3 Reasons To Be Euro Bullish

EUR: 3 Reasons to be Bullish

Euro may have ended the day unchanged against the U.S. dollar but we have at least 3 reasons to believe that the currency will maintain a bullish bias against the U.S. dollar this week:

#1 Stronger German Data - This morning's German IFO report gives us a taste of the better than expected Eurozone economic reports that could lend support to the euro. Despite a decline in investor confidence and slowdown in Eurozone manufacturing and service sector activity, Germany continues to be the locomotive for Eurozone growth. This week we are expecting many economic reports from Germany and given the country's specific strength, we look forward to more upside surprises. Economists had been looking for a slight slowdown but stronger current conditions drove the overall index to its highest level since July 2011. While the drop in the expectations component of the report is a bit concerning, the data still gives us reason to be positive on the euro's outlook this coming week. No major revisions are expected from Tuesdays Eurozone fourth quarter GDP report but on Thursday, we are looking for strong labor market numbers because according to the PMI, February was the hottest month for job growth since January 2012. The Eurozone may not be out of the woods but the upside surprises should make the euro attractive compared to the dollar which could come under pressure from more weakness in U.S. data.

#2 Weaker U.S. Data - We don't expect much in the way of upside surprises in U.S. data this week. House prices, consumer confidence, durable goods, the Chicago PMI index new and pending home sales are scheduled for release. Most of these reports will be affected by the brutal winter weather so the risk of a downside surprise should keep the dollar under pressure.

#3 Risk Appetite and Technicals - Yet despite the weakness in U.S. data, investors are looking past the short term factors and looking forward to the end of winter. Their optimism drove stocks to a record high Monday and the market's appetite for risk should lend support to the euro. From a technical perspective, as long as EUR/USD holds above 1.37, the near term breakout is intact, allowing the currency to take a stab at 1.38.

Dollar: No Criticism of U.S. Policy from G20

While U.S. stocks hit record levels and 10 year Treasury yields edged higher, there was very little consistency in the performance of the greenback. This was due in part to the improvement in risk appetite, which helped to lift high beta currencies such as the British pound, Australian and New Zealand dollars. The EUR/USD and USD/JPY failed to benefit from the move ending the day unchanged. Although there was no U.S. data released Monday, the recent high profile M&A deals have investors excited about renewed corporate activity. With the weather warming up this weekend, investors are dismissing the recent deterioration in U.S. data. It may be easy to do so with an empty economic calendar but if Tuesday's release surprise to the downside, the dollar could drift lower. We have house prices, consumer confidence and the Richmond Fed manufacturing index scheduled for release. According to the University of Michigan confidence index, consumer sentiment has not changed significantly from the previous month. None of this week's economic reports are Tier 1, but they could still impact the dollar especially as the Polar Vortex returns with more winter weather this week. Meanwhile as we expected, the G20 failed to specifically criticize U.S. monetary policy. Instead the communiqué simply said "we will develop ambitious but realistic policies with the aim to lift our collective GDP by more than 2% above the trajectory implied by current policies over the coming 5 years", "all our central banks maintain their commitment that monetary policy settings will continue to be carefully calibrated and clearly communicated, in the context of ongoing exchange of information and being mindful of impact on the global economy".

GBP: Supported by Risk Appetite and M&A Flow

After selling off for 5 consecutive trading days, the British pound finally traded higher against the U.S. dollar Monday. No U.K. economic reports were released overnight and no data is expected Tuesday. In fact, it is a very quiet week for U.K. data, which means that sterling will take its cue primarily from risk appetite. The prospect of a massive M&A flow at the end of the month should also keep the currency bid. While the Vodafone/Verizon deal is already completed, it triggered a $23.9 billion cash payment to shareholders that is due March 4th. Since Vodafone decided to dispose of its stake in Verizon Wireless, the net flow is +GBP and -USD. Based on an example posted on Vodafone's website on February 18th, a Vodafone investor should expect to receive 72 pence in Verizon shares and 30 pence in cash. While we are certain that some of the GBP/USD conversion has already happened, the distribution is scheduled for next week and the actualization of this flow should keep sterling bid between now and then

NZD: Finance Minister Complains about Strong Currency

All 3 of the commodity currencies traded higher against the U.S. dollar Monday. New Zealand was the only country with economic data and the jump in credit spending lent support to the currency. The Finance Minister continues to be befuddled with the strength of the country's currency, which he complained is a headwind for the export sector. Nonetheless based on his comments he plans to do nothing about it but he expects more volatility in the currency when the RBNZ starts raising interest rates. In the long run, he is hoping that Fed tapering will "re-rate" the dollar versus the kiwi, which means he expects tapering to drive the USD higher and NZD lower. New Zealand first quarter inflation expectations were scheduled for release Monday evening -- a stronger number would fuel expectations for a rate hike next month. Meanwhile as G10 currencies consolidate, there has been an unusually large move in the Chinese Yuan. Throughout the past year, the Yuan has been rising gradually in value against the U.S. dollar, driving the USD/CNY rate to a record low in January. However over the past week the currency pair shot up to its strongest level since early November. Overnight, the Chinese Yuan dropped to a 3 month low extending its losses as the Shanghai Composite Index dropped 1.75%. Since the Yuan started to move lower last Tuesday, Chinese stocks are down approximately 3%. Many investors may attribute the move to the slowdown in China but there has been evidence of slowing growth for the past few months and yet the currency only started to weaken rapidly last week. The Chinese Yuan would not be moving this aggressively without the endorsement of the central bank. In fact, the rapid turnaround in the currency pair suggests that the People's Bank of China is shifting away from a policy of Yuan appreciation. Their motivation is simple - to provide support for the export sector and in turn the overall economy as it slows gradually. The PBoC pledged greater Yuan flexibility this year but with the currency moving lower, their actions don't seem to match their intentions. The reason why the recent depreciation in the Chinese Yuan is important for forex traders is because of the potential spillover to G10 currencies. We haven't seen the sell-off in Shanghai stocks hit other stock markets in the region but if they continue to slide, it may be difficult for global investors to ignore the move. If it lasts, the recent rally in USD/CNY is also negative for Asian currencies including the Japanese Yen, Australian Dollar, Korean Won and Malaysian Ringgit.

Overnight Rally in Nikkei Could Drive USD/JPY to Fresh Highs

Normally record highs in U.S. equities translate into broad based strength for all of the Yen crosses. Although many Yen pairs such as AUD/JPY and NZD/JPY benefitted from the move, USD/JPY and EUR/JPY failed to rally. Given the rise in Nikkei futures, we could these pairs catch up in Asia. There is very little reason for the hesitancy in USD/JPY especially with Treasury yields inching higher. The underperformance of the Nikkei overnight could have affected sentiment but if that changes, the USD/JPY could hit fresh monthly highs. No Japanese economic reports were released ahead of Monday's US open, but the corporate service price index was due for release Monday evening. A slight slowdown in price pressures is expected. Thursday night / Friday morning in Japan is when things get interesting for the Yen. Manufacturing PMI, the jobless rate, overall household spending, consumer prices, industrial production and retail trade are among the key reports scheduled for release that day.

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