Will Euro Prove Its Strength This Week?

For the sixth consecutive trading day, the euro made a higher low and higher high against the U.S. dollar. The move has been gradual and consistent which is technically positive for the currency. On a fundamental basis, last week's softer U.S. economic reports and dovish comments from Janet Yellen supports a short term move higher in the EUR/USD but the gains will be limited because the Fed is delaying not canceling their plans to taper. This reality has capped gains in the currency pair but the euro could prove its strength this week if the Eurozone's economic reports surprise to the upside. This week is a busy one on both sides of the Atlantic. The U.S. has retail sales and the FOMC minutes scheduled for release and the Eurozone has ZEW, IFO and PMIs. The recent interest rate cut by the European Central Bank should make investors and businesses more confident because the additional dose of stimulus will solidify the recovery.

However there were a number of disappointing economic releases last week that could also make investors nervous. Current account and trade activity improved but these reports are for the month of September whereas all of the key reports this week are for November. While we believe there's a very good chance that this week's Eurozone reports will surprise to the upside, proving that the euro deserves its near term strength, there's always scope for a downside surprise. Good data would suggest that the ECB does not need to increase stimulus again, which is positive for the euro but at the end of the day, it is U.S. and not Eurozone policy that the market is concerned about at this time. Therefore even if the euro proves its strength its rally should be limited to 1.3650.

FX: Currencies Retreat As Equities Back Off Key Levels There was not much in the way of U.S. data today but currencies were on the move as equities broke out and then failed to close above key levels. The Dow Jones Industrial Average breached 16k and the S&P 500 cleared 1800 for the first time ever but unfortunately both indices erased earlier gains to end the day virtually unchanged. This price action reflects the market's hope that the Federal Reserve will leave asset purchases at its current pace for the rest of the year but the only way they would do so is if U.S. data failed to impress. This week's U.S. retail sales report is also expected to show stagnation in consumer spending but investors are ignoring these risks and focusing instead on the support that another month or two of $85 billion in bond buying could provide to the economy. With the U.S. calendar devoid of any market moving releases on Tuesday, the outlook for the dollar will depend on whether stocks make another run higher and reattempt to break above the key levels. The only piece of U.S. data on the calendar today was the Treasury International Capital Flow report and as usual, its impact on the greenback was limited even though the data showed how much the U.S. fiscal showdown hurt foreign demand for U.S. assets. According to the TIC report, foreigners sold $106.8B U.S. dollars in the month September, the largest amount since 2009. Investors did not respond aggressively because the outflow was concentrated in short term liabilities and changes in the banks own dollar denominated liabilities. Foreign demand for U.S. Treasuries increased by $25.5B that month, which was more than expected and up from net sales the previous month. High beta currencies continued to benefit from China's reform policies as investors hope that more stability for China will mean long-term benefits for the global economy. As it will be years before we see the payoffs from China's policies, in the near term, Federal Reserve Chairman Ben Bernanke's speech this week, the FOMC minutes and U.S. retail sales reports will be the central focus for FX traders.

AUD: All Eyes On RBA Minutes
The Australian, New Zealand and Canadian dollars ended the day slightly higher against the greenback. Economic data from New Zealand and Canada was better than expected but stronger data did not lend much support to the currencies. Service sector activity in New Zealand accelerated in the month in October, matching the 5 year high reached in July. New Zealand's economy continues to outperform its peers, validating the central bank's bias to tighten and as such, we continue to look for more gains in the NZD particularly against the AUD and JPY. In Canada, foreigners bought 4 times more Canadian denominated assets in September compared to August. With the sharp sale of U.S. dollars during that same month, there's a relatively good chance that part of that money got invested in Canadian securities. Tonight, the minutes from the most recent RBA meeting will be released and the outlook of the A$ will depend on the tone of the central bank. Despite improvements in Australia and China's economy, this month's RBA statement was more dovish than investors had anticipated with the central bank specifically expressing concerns about the exchange rate. If they reemphasize these concerns and talk about the possibility of an additional easing, the A$ could hit 2-month lows. However if they sound optimistic about the outlook for the economy despite their concerns about the currency, today's attempt to break above 94 cents could turn into reality.

GBP: House Prices Drop Despite New Phase Of Treasury Support
After last week's strong rally, sterling edged slightly lower today against the U.S. dollar and euro. This is a quiet week for U.K. data but on Sunday house prices dropped 2.5% in the month of November according to property website Rightmove. Seasonality is largely to blame but the U.K. government also launched the second part of its Help to Buy last month and so far it has not had much impact on the housing market. The first part of the program was launched in April and involved the Treasury offering top-up loans to buyers of newly built homes. The second part was launched in October and involves the Treasury guaranteeing as much as 95% of loans for qualifying new and existing home buyers. While ambitious, Rightmove's director and housing market analyst said lenders were applying tough new affordability rules that have made it difficult for borrowers to be approved. Regardless, the housing market should be supported by the recent introduction of Part 2 of the program. Looking ahead, the next key release for the U.K. will be Wednesday's Bank of England minutes. However no surprises are expected because any significant announcements were included in last week's Quarterly Inflation Report.

JPY: Fed Attributes Nikkei Rally To Weak Yen
The Japanese Yen ended the day unchanged against most of the major currencies. Despite the rally in U.S. equities, early gains evaporated as stocks backed off their highs. USD/JPY continues to struggle near the psychologically significant 100 level and without a further rise in the Nikkei or an upside surprise in U.S. data, the currency pair may have a hard time extending higher. According to the latest housing market reports from Japan, housing loans grew at a slower pace in Q3 and Tokyo condominium sales slowed in the month of October. Department store sales will be released this evening and steady demand is expected. The NY Federal Reserve released a very interesting article talking about the response of the Nikkei to the Yen. Over the past 2 years, the Nikkei rose more than 78% in value and during this time, the yen weakened more than 20% against the U.S. dollar. According to the Fed, "roughly half of the recent movements in the Nikkei can be ascribed to the changing value of the yen, with the remainder reflecting the domestic implications of Abenomics and other factors." A weaker yen helps to boost the international profits of Japanese exporting firms and in turn the valuations of those companies on the Japanese stock exchange. In their special report, they compare the percentage move in the Yen versus the Nikkei and conclude that the impact of the Yen highlights the role of the exchange rate on other markets. By examining the Yen's impact on the Nikkei, the Fed could also be considering how the dollar affects U.S. equities.

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