Quiet FX Trading Disrupted By ECB Yield Cap Rumors

: Thin Trading Disrupted by Rumors of Yield Cap
USD: Treasury Yields Still Driving Dollar Flows
GBP: Sharp Decline in House Prices
AUD: RBA Minutes Big Focus Tonight
CAD: Wholesale Sales on Tap
NZD: Credit Card Spending Numbers Due
USD/JPY Rally Stalls

EUR: Thin Trading Disrupted By Rumors Of Yield Cap
With no major global economic data on the calendar, it has been another quiet day in the foreign exchange market. The big story today was an article in the German newspaper Der Spiegel talking about the possibility of a yield cap set by the ECB for certain European government bonds.

Considering the risk of rising borrowing costs is the greatest challenge for peripheral governments, a cap would go a long way in ending Europe’s sovereign debt crisis from a practical and psychological perspective. A good example is the psychological impact that the 1.20 peg had on EUR/CHF. If investors knew that the European Central Bank would not allow Spanish and Italian yields to rise above a certain point, they would hopefully stop attacking the bonds of those countries.

If the rumors were true, it would represent major progress for the ECB in their battle to end the region’s debt crisis but unfortunately the central bank completely refuted the article. Later on, the WSJ released an article discussing the dangers of capping European bond yields. They argue that once Spanish yields reach their maximum spread or yield, investors would start to sell German bonds.

The recent stability of the EUR/USD hinges on expectations for some type of action by European policymakers in September or October. The European Central Bank meets first followed by the EU Summit in October. This consolidative price action may be something FX traders need to get use to for the next 2 weeks as there is little in the way of major event risk until the Jackson Hole Summit at the end of this month, the ECB meeting in the beginning of September and the EU Summit in October.

Meanwhile headlines are flowing out of Greece ahead of the Prime Minister’s meeting with the German Chancellor, French President and Eurogroup head later this week. Greece needs an extension to its bailout program but they may opt to wait until October to ask for one. According to the Foreign Minister, Greece wants to stay in the eurozone and accepts its responsibilities to its partner. Before making any rash decisions however, they will want to wait for the Troika report to be released. The lack of major eurozone or U.S. economic data Tuesday should mean another day of quiet trading.

USD: Treasury Yields Still Driving Dollar Flows
Currencies and equities ended the day on Monday virtually unchanged. Ten-year U.S. Treasury yields ticked lower, ending the 5-day winning streak in USD/JPY. In the note that we released this morning, we talked about the relationship between USD/JPY and Treasury yields and it appears that the strong correlation between these 2 instruments remains intact.

The most important event risk this week for the U.S. dollar will be the FOMC minutes. We believe there is room for yields to head higher if investors start to price in the possibility of less pessimistic or more optimistic comments from Bernanke at Jackson Hole later this month. The FOMC minutes this week should be as unsatisfying as the last Federal Reserve meeting.

There’s no consensus in the central bank on the need for QE3 and the minutes will reflect that. Instead, we will be listening more closely to the comments made by FOMC voter Lockhart who endorsed another round of QE back in July. If he moves away from that call even slightly, there’s a good chance Bernanke could do so as well in Jackson Hole. USD/JPY could continue to track yields higher especially if there are no major disappointments in U.S. data and equities continue to rally. Investors have plenty of reasons to hold onto their optimism in the near term including:

• First Rebound in Retail Sales in 4 Months
• Job Growth Exceeds 150k in July
• Consumer Confidence Picks Up
• Hotter Producer Prices
• Spanish Bond Yields Drop to 4 Month Lows
• US Stocks Rise to 4.5 Year High

The minutes will be released on Wednesday so between now and then currencies will probably take their cue from equities and Treasuries.

GBP: Sharp Decline In House Prices
The British pound ended the day unchanged against the euro and U.S. dollar. House prices in the UK declined at its fastest pace ever in August as demand in the housing market plummeted. Prices declined by 2.4% to 236,260 pounds, which followed a 1.7% drop in July. This was the largest fall Rightmove has ever reported. The Olympics failed to attract housing growth and instead added pressures for sellers to compete on prices to attract summer buyers.

The Bank of England, which cut its growth forecasts this month is trying to bolster its economy. The British Retail Consortium said sales in UK stores declined in the past three months due to wet weather and financial strains in consumers. Public finances and public sector net borrowing numbers are scheduled for release on Tuesday along with the CBI Total Trends Survey.

AUD: RBA Minutes Big Focus Tonight
The Australian, New Zealand and Canadian dollars rose slightly against the greenback thanks to hotter Chinese economic data. More than half of the cities in China reported an increase in house prices, which is the first since October 2011. The big focus tonight will be on the Reserve Bank of Australia’s monetary policy minutes. The last time the RBA met, they left interest rates unchanged but the statement contained a tinge of pessimism as they expressed concern about the strength of the Australian dollar, the peak in the terms of trade and the weaker global economic outlook.

It will be important to see how much of this concern is emphasized in the RBA minutes. If the minutes give off any clues of increased pessimism, the market could begin to price in another round of easing. New Zealand will release its credit card spending numbers tonight along with inflation expectations. Canada has wholesale sales on the calendar, which is important because it tends to be a reliable leading indicator for retail sales.

USD/JPY Rally Stalls
The Japanese yen strengthened against the greenback, euro, sterling, loonie and Swiss franc but weakened against the kiwi and Aussie. After 5 straight trading days, USD/JPY finally pulled back to end the day lower. Bank of Japan Governor Masaaki Shirakawa who set out inflation goals six months ago to combat deflation has failed to weaken the currency to attract exporters.

The BOJ announced a 1% inflation target and expanded its asset purchasing program in February which caused the yen to decline by as much as 8.8%. However, the BOJ refrained from easing since April and has caused the yen to rally back to its high postwar levels. Even though the BOJ wants to keep its currency from going too high, demand for global safety trumps Japan’s needs. With the eurozone crisis entering its third year, many nations are looking to Japan’s securities as a safe haven.

The Japanese economy is forecasted to slow to 1.3% compared to 1.5% for the G10 countries. Consumer prices are expected to grow to 0.1% this year and next after declining 0.28% last year. The BOJ has failed to entice consumers to borrow and expand business as bank loans fell 26% and wages declined 7% causing consumers to cut spending and deepen deflation. Japanese trade numbers are due for release tomorrow and they will tell us exactly how much pain the strong currency has had on the economy.