By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
- Dollar Performance Table: Is Jackson Hole Really THAT Big of a Deal?
- Why EURO Rallied on Weak PMIs
- Sterling Hits 4 Month Lows on Weaker Retail Sales
- CAD: Retail Sales and CPI on Friday
- NZD: Shrugs Off Drop in Confidence and Spending
- AUD: Chinese Manufacturing Activity Slows
- JPY: PMI Manufacturing Index Hits 5 month Highs
Dollar Performance Table: Is Jackson Hole Really THAT Big of a Deal?
For the past 36 years, central bankers around the world have gathered in Jackson Hole Wyoming for an annual conference to discuss the world economy. In certain years there were pressing issues to talk about including the coordination of global monetary policy but this year, central banks are moving in different directions. However, that does not mean that investors are not watching the meeting closely. Both Fed Chair Janet Yellen and ECB President Mario Draghi are scheduled to speak Friday and while we have a pretty good idea of what Draghi will say, the latest FOMC minutes has investors eager to see if Yellen adopts a less dovish stance. The dollar traded sharply higher on Wednesday but on Thursday, profit taking caused the greenback to give up its against most of the major currencies. Even back-to-back upside surprises in U.S. data failed to extend the rally in the dollar. Investors are worried that Yellen could maintain her dovish stance and downplay the Fed minutes, which raised the possibility of a change in their view on labor market underutilization and the likelihood of an earlier rate rise. This has happened before so if she refrains from taking a more hawkish stance, investors would respond by selling dollars. If she acknowledges the improvement in the labor market and suggests that they could change their guidance as Quantitative Easing comes to an end, it could be just what investors need to hear to resume their purchases of U.S. dollars. Both Bernanke and Greenspan have signaled major shifts in policy at Jackson Hole so it would not be out of line for Yellen to do so as well.
However as traders first and analysts second, we always think about what type of impact this event risk can have on currencies. The Wall Street Journal republished an article earlier this week that talked about how the Dow generally experienced triple digit gains on the day of the Fed Chairman's Jackson Hole speech so we decided to see if there was any consistency in the dollar's performance during this same period. Unfortunately the following table shows one of two things. First, there's no consistency in the direction of the dollar and for the most part, the moves were relatively modest even when Bernanke was clear on where monetary policy was headed next. While it is possible for the dollar to experience a big move Friday, chances are that its magnitude will fall short of expectations. We expect Mario Draghi to maintain his cautious outlook on the Eurozone economy and use Friday's speech as an opportunity to remind investors that they stand ready to increase stimulus if necessary.
Why EURO Rallied on Weak PMIs
The euro traded higher against the U.S. dollar Thursday despite a softer Eurozone PMI report. The currency pair has become deeply oversold according to CFTC positioning and a rebound is not unusual although we have to admit that we anticipated a bigger reaction to the weak Eurozone PMI report. For the region as a whole, economic activity slowed during the month of August with weakness seen in both the manufacturing and service sectors. However disappointments in other economic reports and dovishness from the ECB had investors bracing for a soft number and when they realized that economic activity in Germany beat expectations, it was the perfect excuse for a short covering driven relief rally. In the Eurozone's largest economy, manufacturing and service sector activity did not slow as much as anticipated and in France service sector activity actually accelerated. Of course, there is weakness in other parts of the region but as long as the two largest contributors to Eurozone GDP (Germany and France) are holding up well, the outlook for the Eurozone as a whole is less dismal. At the same time, the case for ECB easing becomes weaker if the German and French economy stabilizes but we don't think the PMI numbers are enough to convince the central bank that it is not necessary. The main focus is on Yellen Friday -- if she is hawkish, the EUR/USD could resume its slide but if she refrains from taking a more hawkish stance, it could accelerate the rebound in the currency because going into this week's event risks, short Eurozone positions were hovering near 20-month highs.
Sterling Hits 4-Month Lows on Weaker Retail Sales
The Bank of England's credibility continues to come into question with the latest U.K. retail sales report. Led by BoE Governor Carney, policymakers are signaling that rates could rise before wages increase but everything from Thursday's spending number to consumer prices and the Quarterly Inflation Report undermines the case for earlier tightening. The divergence between official rhetoric and economic data has left investors confused but based on the price action of sterling, they are giving more credence to the data. U.K. retail sales grew only 0.1% in the month of July, which was significantly weaker than the market's 0.4% forecast. On an annualized basis, this slowdown drove retail sales growth to an 8 month low of 2.6%. Although much of the disappointment was caused by weaker auto sales, excluding autos, demand still slowed to 3.4% from a downwardly revised 3.8% year over year. Of course, our readers should not be surprised by this softer release because we pointed out in Wednesday's note that the drop in demand and prices reported by the British Retail Consortium put the odds in favor of a downside surprise. As our colleague Boris Schlossberg pointed out "with both UK inflation and retail sales lower than forecast for the past three months, the data makes a mockery of yesterday's hawkish MPC minutes which saw two members vote for a rate hike. At present neither price pressures nor consumer demand pose any danger to inflation in the UK economy and therefore monetary tightening would be counter productive." However given how quickly and aggressively GBP/USD has fallen over the past month, we think the currency pair is due for a relief rally. The currency pair should find support at 1.65 and if Yellen's speech falls short on hawkishness, the GBP/USD could rebound back above 1.67.
CAD: Retail Sales and CPI on Friday
All three of the commodity currencies traded higher Thursday led by gains in the New Zealand dollar. What's interesting is that NZD/USD completely ignored weaker Chinese and New Zealand data as well as this morning's stronger U.S. economic reports. According to HSBC, manufacturing activity in China grew at a slower pace in the month of August. Since April, manufacturing activity has been growing at a steady pace and up until Thursday's release, other reports showed that China's economy was gaining momentum, raising hope that it would be a bright summer for Asia's largest economy and its trading partners. Unfortunately Thursday's report along with recent weakness in lending raises some concerns about this theory. Aside from the softer Chinese PMI report, the drop in New Zealand consumer confidence and credit card spending should have also weighed on NZD but instead the currency rebounded strongly versus the dollar on the back of short covering, a dynamic that also lifted the Australian dollar. The focus on Friday will be on the Canadian dollar with retail sales and consumer prices scheduled for release. Economists are looking for weaker numbers all around but after last week's hot employment report, we can't rule out an upside surprise.
JPY: PMI Manufacturing Index Hits 5-month Highs
Over the past 24 hours, the Japanese Yen traded lower against many major of the currencies but its gains were modest compared to Wednesday's rally because investors are trading cautiously ahead of Jackson Hole. With that in mind, economic data from Japan continues to improve, easing concerns about a loss of momentum in the economy. The manufacturing PMI index rose to a 5 month high of 52.4 from 50.5 with sizeable increase seen in new orders and exports. Earlier this month there were concerns that the rebound in June was beginning to fade but between the rise in exports and last night's higher manufacturing PMI index, there's hope that the economy is returning to normal conditions. The Nikkei rose 131 points overnight thanks to the stronger economic data and reports from one of Japan's largest newspapers that the government is considering setting aside 1 trillion yen for stimulus spending next fiscal year. If true, this decision would be motivated by Prime Minister Abe's attempts to shore up confidence. Additional fiscal and monetary stimulus is still on the table but whether or not the government moves forward with their plans hinges on the pace of recovery in the third quarter.