Watch For FX Range Trading

The lack of U.S. data Wednesday left the dollar mixed. While the greenback strengthened against European currencies, it weakened against the Japanese Yen and comm dollars. Stocks continued to perform well, climbing to fresh highs and this helped to support most of the majors. The ones that are down on the day would have probably experienced steeper losses if not for the positive sentiment created by the move in equities. Part of the optimism stems from better than expected Chinese data. Exports jumped 14.7% in April, which helped to drive the country's trade balance to a surplus of $18.16B from a deficit of -0.88B. This increase confirms our belief that the slowdown in China's economy is limited. Consumer and producer prices were due for release Wednesday night and, if as anticipated, inflation shouldn't change much yielding little if any impact on the FX market. The same is true for Thursday's U.S. jobless claims report. A small uptick is expected after the sharp improvement last week but jobless claims is having a diminishing impact on the dollar as fewer job losses fail to translate into stronger job growth -- so expect more range trading this week. The other reason why stocks have increased but currencies have not is because countries around the world are engaged in a currency war. Over the past week we have seen a number of central banks take action to devalue their currencies. The European Central Bank and Reserve Bank of Australia cut interest rates by 25bp to record lows and last night, we learned that the Reserve Bank of New Zealand sold its currency to cap its rally.

Techniques have varied but the goals have been the same -- to stimulate their economies and boost their competitive advantage through a weaker currency. At a time when growth is a premium, every country could use a weaker currency because a stronger currency threatens the meager of amount of growth that most countries are expected to see this year. As a result central banks around the world have been fighting hard to prevent their own currencies from appreciating. The Fed, BoJ and BoE are buying bonds, the ECB and RBA cut interest rates and the RBNZ intervened in its currency directly. The choice of technique depends on a central bank's level of aggressiveness and availability of other measures (U.S. and Japanese rates are already at zero). However, with central banks around the world trying to depreciate their currencies at the same time, their efforts are offsetting each other and leading to consolidative price action currencies. In other words, the reason why we haven't seen any breakout moves in FX over the past three months is because of all of the shots taken by central banks around the world. Until one comes to the war with a machine gun in tow, currencies could be stuck in range. As we said in our note this morning, the one unambiguous benefit of the currency war however is cheaper financing for individuals and corporations, which is why equities are on tear. Central banks are flooding the market with different forms of liquidity and making life easier by weakening their currencies. Eventually this should translate into stronger business and consumer confidence and hopefully spending but for the time being with inflationary pressures low, more shots could be fired in the war.

Triple Top For USD/JPY?
If you take a look at a daily chart of USD/JPY, you will notice that over the past three trading days, we've seen the currency pair make lower highs and lower lows. For technicians, this is traditionally a signal of reversal and we agree that in the short term, USD/JPY has potential for more losses than gains. Going into this week, we looked at the economic calendar and said that there wasn't enough catalyst for USD/JPY to break 100 and if it doesn't, something else needs to happen which is usually consolidation and profit taking. So while USD/JPY could slip down to 98 and possibly even 97, the uptrend still remains intact as long as it holds 96. In other words, this should only be a short-term top for USD/JPY. With U.S. stocks at record highs and Japanese stocks near five-year highs, USD/JPY should be trading much higher but it isn't. The reason is because U.S. bond yields have fallen and there is still no evidence of Japanese investors diversifying into foreign bonds. As we said earlier this week, the attractiveness of the Nikkei rally is keeping Japanese investment flows domestic while at the same time attracting funds from global investors. We finally get some U.S. and Japanese data Thursday but it is unlikely that these reports will have the power to drive USD/JPY above 100.

EUR Lifted By Stronger Data
The euro continued to trade higher against the U.S. dollar thanks to stronger than expected economic data from Germany. As a follow up to yesterday's surprising increase in factory orders, industrial production jumped 1.2% in March. Economists had been looking for production to fall by 0.2% but energy output exceeded their expectations. Overall, it appears that manufacturing will now provide a boost to first quarter GDP. The outlook of the second quarter is also promising with construction activity generally set to increase as the weather improves. Since the European Central Bank is watching incoming data closely, the latest reports will relieve some of their near term concerns. However the ECB monthly report is scheduled for release Thursday and we still expect it to echo Draghi's cautious and bearish tone. The Swiss Franc traded sharply higher against the euro and U.S. dollar despite softer inflationary pressures. Price growth was flat last month with the annualized pace holding steady at -0.6%. There have been moderate signs of improvement in Switzerland's economy last month with manufacturing activity turning positive and the unemployment rate declining. Yet flat price pressures and a drop in consumer confidence will keep monetary policy in Switzerland easy.

AUD: Labor Market Numbers Due From Australia And New Zealand
It was a very mixed day for the commodity currencies with the New Zealand dollar dropping to its lowest level in more than a month, the Australian dollar consolidating and the Canadian dollar ticking higher. Wednesday night was also a busy one for the AUD and NZD with employment reports scheduled for release from both countries. March was a very tough month for the Australian economy with more than 36k people losing their jobs. A rebound is expected in April but with the employment component of the manufacturing, service and construction PMI reports contracting more significantly last month, it is hard to believe that there will be a meaningful recovery. In their latest monetary policy statement, the RBA admitted that, Employment has continued to grow but more slowly than the labour force, so that the rate of unemployment has increased a little, though it remains relatively low. This may be an acknowledgement of the 0.2% uptick in the unemployment rate in March but even so there's still scope for a downside surprise. The weakness in the NZD on the other hand was caused by a surprising announcement from the RBNZ who said they recently intervened in the FX market to sell the currency. They have clearly grown uncomfortable with the rise but their decision to intervene over cutting interest rates was particularly interesting since New Zealand has plenty of room to lower rates. This was a conscious decision on the part of the RBNZ to focus on capping the currency's rise. Taking a look at the charts, the "intervention" appears to have occurred on April 15, which suggests that 86 cents is their pain threshold for the currency. Finally lower housing starts did not stop the Canadian dollar from extending to a fresh 2.5-month high on the back of rising oil prices.

GBP: No Surprises Expected From BoE
The British pound traded higher against the U.S. dollar despite mixed economic data. House prices jumped 1.1% in the month of April, the largest gain in nearly three years -- the Bank of England will surely believe that this improvement is in part due to their Funding for Lending Scheme. However, retail sales dropped 2.2% year over year according to the British Retail Consortium. Apparently an early Easter and wintry weather drove down demand in the beginning of the month but at the end of the month there were signs of recovery. According to the BRC, a "convincing trend towards revival is hard to spot and competitive pricing is still critical to generating sales." This obviously isn't good news for the U.K. but the details suggests that there is less to worry about than the headline number suggests. We finally get some meaningful data Thursday with industrial and manufacturing production scheduled for release. Manufacturing activity is expected to grow at a slower pace but if the data surprises to the upside, the GBP/USD could test 1.56 once again. The Bank of England on the other hand is widely expected to leave monetary policy unchanged after the uptick in PMIs and when they do very little detail is provided, making the announcement a nonevent for sterling.

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