Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- FX: Here are the Top 10 Takeaways from Yellen Testimony
- CAD: What to Expect from the Bank of Canada EUR: Draghi Says QE Falls into ECB Mandate
- NZD: Slips Ahead of CPI
- AUD: No Surprises in RBA Minutes
- GBP: Sterling Should Break 1.72 on Strong Labor Data
- EUR Hits 3-Week Low on Weaker ZEW
- JPY: BoJ Leaves Policy Unchanged but Alters GDP and Inflation Forecasts
FX: Here are the Top 10 Takeaways from Yellen Testimony
After all of the fanfare around Janet Yellen’s semi-annual testimony on the economy and monetary policy, she ended up causing very little action in currencies, equities and Treasures. Of course, this is the best-case scenario for central banks that go to lengths to avoid triggering unnecessary volatility for the financial markets. The US Dollar ended the North American trading session slightly higher against all of the major currencies except British pound while the Dow and 10-year bond yields were unchanged. Yellen provided absolutely no guidance on when rates would rise and despite the rally in the greenback, the general tone of the FOMC statement was dovish. The bottom line is that even with the improvements in the labor market, the Fed is not convinced that the economy is performing better. As a result of their uncertain economic outlook, plans for monetary policy are still dependent on data. If the labor market continues to improve, rates could rise sooner but if it deteriorates, more stimulus is possible (though not probable). The dollar’s resilience in the face of the Fed’s continued reluctance to raise rates and disappointing retail sales data indicates that trading ranges remain intact. Growth is expected to accelerate in the third quarter with investors happy to see manufacturing activity in the NY region rise sharply in the month of July. Yellen said details on an exit strategy will come later this year and we believe that will be in September when their economic forecasts are updated and Yellen holds her next post monetary policy meeting press conference. Producer prices, the Treasury International Capital Flow report, industrial production and the Federal Reserve’s Beige Book report is scheduled for release Wednesday. We expect the various Fed districts to report a continued improvement in economic activity. How the dollar performs the rest of the week will depend on U.S. earnings and Chinese data.
Here are the Top 10 Takeaways from Yellen Testimony
1. Fed’s overall view of economy is positive, but their GDP projections have been too optimistic
2. But even with improvements, unemployment is still very high
3. Slow wage growth is a problem, inflation is subdued
4. Very little progress on housing
5. Fed says Q2 growth rebound bears watching, looking for moderate growth this year
6. Risk of money fund runs remains significant
7. Expects to keep rates low for extended period after QE ends, high degree of accommodation needed
8. No decisions made on exit strategy but details to come later this year – SEPT?
9. Economy must be on solid footing before rates rise
10. Increase in Fed Funds rate will likely occur sooner and be more rapid if labor market continues to improve. If it deteriorates, more stimulus is possible as well.
Bottom Line
Fed is not convinced economy is doing better despite stronger labor data
Economic outlook remains uncertain so everything is data dependent
CAD: What to Expect from the Bank of Canada
All three of the commodity currencies sold off against the greenback Tuesday. While Australia had the biggest event risk over the past 24 hours, the largest losses were experienced by the Canadian and New Zealand dollars. CAD was hit hard by a slowdown in existing home sales, which grew only 0.8% in June compared to 5.9% the previous month. The Bank of Canada meets Wednesday and while the central bank is widely expected to leave monetary policy unchanged, Governor Poloz will have to decide where the greatest risks lie – inflation or growth. Last month, we learned that the annualized pace of CPI growth hit 2.3%. Not only was this the strongest pace since February 2012 but it also exceeds the central bank’s forecast, which means the BoC will most likely have to move forward its date for hitting 2% CPI. However the rise in inflation is happening at a time when the labor market remains weak and manufacturing activity is slowing. How USD/CAD responds to Wednesday’s monetary policy announcement will be determined by whether the central bank downplays inflation and focuses on growth or emphasizes the danger of price pressures, downplaying the deterioration in activity. We think he will err on the side of caution and express reservations about growth, which would be positive for USD/CAD. No economic data was released from New Zealand but the currency came under selling pressure due to the possibility that lower commodity prices slowed CPI growth in second quarter. Finally, the tone of the RBA minutes was slightly more dovish than the statement, putting pressure on AUD. The central bank said they expect economic growth to be “a little below trend” for the next year or so, expressed concerns about the strong currency and indicated that stability in interest rates is the “most prudent” course for the time being. AUD and NZD looked to be in play Tuesday night with Chinese Q2 GDP, industrial production and retail sales scheduled for release. The focus should be on the annualized pace of growth in China and if it slows from 7.4%, the commodity currencies will extend their losses but if GDP rises, showing further stabilization in the economy, then we can expect a rebound in these currencies.
