By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The primary focus this week is FOMC and its impact on the U.S. dollar. But with no major U.S. economic reports released on Monday and the Fed announcement not due until Wednesday, everyone is talking about the British pound. GBP/USD broke above 1.45 and while part of Monday’s move can be attributed to the improvement in the CBI Industrial Trends survey, the main reason for the currency’s strength and its complete disregard for recent data disappointments is Brexit. Leaving the European Union poses significant risks for the country and the region as whole but with traders spending the better part of the year placing Brexit bets, what we’ve seen in recent weeks is widespread short covering.
With less than 2 months to go before the E.U. referendum, positioning is playing a very big role in the pound's performance. Recent U.K. data has been terrible but instead of falling, sterling rallied as investors reduced their short positions. While it may seem counterintuitive, they are interpreting every negative headline as a reason for voters to favor remaining in the European Union. However the cost of hedging Brexit has declined in recent weeks confirming that Brexit angst is driving sterling trade. GBP/USD cleared 1.4500 after President Obama warned that the U.K. would have to wait as long as a decade for a free-trade deal with the U.S. if it departs the E.U. More consequences for Brexit should logically be negative for the pound because it raises the stakes for leaving the Union, but with many traders already short, they believed this would scare voters on the sidelines into remaining in the E.U.
Now that GBP/USD has broken above the 100-day SMA, the next stop should be the February high of 1.4670. Since the only piece of market-moving U.K. data this week is first-quarter GDP, this move should be driven by the market’s appetite for U.S. dollars and any Brexit related headlines.
Monday's U.S. dollar traded lower against all of the major currencies with the exception of the Canadian dollar -- one of the strongest-trending currencies in the market right now. New home sales fell short of expectations but the impact on the greenback was limited. We expect the dollar to trade quietly ahead of FOMC. While no one expects any changes from the central bank, its guidance will play a significant role in the dollar’s performance in the days and weeks ahead. The big question that everyone has is whether it will bring back its balance of risks assessment. It was taken out of the January and March monetary policy statement because policymakers were split on the outlook for the economy. This month the Fed has more to be worried about domestically but less to concern it internationally. If the line remains absent from the statement, investors would interpret it as reluctance to raise rates in June. If it reappears and the FOMC says the risks are balanced, it would signal a greater chance of a June hike. Aside from the risk statement, the central bank’s comments about recent data disappointments will also be important. If it says the deterioration is transitory, it will help the dollar.
The USD's pullback helped the euro shrug off Monday's softer German IFO report. German businesses grew less optimistic about current conditions and only slightly more optimistic about the economic outlook. If the euro is unable to rally off last week’s less-hawkish ECB minutes, there’s nothing on the calendar that will help the euro this week aside from a dollar-negative FOMC statement. Eurozone GDP numbers are scheduled for release and while growth is expected to accelerate, this backwards looking report is likely to have a limited impact on the euro.
Aside from the Fed, the Bank of Japan’s monetary policy announcement will also be a big focus as speculation of BoJ easing grows. USD/JPY came within a few pips of 112 on Monday after breaking out on Friday. With the Japanese economy struggling under the weight of a strong yen, slower global growth and speculators holding a record amount of long yen positions, the BoJ could complement negative deposit rates with negative lending rates.
With markets in Australia and New Zealand closed for holiday, the commodity currencies were quiet. Oil prices moved lower contributing to the slide in the loonie. But even with Monday’s move, the uptrend in CAD in AUD remains intact. The main focus for AUD this week is Australian CPI; for NZD it will be the Reserve Bank’s monetary policy statement. For their part, CAD traders will be focusing on oil data (stock, inventories and rig count) plus February GDP numbers.