Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- US Dollar Outlook: Further Weakness Ahead?
- ECB Will Cap Gains in the Euro
- EUR Retraces but Recovery Remains Intact
- NZD Hits 2.5 Year High on Healthier Trade
- USD/CAD Drops to Fresh 5 Month Lows
- AUD: Busy Week Ahead with Key AU and CH Data
- JPY: Recovery Still on Track
US Dollar Outlook: Further Weakness Ahead?
The U.S. dollar traded lower against all of the major currencies this past week on the lack of consistently positive data. Big disappointments in GDP and a steep decline in durable goods raised concerns about the strength of the U.S. recovery. As a result, currency traders are not the only ones who pulled back their expectations for Fed tightening. Ten-year Treasury yields dropped more than 10bp from last week's high and appear positioned for a dip below 2.5%. The majority of market participants don't expect the Fed to raise interest rates until the second half of next year but after this week's reports, the odds of a rate hike in June 2015 fell to 50% from 60% a week ago. Non-Farm payrolls are scheduled for release next week along with ISM and many traders are wondering if a healthy jobs number will be enough to stem the slide in the greenback. Unfortunately the chance of a strong recovery in the dollar is slim, even if non-farm payrolls beat expectations. The problem is that the recovery is too slow and unless payrolls rises by 300k or more for 2 straight months, the Fed will stick to their plans to keep interest rates low for an extended period of time. Earlier this month, the Federal Reserve reduced monthly asset purchases by $10 billion and if they continue on this current pace, the Quantitative Easing program will come to an end in October or December at the latest. So the next real opportunity for the central bank to share their plans on what happens after QE ends is in September. Between now and then we don't expect any significant upside momentum in the greenback and chances are come September, the central bank will say they do not see an appropriate timing for tightening and will decide when that happens later based on data. At the same time, the sell-off in the dollar will be limited because the next steps that the Fed takes will be to reduce stimulus. This means EUR/USD could test its June high of 1.3677 and USD/JPY could slide towards support at 100.75. For USD/JPY specifically, this is the first time since November 2012 that the currency pair has closed below 200-day Simple Moving Average. From a technical perspective a close below the SMA would be significant because it could mark the beginning of a broader downtrend for USD/JPY. However steady monetary policy also means low volatility, which is why we expect the moves to be closer in magnitude to 2012 than 2009 to 2011. Last year, when USD/JPY broke below the 200-day SMA, the declines ranged between 0.3% and 2%. Between 2009 and 2011, the declines ranged from 1.6% to 13% with two periods of moves in excess of 8% but that was during a period of significantly greater volatility. So as result, while the dollar is vulnerable to further weakness, we don't expect any new trends to emerge in EUR/USD or USD/JPY as monetary policy certainty keeps both currency pairs in consolidation mode.
ECB Will Cap Gains in the Euro
Three weeks ago, EUR/USD hit a low of 1.35 after the European Central Bank eased monetary policy but since then, the currency pair experienced a modest but consistent recovery with the EUR/USD closing above 1.3600 every day this week. While the decline in U.S. yields contributed to the rally, the notion that the ECB won't consider easing again for a few months also stemmed the slide in the currency. The most important event risk for EUR/USD next week will be Thursday's ECB meeting. The central bank has no plans to ease monetary policy for the second month in a row but the tone of Mario Draghi's press conference could decide whether EUR/USD takes out 1.37 or reverses and heads back to 1.35. Unlike the Bank of England who left the market confused with their flip flopping, we believe Draghi will take the opportunity to reinforce the central bank's dovishness and make it clear they are ready to increase stimulus if inflation or economic activity refuses to rise. A dovish tone would cap gains in the euro. According to the latest economic reports, inflation in Germany increased slightly but economic sentiment weakened. Although we expected a bounce in the EUR/USD, the long term outlook favors weakness and therefore we view any move above 1.3650 as an opportunity to sell at higher levels. Aside from the ECB meeting, German retail sales, unemployment and the Eurozone's final PMI reports are also scheduled for release next week. The currency pair remained confined in a 125-pip range for the past week and with the upcoming European and U.S. event risks, the range should widen slightly.