GBP: Sterling Should Break 1.72 on Strong Labor Data
The British pound rose to a fresh 5.5-year high on the back of stronger inflation. Economists expected CPI to decline because of the drop in shop prices but instead inflation rose 0.2% in June, bringing the annualized pace of growth to 1.9%, just shy of the central bank’s 2% forecast. While GBP/USD is a long way from its 6-year high near 2.0, from both a fundamental and technical perspective the path of least resistance is upwards. We expect the currency to trade strongly ahead of the labor market report. Based on the PMIs, the job market improved in the month of June and not only did the employment component of manufacturing and service sector increase, signaling stronger job growth but job creation in the construction sector broke records. Strong labor data could be just what sterling needs to take out 1.72 and make its way towards its next resistance level of 1.7335, the 50% Fibonacci retracement of the 2007 to 2009 decline. Sterling also performed well versus the euro GBP/EUR, rising to its strongest level since September 2012. Meanwhile the much anticipated testimony by BoE Governor Carney proved to be a bore. He said his earlier comments on an earlier rate hike were aimed at manipulating market expectations and they were “useful.” Nonetheless even though the FPC is not thinking about more housing action at this time, if the rise in CPI is accompanied by a pickup in job growth, pressure on the BoE to tighten will increase exponentially.
EUR Hits 3-Week Low on Weaker ZEW
The euro dropped to a 3 week low against the U.S. dollar EUR/USD Tuesday on the back of softer than expected investor confidence. According to the German ZEW survey, investors grew less optimistic about the outlook for the Eurozone’s largest economy and the region as a whole. Who can blame them when there’s been sluggish growth, geopolitical risks and banking troubles in Portugal? In fact, these are the very reasons why ECB President Draghi said the central bank is intensifying preparations for an Asset Backed Securities purchase program. The recent trend of Eurozone data requires the ECB to prepare for the need for more stimulus. The amount of confidence that investors have for Germany dropped to its lowest level in 1.5 years while their confidence for the Eurozone fell to an 8-month low. Wednesday’s Eurozone trade balance is not expected to have a significant impact on EUR/USD – the path of the currency will instead be dependent on the market’s appetite for U.S. dollars and the divergence in the performance between Eurozone and U.S. yields.
JPY: BoJ Leaves Policy Unchanged but Alters GDP and Inflation Forecasts
The Japanese Yen ended the North American trading session higher against all of the major currencies with the exception of the U.S. dollar USD/JPY and sterling JPY/GBP. As expected the Bank of Japan left monetary policy unchanged last night with central bank Governor Kuroda providing no new information in his press conference. Despite mixed economic reports, the BoJ is comfortable with the current level of monetary policy and are optimistic that the economy will continue to withstand the tax increase. Yet Kuroda made one interesting comment, which is that it is unlikely for core CPI to exceed 1% in the coming months. Given that the central bank’s target is 2% inflation (although this is headline and not core), their expectations for a slow increase in CPI leaves the prospect of additional easing on the table. In their mid-term forecast, the Bank of Japan revised down its 2014 Fiscal Year GDP forecast to 1% from 1.1% and revised up its FY2014 core CPI forecast to a 1.2%-1.5% range versus a 1-1.5% range. This divergence is yet another reason why the BoJ keep monetary unchanged for the time being.