Top 5 FX Risk Events

Forex: Top 5 Events on Our Watch List

With the recent moves by central banks, volatility is beginning to pick up in the foreign-exchange market and if some of this week’s event risks reinforce their biases, certain currency pairs could climb to fresh year to date highs. There are 5 primary things on our watch list this week, in order of release – New Zealand’s dairy auction, the Bank of England minutes, Federal Reserve monetary policy announcement and the Swiss National Bank’s monetary policy decision. We are also watching the ongoing developments in Iraq and the tensions between Russia/Ukraine.

#1 New Zealand Dairy Auction – Starting with New Zealand’s dairy auction, the chart below shows how NZD/USD weakened after the last 5 auctions. As dairy prices declined on a bi-monthly basis, investors became increasingly confident that the RBNZ would respond with less hawkish monetary policy. However this concern proved to be invalid as the central bank spent very little time talking about the negative implications of the decline in prices on the economy and made it clear that they want to continue bringing rates back to normal levels after last week’s 25bp hike. As a result, if dairy prices continue to fall, the market could have a more muted reaction to this month’s auction. If prices stabilize, it could be just what NZD/USD needs to make a run for its 2014 high.

#2 Bank of England Minutes – Investors will be looking for the BoE minutes to reinforce the hawkish comments from Mark Carney. What’s interesting about the BoE is that in May when the Quarterly Inflation Report was released, they went out of their way to avoid giving into the market’s speculation for earlier tightening and a month forward, Carney is now talking about raising rates sooner. So the change must have occurred at the June monetary policy meeting. The minutes will provide important insight on what drove the shift in stance especially given the relatively muted improvements in economic data. If the minutes indicate that a rate hike is coming, GBP/USD will find itself trading firmly above 1.70, but if there is any ambiguity, the rally in sterling will fizzle.

#3 FOMC Meeting – The most important event risk this week is the Federal Reserve’s monetary policy decision. The Fed is widely expected to taper asset purchases by another 10 billion. However with the unemployment rate having fallen to the top of the central bank’s 6.1% to 6.3% Q4 forecast (it was 6.3% in May), the Fed will find themselves in the uncomfortable position of adjusting down their unemployment forecast to the 5 handle. Their inflation forecast could also be revised slightly higher. If these changes are made, Janet Yellen will need to provide an explanation that convinces the market they hasn’t gotten any closer to tightening. If she fails, the US Dollar and Treasury yields will rise but even then, we expect gains in USD/JPY to be capped at 103.

#4 SNB Rate Decision – A small subset of investors believe the Swiss National Bank could cut interest rates after the European Central Bank’s easing but we think the chance of that happening is extremely slim. As long as EUR/CHF holds comfortably above 1.20, the SNB won’t do more than reiterate its unwavering stance to defend the currency because some Swiss interest rates are effectively negative. Furthermore, a strong housing market and ample liquidity minimizes the need for additional policy action. Nonetheless if the SNB does ease, it would be a huge shock for the FX market and could drive the Franc sharply lower against all major currencies.

#5 Iraq, Russia/Ukraine Tensions – Ongoing geopolitical tensions are also worth monitoring because if oil spikes to $110 a barrel, the consequences for currencies would be significant. Not only would certain pairs be hit by risk aversion but others would benefit from the rise in oil.

GBP: What is the Chance of Double Top at 1.70?

Although the British pound rose to a 4.5 year against the U.S. dollar Monday (GBP/USD), its failure to hold above 1.70 leads many traders to wonder what the chances are for a double top at this key level. We know there are a number of important event risks for sterling this week including Tuesday’s consumer price report, Wednesday’s Bank of England minutes and Thursday’s retail sales release. The Financial Planning Committee also meets on Tuesday but no major revelations are expected before the Financial Stability report is released on June 26. Judging from the market’s muted reaction to Monday morning’s report of slower house price growth, investors are looking past every piece of weak data and focusing on last week’s hawkish comments from BoE Governor Mark Carney. Based on the drop in consumer prices and the weaker BRC retail sales report, there’s a good chance that inflation and consumer spending weakened in the month of May. However if the BoE minutes reinforce Carney’s hawkish monetary policy bias, downside surprises in both of these reports will matter little as sterling makes another run through 1.70. If there is a lot of ambiguity in the minutes and not much indication of an urgency to raise rates, sterling could give up its gains quickly and drop below 1.6900. We view any move below 1.6850 as an attractive opportunity to buy GBP/USD at lower levels.

Euro Bounces, Idea of a Few Months of Steady Policy Gains Traction

Euro rebounded against the U.S. dollar Monday (EUR/USD) after Bloomberg cited an “ECB source” as saying that the central bank will refrain from new measures in the coming months. Considering that we have been making the same claim since the European Central Bank eased monetary policy on June 5th, this notion should not come as surprise to our readers. Having just introduced a series of aggressive monetary policy changes, it makes sense for the ECB to wait a few months to see how the economy responds before taking additional action. We argued that a period of steady policy should help stabilize the currency pair above 1.3475 and so far this support level continues to hold. While the FOMC meeting poses a downside risk for EUR/USD, the losses should be limited. The German and Eurozone ZEW surveys are scheduled for release on Tuesday and the recent proactive measures taken by the central bank are expected to boost confidence, which could lend additional support to the euro.

AUD: RBA Minutes Expected to Contain an Upbeat Tone

The commodity currencies ended the day virtually unchanged against the U.S. dollar. Just after the U.S. markets closed, the minutes from the last Reserve Bank of Australia meeting were due for release and we were expecting a relatively upbeat tone because going into the RBA meeting, many economists expected concerns about domestic activity but instead the statement was virtually unchanged with very little concern about the level of the currency. While a positive tone could lend support to AUD/USD, a renewed sense of hawkishness would be needed to drive the currency pair above its April high of 0.9461. Meanwhile the Reserve Bank of New Zealand’s hawkishness monetary policy bias helped the New Zealand dollar shrug off weaker economic data. Although house prices declined and service sector activity slowed, leading to a drop in consumer confidence for the second quarter none of this deterioration in economic activity stopped the central bank from raising interest rates last week. In fact the RBNZ expressed very little concern about the recent fall in dairy prices, which is why it will be interesting to see how NZD reacts to Tuesday’s dairy auction. Finally, stronger Canadian data helped to drive the Canadian dollar slightly higher. While it was encouraging to see the jump in foreign purchases of Canadian securities and existing home sales, loonie traders are primarily focused on the move in oil.

JPY: Keep an Eye on Risk Appetite

The overnight sell-off in the Nikkei, ongoing turmoil in Iraq and Russia’s decision to cut off gas supply to Ukraine drove the Japanese Yen higher against most of the major currencies. The Yen tends to outperform in periods of geopolitical uncertainty especially during a week with very little Japanese data on the calendar. This makes it extremely important for Yen traders to keep an eye on risk appetite. According to the latest IMM report, Yen positioning is now at its shortest level in 2 months, which implies that speculators are looking at the recent decline in USD/JPY as an opportunity to reload their long positions. This week’s Japanese economic reports are not expected to have a significant impact on the Yen and the same is true for BoJ Governor Kuroda’s speeches. We know exactly where the central bank stands with regards to monetary policy and until there is consistent deterioration in Japanese data, the BoJ sees no reason to increase stimulus. While this week’s Federal Reserve monetary policy decision could increase the volatility of USD/JPY, we do not expect the currency pair to break out of its 100.75 to 103 trading range.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.