By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- 5 Serious Risks for the Euro
- Dollar: The Importance of Quarter End Flows
- AUD Crashes as Iron Ore Hits 6-Year Lows
- NZD: Lots of Data
- CAD: Oil Prices Decline
- GBP Drops to 1-Week Lows
5 Serious Risks for the Euro
After rejecting the 1.10 level three times last week, the euro extended its losses against the U.S. dollar Monday. The sell-off has taken the currency pair to 1.08 -- an important short-term support level. In the long run, we always believed that EUR/USD would drop back below 1.05 because Eurozone and U.S. monetary policy is drifting further apart. But 5 serious risks could cause this decline to happen sooner rather than later:
- Greece – Greece is back in the headlines. They are no closer to repaying their debt and according to the Finance Minister, in order for them be repaid, they need to be restructured. At the same time, Greece’s creditors want a detailed and credible reform plan before they are willing to release additional financial aid. According to Germany, quality is key. The Eurogroup could hold a meeting on Greece as early as this week and the headlines could add pressure on the currency as investors realize that a Grexit remains on the table as they are no closer to enacting sustainable reforms today than 2 months ago.
- ECB Minutes – On Thursday, the ECB will release the minutes from its March 4-5 monetary-policy meeting. Earlier this month, the EUR/USD fell to 11.5-year lows after the March meeting when the central bank said it would buy bonds with negative yields. Considering that the central bank is willing to go that far to stimulate the economy and keep interest rates low, the minutes will be dovish, adding pressure on the currency.
- Portfolio Outflows – Last week we learned that a wave of cash is leaving the Eurozone. According to the Balance of Payments data, investors withdrew more than 200 billion euros from the bond market in the 12-month period to January. Quantitative Easing this year will most likely drive more money out of European fixed markets as investors rebalance their portfolios and underweight debt with negative yields.
- Expectations for Weaker German Data – While Monday morning’s confidence numbers surprised to the upside, we believe that Tuesday’s retail sales and labor market reports from Germany will hurt the euro. According to the Markit Economics’ retail PMI report, sales rose at its slowest pace in 4 months. Job growth also slowed according to the manufacturing and service sector PMI reports.
- More Fed Talk – A number of Federal Reserve officials are scheduled to speak this week and chances are they will take the opportunity to remind us that rates will rise in 2015. The message from the Fed has been clear and consistent and Monday’s rally in the dollar means that investors could finally be listening.
The only wildcard is Friday’s non-farm payrolls report. The slowdown in U.S. data in March points to the possibility of weaker job growth, but what the market really cares about is average hourly earnings and the rise in personal income points to a stronger number. With short positions at a record high, the EUR/USD is vulnerable to a short squeeze but a catalyst is needed and based on all of the risks, weakness is more likely than strength.
Dollar: The Importance of Quarter End Flows
The U.S. dollar traded higher against all of the major currencies Monday on the back of month and quarter end flows. While the Dow and the S&P 500 both increased in value in the first quarter, their gains were miniscule compared to strong gains in European and Japanese equities. To be more specific, between January and March, U.S. stocks increased 1% while the DAX rose 23% and the Nikkei 11%. On a monthly basis, U.S. stocks declined this month while European and Japanese equities gained value. Considering the sharp rise in non-U.S. markets, in order for portfolio managers to rebalance their exposure and hedging ratios, they needed to buy dollars and sell other currencies like the euro and Japanese yen. The size of the impact that quarter end flows have on the market depends on the divergence in the performance of global equities and in the first quarter, the deviations were large. Meanwhile, better-than-expected US. data also helped lift the greenback. While personal spending growth slowed, the savings rate rose to its strongest level since 2012. The data shows that Americans are not making less; instead they are saving more because the personal income rate rose 0.4%. Pending home sales also jumped 3.1% beating expectations for a slowdown to 0.3%. On Tuesday, the CaseShiller House Price Index is scheduled for release along with Chicago PMI and the consumer confidence index. The weakness in NY and Philadelphia manufacturing activity along with the sharp decline in the University of Michigan Consumer Sentiment index raises the risk of a downside surprise.
AUD Crashes as Iron Ore Hits 6-Year Lows
The Australian dollar was the worst-performing currency pair Monday, losing more than 1.25% of its value against the greenback. The weakness was broad based with AUD falling to a fresh record low versus the New Zealand dollar. As there was no economic data to trigger the move, the persistent decline can be best attributed to falling commodity prices. The price of iron ore, one of Australia’s most important exports, dropped to a 6-year low. This decline reflects excess supply and weaker demand from China. House prices in China have fallen for 6 months in a row and a decline in the property market always impacts the cost of raw materials. There was talk that China could increase stimulus but when an announcement failed to be made ,Monday, the Australian dollar pressed lower. The Reserve Bank meets next week and the recent decline in iron ore will have traders positioning for a rate cut. The overall pressure on commodity prices also drove the Canadian and Australian dollars lower despite an increase in raw material and industrial product prices in Canada. New Zealand building permits and business confidence were on deck Monday night followed by Canadian GDP numbers on Tuesday. Data from Canada will most likely be weak, adding pressure on the loonie. The path of least resistance for USD/CAD is to 1.28 after Bank of Canada Governor Poloz warned of an atrocious first quarter and said monetary stimulus is needed to avoid recession.
GBP Drops to 1 Week Lows
The British pound dropped below 1.48 to trade at its weakest level in more than a week. The move cannot be attributed to the latest economic reports because weaker consumer credit was offset by stronger mortgage approvals. However the lack of upside surprise in recent data and the slowdown in price pressures has been weighing heavily on the currency over the recent week. Unfortunately this week’s economic reports are not expected to help. While economists are looking for an improvement in Tuesday’s current account balance, the PMI manufacturing index -- this week’s key report -- could surprise to the downside given the sharp drop in the Confederation of British Industry’s Total Trends Index. With that in mind, we believe that the 1.4635 to 1.50 range will remain intact for the time being.