By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Keep Selling Euros
- Dollar: Why We Aren’t Worried About the Fed
- NZD Extends Losses But Is Decline Justified?
- CAD: Hits Fresh Lows as Oil Prices Decline
- AUD: Gold Prices Edge Lower
- GBP: BoE Confusion
Keep Selling Euros
The European Central Bank’s decision to start buying government bonds took a major toll on the EUR/USD. The currency pair lost more than 4.5% in a matter of days with the move exceeding our initial 500-pip target. After such a fast and sharp decline, a rebound like the one seen on Monday is not unusual and expected especially given the massive amount of short positions in the euro. An increase in German business confidence helped the euro recover from its initial post Greek election decline but we believe the gains will be short-lived and investors should continue to sell euros. The electoral victory by the Syriza party raises medium-term problems for the euro. The opposition ran on an anti-austerity campaign that is great for voters but terrible for creditors. As the country runs low on cash, Prime Minister Alexis Tsipras will need to restructure the country’s loan agreements quickly. Tspiras wants part of their debt to be written off but their creditors, which include the ECB and Germany, refuse to do so. If a new agreement is not made, its creditors could withhold the next bailout payment and Greece could face default. Of course, the Eurozone and the ECB have a lot to lose if Greece defaults because the central bank is tasked with maintaining financial stability and this would wreck havoc on European assets. In response to the Syriza party’s victory, bond yields in Europe jumped, reflecting increased uncertainty and ongoing risks for the euro. At the same time the upcoming FOMC meeting should keep the dollar bid. If the Fed leaves its monetary policy statement unchanged, the dollar will rise, sending the EUR/USD pair lower (more in the dollar portion of our commentary). Even though EUR/USD has fallen from 1.1650 pre ECB to a low of 1.1098 Monday, Quantitative Easing can mean even greater losses for a currency. Remember, the first round of QE from the Fed led to a 900 pip decline in USD/JPY over the course of 3 weeks and the QE announcement from the BoJ last year drove USD/JPY from a low of 109 to a high just shy of 120 in 6 weeks time. This means there is additional room for the EUR/USD to fall. If 1.1200 is breached again, we could see the EUR/USD hit and most likely break 1.10.
Dollar: Why We Aren’t Worried About the Fed
As the Northeast hunkers down for a major snowstorm, forex traders around the world are turning their eyes to the upcoming Federal Reserve monetary policy announcement. How major currency pairs trade will be largely determined by the market’s appetite for dollars. While recent stimulus from the ECB and other central banks gives the Fed more leeway, we do not believe they will alter their forward guidance having just changed it in mid-December. If you recall, last month the Fed replaced its vow to keep rates near zero for a “considerable time” with a pledge to be “patient” on the timing of the first rate hike. At the time, this was viewed as such a hawkish shift that it drove USD/JPY from a low of 116.30 to a high of 120.80 in a matter of days. There has been a few weak data points since the last Fed meeting, most notably retail sales and average hourly earnings, but this follows many months of positive economic surprises. The Fed also believes that the decline in oil prices will pick up the slack. If they dialed back their hawkishness, it would risk undermining credibility. The next big meeting is in March so there’s no need to rush any changes. If we are right and the Fed provides no fresh insight at this week’s meeting, their tightening bias should help the dollar sustain its gains. If they over-emphasize the need for patience, pointing to recent data as reasons, expect a steep slide in the dollar that is driven by profit taking. No U.S. economic reports were released Monday but Durable Goods, S&P CaseShiller House Price Index, New Home Sales and Consumer Confidence are scheduled for release Tuesday. We are looking for broad-based improvements.
NZD Extends Losses But Is Decline Justified?
The Canadian, Australian and New Zealand dollars continued to fall to fresh multiyear lows against the greenback. Lower commodity prices contributed to the move but the fear of easing is the main reason why these currencies are performing so poorly. Investors are worried that the Reserve Bank of New Zealand will surprise with a rate cut or, at minimum, draw their tightening cycle to a close. While the Reserve Bank of Australia will most likely lower interest rates next week, the RBNZ may not feel the same pressure. According to the PMI report, service sector activity expanded at a faster pace in September, which follows an uptick in manufacturing activity. The recent decline in NZD/USD and stabilization in dairy prices should also leave the RBNZ comfortable with current policy. We could be completely wrong because NZD is falling aggressively but we do not believe the decline is justified because of improvements in New Zealand’s economy since the last meeting.
GBP: BoE Confusion
The British pound traded higher against the U.S. dollar Monday on the back of conflicting signals from the Bank of England. Last week we learned that the Monetary Policy Committee voted 9-0 to keep rates unchanged but Monday morning MPC member Kristin Forbes warned that a rate hike could come sooner than the market expects. She indicated that the central bank could look past the temporary oil-driven decline in inflation. BoE Carney also felt that easy monetary policy can mean excessive risk taking. Fourth-quarter GDP numbers are scheduled for release on Tuesday and based on the narrower trade deficit and rise in retail sales, solid GDP growth is expected. The U.K. has a brighter outlook than the Eurozone and less dire disinflation conditions. As long as this persists and certain members of the BoE believe that tighter policy is needed, sterling will outperform euro. EUR/GBP dropped to its lowest levels since 2008 Monday morning with no major support until 0.7260.