Will Sterling Climb to New Highs Next Week?
While the British pound failed to extend to new highs this week versus the U.S. dollar (GBP/USD), it has done a pretty good job of holding onto its recent gains. Expectations for tightening from the Bank of England eased only slightly with the central bank's mixed messages. According to the latest CFTC data, long positions in the GBP/USD remain overstretched and the consolidation in the currency pair suggest that speculators and investors are waiting for evidence to reinforce their expectations for tightening. Next week's economic reports present a perfect opportunity - if the PMI manufacturing, service and construction sector reports increase, reflecting an improvement in economic activity, it could be just what GBP/USD needs to break above its 5.5-year high of 1.7063. Unfortunately according to Bloomberg, the problem is that economists are looking for manufacturing, service and construction sector growth to slow in June. If the PMI indices decline, we could see a stronger pullback in the British pound with a move below 1.70, opening the door for a deeper decline towards 1.6900. On Friday, U.K. GDP growth was confirmed at 0.8%. Business investment was revised higher but with the current account balance missing expectations, the overall impact on sterling was limited.
NZD Hits 2.5-Year High on Healthier Trade
During the Asian trading session, the NZD/USD rose to its strongest level since August 2011 after better than expected trade numbers validated the Reserve Bank's hawkish bias. Although the country's trade surplus shrank to $285 million from a downwardly revised $498 million, the dip was less than expected and more importantly, the export balance exceeded expectations which is surprising given the recent decline in dairy prices. The details of the report show that dairy demand remains strong with rising volumes offsetting the decline in prices. Crude oil exports also rose 30% as overall exports to China exceed exports to Australia. Imports also beat expectations, reflecting healthier domestic demand. While there are no major economic reports scheduled for release from New Zealand next week, prospects for RBNZ tightening could keep NZD/USD bid. As long as the currency pair holds above 0.8660, the uptrend remains intact with the next potential level of resistance being the 2011 high of 0.8843. Meanwhile investors continued to buy Canadian dollars, driving the currency to a fresh year to date high versus the greenback. After breaking the 200-day SMA at 1.08, there has been significant downside momentum in the currency pair, which shrugged off lower industrial and raw material prices along with a decline in oil prices on Friday. The next level of support comes in at 1.0650, the 38.2% Fibonacci retracement of the 2012 to 2014 rally. We start the week off with Canadian GDP on Monday followed by the trade balance on Thursday. The Australian dollar ended the North American session unchanged for the second day in row. This consolidation should be temporary given next week's busy economic calendar. Manufacturing and service sector PMIs are scheduled for release along with retail sales, the trade balance and a monetary policy announcement from the Reserve Bank. On top of that, there are a significant amount of economic reports expected from China. The RBA is widely expected to maintain a neutral bias and leave monetary policy unchanged.
JPY: Recovery Still on Track
The Japanese Yen ended the week higher against most of the major currencies with its recent strength driven by the decline in U.S. Treasury yields, the more than 1% sell-off in the Nikkei on Friday and weakness in U.S. stocks. Considering that we could see additional weakness in equities in the coming week along with low Treasury yields, there is a reasonable chance for further gains in the Yen, particularly against the euro and U.S. dollar. Like many other countries Japan will be releasing a number of important economic reports in the coming week. This includes industrial production, the Quarterly Tankan survey, the final manufacturing and service sector PMI indexes. For the most part, we are looking for further improvements with the outlook for large manufacturers poised to rise to its highest level since 2007. It has been 3 months since taxes have been increased and so far the economy hasn't experienced the deep setback than many market participants feared thanks in large part to an increase in capital spending. Next week's reports mostly center around the manufacturing sector and should reinforce the sector's recovery. According to last night's economic reports, inflation is on the rise and the labor market is improving. Consumer price growth hit 3.7% in the month of May, up from 3.4% while the unemployment rate dropped to 3.5%, its lowest level since December 1997. The job to applicant ratio rose to its strongest level since June 1992. Although overall household spending dropped a whopping -8% in May compared to the -2.3% forecast, the larger increase in retail sales and tightening of labor market conditions eases our concerns that this sharp decline will persist in the coming months.