Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Dollar: The One Thing the Fed Could Say to Rock FX
- EUR: German Yields Hit Record Lows on EU Sanctions
- Sterling Rejects 1.70, Extends Lower
- NZD Collapses after Fonterra Cuts Dairy Payouts
- AUD Shrugs Off Stronger Home Sales
- USD/CAD Hits 1-Month Highs
- USD/JPY: 8 Straight Days of Gains
Dollar: The One Thing the Fed Could Say to Rock FX
Two of this week’s most important event risks will occur Wednesday. We start the day off with second quarter U.S. GDP numbers at 8:30am ET / 12:30 GMT followed by the FOMC rate decision at 2pm ET / 18 GMT. While GDP is typically a backwards looking report that receives less attention than ISM or NFP the last time the GDP numbers were released on June 25th there was a sharp downward revision that drove USD/JPY from 101.90 to a low of 101.21 and EUR/USD up to 1.3665 from 1.36. In the grand scheme of things, this move is small but in a low volatility environment, it can be described as a sizeable reaction. GDP only matters when there is a big change and this month’s report is expected to show a significant rebound in growth – the only problem is that many economists lowered their forecasts in recent weeks, which means both an upside and downside surprise could trigger a reaction in the greenback. In fact, we don’t rule out the possibility that the dollar could have a bigger reaction to GDP than FOMC.
As for the Federal Reserve meeting, the central bank is widely expected to taper asset purchases by another $10 billion so at this stage, there’s only one thing the central bank could legitimately say that would rock the markets because the other possibility, which would be to provide a clear timing on tightening is extremely unlikely. The Fed feels that the current level of unemployment is too high even though it has been gradually declining and since the June meeting, the unemployment rate dropped to 6.1% from 6.3%. If they decide to tweak their assessment of the labor market, it would accelerate the gains for the dollar. More likely however, they will opt to push off any changes on their outlook and guidance to late August after the Jackson Hole Summit. Major policy shifts in past years have been decided at this conference, which begins on August 22 so the Fed may choose to delay any new guidance until after this meeting.
The following table shows how the U.S. economy changed since the last Fed meeting in June. Although confidence is up, the unemployment rate declined and payrolls increased, consumer spending and average hourly earnings growth weakened. There have been no major changes in inflation and the housing market but service and manufacturing activity slowed. Taken together there is very little reason for the Fed to change its assessment of the economy before seeing another month of economic reports.
EUR: German Yields Hit Record Lows on EU Sanctions
The decline in European bond yields and rally in the U.S. dollar revived the sell-off in the EUR/USD, driving the currency pair to its lowest level since November. German and Spanish 10 year bond yields fell to a record low. While no major Eurozone economic reports were released Tuesday, European Union governments agreed to impose tougher economic sanctions on Russia. We are still waiting for specific details, which should be released by Thursday but the sanctions will cover four specific sectors 1) finance 2) defense 3) technology 4) oil. They will also significantly restrict the ability of Russian companies to raise funds through European capital markets. Although the sanctions will be reviewed in 3 months, Russia will not be the only country to suffer. We have already seen how confidence in the Eurozone has been affected by the Russian / Ukraine crisis and concerns about the fallout from these latest announcements could erode confidence even though the actual impact on trade should be small. Nonetheless, with the Eurozone already undergoing a muted recovery, any further deterioration large or small will boost the chance of additional easing.
Sterling Rejects 1.70, Extends Lower
The British pound ended the day lower against the greenback GBP/USD on the back of mixed housing market numbers. Mortgage approvals rose 67.2k in the month of June up from 62k in May – the first improvement in 5 months. Unfortunately the stronger number, which drove sterling to test 1.70 was offset by a decline in net lending. As a result, the knee jerk rally in sterling faded quickly as investors came to realize that the latest numbers do not increase the odds of central bank tightening in 2014. Earlier this year mortgage approvals declined after the U.K. government introduced tougher affordability rules and this also helped to ease house price growth. Later this week, the Nationwide House Price report will provide us with more insight into whether the rebound in mortgage approvals has translated into stronger price growth.
NZD Collapses after Fonterra Cuts Dairy Payouts
All three of the commodity currencies traded lower Tuesday but the New Zealand dollar experienced the steepest losses. Fonterra, the world’s largest dairy exporter and New Zealand’s largest company lowered its milk payout forecast for 2014/2015 by 14%. This follows a reduction back in May that lowered payouts by almost 20%. This means that farmers stand to lose approximately $4 Billion in collective income, which equates to approximately 2% of GDP. Although the decision was widely expected by the dairy industry, the decline in the New Zealand dollar shows that investors were off guard as NZD/USD dropped to its lowest level in 7 weeks. There’s no question that New Zealand’s terms of trade and GDP will be negatively affected by the lower payout and in light of Tuesday’s announcement, the Reserve Bank is likely to leave interest rates unchanged for the rest of the year. 85 cents is an important support level for NZD/USD and if this level breaks, there’s still the 200-day SMA at 0.8450. The Australian dollar also fell sharply against the U.S. dollar AUD/USD despite stronger home sales while a drop in Canadian bond yields and Crude Oil prices drove USD/CAD to a 1-month high.
USD/JPY: 8 Straight Days of Gains
Eight days have passed without any weakness in USD/JPY, which is significant considering that there has been a lot of back and forth action in U.S. Treasury yields. The break down in the correlation between these instruments will not last for long but it tells us one important thing which is that despite the decline in yields, investors have gotten tired of selling USD/JPY. The Fed is planning to end Quantitative Easing in June and Japanese data has taken a turn for the worse. Last night, the jobless rate rose from 3.5% to 3.7%, overall household spending fell 3% and retail sales grew a modest 0.4%, bringing the annualized pace of growth down to -0.6% from -0.4%. The only good news was that small business confidence rose slightly. The Bank of Japan has been prepared for weaker growth in Q1, having recently cut their GDP forecasts. The big question now is how well the economy fares in the third quarter. If the recovery does not gain momentum, the Bank of Japan may have to ease.