer demand has been soft and if the economists are right, this would be the first month of positive spending in 3 months. However with confidence deteriorating sharply according to the GfK report, it is hard to believe that Britons have the appetite to spend. Earlier this month, the British Retail Consortium said this holiday shopping season was underwhelming for most retailers. Sales increased a mere 0.3% in December, down from 0.4% the previous month. If we are right and spending falls short of expectations, not only could the GBP/USD finally break below 1.60 in a convincing manner but retail sales could also weigh on GDP growth in the fourth quarter.

EUR Continues to Power Higher Against the CHF

The euro ended the day higher against the U.S. dollar thanks to another successful Spanish bond auction. There was nothing interesting in the price action of the EUR/USD outside of the fact that the currency pair is holding near its 10 month highs. The big story continues to be its extension of gains against the Swiss Franc and British pound. The euro appears to be benefitting from capital flowing back into the Eurozone. Our colleague Boris Schlossberg has written about this extensively – “The single biggest beneficiary of the unwind of the “Euro breakup” trade was EURCHF which continued its torrid climb higher hitting fresh yearly highs of 1.2452 before easing off a bit. The rally in EURCHF has been nothing short of astounding as the pair has now tacked on more than 350 points since the start of the year. The short covering squeeze has been relentless, but the pair now faces formidable resistance at the 1.2500 level and is likely to stall a bit and digest its gains as the initial enthusiasm wears off.”