Can Euro Survive The Week Ahead?

Will Euro Be Able to Survive the Week Ahead?

Two weeks ago, the European Central Bank announced a series of measures to ease monetary policy and in doing they shifted the medium term outlook for the euro. Although the currency had been on a downtrend since early May, investors did not aggressively short euros until the central bank's June 5 announcement. Not only did the ECB increase support to the economy but they also expressed their willingness to do more, making them one of the most dovish G7 central banks. Two weeks forward, EUR/USD stabilized above 1.35 as investors realized that even if the central bank is open to increasing stimulus, they won't be doing so for at least another 2 months. As a smart central bank, they will want to see how the economy responds to the latest measures before taking further action. However even though that may be the case, next week's busy Eurozone economic calendar is an important test for the euro because investors will be looking to the data to provide confirmation on the need for additional easing. On the calendar is Tier 1 economic reports including Eurozone flash PMIs for the month of June, the German IFO report, retail sales, consumer prices and Eurozone confidence. Economists are not looking for any major changes in economic activity but after the plunge in investor confidence (ZEW survey), the risk is to the downside for these reports. Back to back disappointments could cause EUR/USD to test the lower bound of its recent range and its support at 1.35. If the EUR/USD breaks through its February low of 1.3475, then it could be clear sailing down to 1.33. Whether the EUR/USD will be able to survive the coming week will depend almost exclusively on Eurozone data because the U.S. economic calendar is busy but mostly with Tier 2 economic reports. In the long run, we believe U.S. rates will have a larger influence on the currency pair because while Quantitative Easing is a possibility, it is a nuclear option that won't be implemented until absolutely necessary. The Fed on the other hand needs to start talking about normalizing monetary policy and will likely do so in September, the next time the central bank updates its forecasts and Janet Yellen delivers a press conference. By that time we will be nearing the end of the U.S.' QE program.

Don't Expect Much from the Dollar

We don't expect much from the U.S. dollar in the coming week, as any big moves in the FX market will most likely be driven by the price action of other currencies. The Federal Reserve made it very clear on Wednesday that for the time being, there will be no changes in their monetary policy bias and next week's economic reports are not significant enough to shift market expectations, let alone cause Fed to lean in one direction or the other. We have existing and new home sales scheduled for release along with consumer confidence, revisions to Q1 GDP, durable goods, personal income, personal spending and revisions to the University of Michigan consumer sentiment survey. Most of these reports are expected to see minor improvements expect for Q1 GDP, which will be revised significantly lower especially after the Fed changed their forecasts. However with that in mind, we are still looking for further consolidation in the U.S. dollar and Treasury yields because the central bank has given investors no reason to sell Treasuries. In a few months, the central bank's Quantitative Easing program will come to an end and we as we get closer to that time, volatility in the FX market will increase but between now and then, the lack of uncertainty in U.S. monetary policy should keep volatility contained. Instead, FX traders should keep an eye on equities. U.S. stocks climbed to a record high this past week and how the dollar trades could be determined by whether these gains continue.

GBP: Still Waiting for the Clean Break

After rising to its strongest level since October 2008, the rally in the GBP/USD stalled right where it topped out in 2009. For the past week we have been saying that the 1.7040 to 1.7050 zone is key and a clean break is needed for the currency pair to make run to 1.73. Unfortunately we haven't seen that clean break yet and with no major economic reports scheduled for release next week, it will be up to Mark Carney and the Bank of England' Financial Policy Committee's announcement to drive sterling to fresh highs. We doubt that Carney will waver from his newfound hawkishness but what we will be looking for are new measures from the central bank to curb the housing market. Back in November, Carney who heads up the FPC said "We will not hesitate to take further proportionate and graduated action as warranted. That will allow monetary policy to remain focused on providing the stimulus the economy needs for as long as it is needed to secure a strong, sustained recovery." If new measures are outlined in the Financial Stability Report and the central bank successfully convinces the market that they are moving closer to raising rates, sterling could find its way towards its next resistance level at 1.73, the 50% Fibonacci retracement of the 2007 to 2009 decline -- but in all likelihood it will be a slow drift higher.

Strong Data Drives USD/CAD Through 1.08

The best-performing currency Friday was the Canadian dollar, which traded sharply higher against the greenback following better than expected data. Retail sales rose by 1.1% in the month of April, the strongest pace of growth since October 2011. Economists were looking for a rebound after the previous month's decline but the final print nearly doubled expectations. Excluding autos, sales rose 0.7%, up from 0.2% in March. While this gap between the headline and core release indicates that sales of automobiles and food accounted for a large part of the increase, 10 out 11 categories, representing 98% of total sales saw an increase in demand. The rise in retail sales is encouraging, but consumer prices is the report that will have the central bank second guessing their economic forecasts and monetary policy bias. The 0.5% rise in CPI in May, brought the annualized pace of increase to 2.3%, its highest level in 2 years. Economists expected the annualized inflation rate to remain unchanged at 2% but for the first time in 2 years, it exceeded the central bank's target. What makes Friday's release so important is that the Bank of Canada predicted that CPI would hit their 2% target in the first quarter of 2015 and now that it has already achieved this level, they will need to reevaluate their forecasts and monetary policy stance. Meanwhile the New Zealand dollar extended its losses on the back of a sharp decline in job advertisements. We view the recent pullback as a natural correction after this month's extended uptrend. Consumer confidence increased in June which means that the labor market is not doing nearly as poorly as job ads suggests. As long as NZD/USD holds above 86 cents, the uptrend remains intact. The Australian dollar ended the day slightly lower against the U.S. dollar. No data was released but watch out for Sunday's HSCB flash manufacturing PMI report for China.

JPY: Cabinet Leaves Economic Assessment Unchanged

There was very little consistency in the performance of the Japanese Yen Friday, which traded lower against some currencies and strengthened against others. USD/JPY specifically rebounded thanks to the recovery in Treasury yields. On Thursday night, Japan's Cabinet kept its monthly economic assessment unchanged. They said "The Japanese economy is on a moderate recovery trend, while some weak movements were seen lately due to a reaction after a last minute rise in demand before a consumption tax increase." Just like the U.S., the certainty of monetary policy in Japan is limiting the moves in the Yen. While there are a number of important economic reports scheduled for release next week including manufacturing PMI, jobless rate, consumer prices and retail sales -- we expect the message to remain unchanged, which is that Japan is undergoing a steady recovery and holding up exceptionally well since the consumption tax increase.

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