What Will Weekend Elections Do To The Euro?

EUR: Will Weekend Elections Impact on EUR?

Investors sold euros four out of the last five trading days and the currency should remain weak ahead of the June 5th monetary policy decision. We’ve been looking for euro to drift lower ahead of the meeting but the decline could stall between 1.36 and 1.3550, a former support zone for EUR/USD. Thanks to clear signals from the central bank, the market has almost fully priced in ECB easing. Friday’s weaker German IFO report will only make the central bank’s decision to increase stimulus easier. However we believe that there’s only slightly more downside left in the pair with EUR/USD poised for no more than a 3% decline if the central bank drops interest rates to negative levels. Even though Eurozone data has taken a turn for the worse, they are still consistent with recovery. Recent upgrades by rating agencies should also encourage more inflows into peripheral nations. Friday morning, S&P upgraded Spain to BBB with a stable outlook while Fitch upgraded Greece by one notch to B with a stable outlook. With no major Eurozone economic reports scheduled for release on Monday and U.S. markets closed for Memorial Day, the focus will be on this weekend’s elections.

There are 3 elections worth watching – European Parliament Election, Greek Local Elections and the Ukraine Presidential Election. The European Parliament’s election could impact the future composition of the European Commission. If Euro-skeptic parties secure more than 25% of the seats in the 751-member Parliament, it could increase uncertainty in the region, which would be mildly negative for euro. The Greek local election is not expected to have much impact on the currency market but the election in the Ukraine is definitely worth watching, as there has been renewed violence ahead of this weekend’s election in Eastern Ukraine. Petro Poroshenko is widely expected to win in the first round of elections but it is unclear whether Putin will stay true to his promise to “respect” the Ukraine vote by recognizing that Ukraine is an independent sovereign nation with a legitimate government. If Putin continues to create chaos in the Ukraine, it would add pressure on the financial markets and the euro. Only a handful of Eurozone economic reports are scheduled for release next week and unlike U.S. data, German retail sales and unemployment are Tier 1 economic reports. According to Germany’s flash PMI report private sector employment hit a 29-month high in the month of May, which suggests that labor market conditions improved in the region’s largest economy. If this true, the euro could rebound slightly next week and then sell-off in the days ahead of the ECB meeting.

USD: What is Clear / Unclear about Fed’s Policy Plans

The U.S. dollar extended its gains against the euro, British pound and Japanese Yen. U.S. yields did not edge higher but new home sales were mildly supportive of the dollar. While the 6.4% increase on a percentage basis was less than economists anticipated, the absolute amount of homes sold beat expectations, rising to its highest level in 6 months. Unfortunately prices declined, giving the central bank more reason to keep monetary policy easy. We’ve had a number of U.S. policymakers speak this week and over the past 48 hours, a series of economic reports were released but no additional insight was provided on the Fed’s exit strategy. If anything, it is becoming clear that there is no consensus on when rates will rise. What we know is that there will be a long period of time between the last taper to the first rate hike. According to the comments from most Federal Reserve officials, QE is on track to end this year and before they raise rates, the central bank will want to make sure that yields do not rise quickly after the central bank steps away from the bond market. Unless there’s a string of consistent improvements in the economy or a sharp rise in inflation, the central bank won’t feel any pressure to move the timetable for tightening forward. Like yesterday’s economic reports, Friday’s new home sales release was far from inspiring. U.S. markets are closed on Monday and when trading resumes in the coming week, we have durable goods, S&P Caseshiller House Prices, Consumer Confidence, revisions to Q1 GDP, pending home sales, personal income, spending, Chicago PMI and the final May University of Michigan consumer sentiment report. While next week’s releases are slightly more market moving than this past week’s, none of these reports are expected alter the Federal Reserve’s monetary policy stance and the impact on the dollar should therefore be limited.

GBP: 1.70 is the Top for the Time Being

For the time being, 1.70 should mark the near term top for GBP/USD and this is not because the Bank of England has given us a reason to believe that they have grown more dovish. Quite the contrary, while the Quarterly Inflation Report released earlier this month signaled that the central bank has no plans to raise interest rates this year, the BoE minutes offered a more encouraging view for sterling bulls. The Monetary Policy Committee felt that all members agree that they need to see more evidence of slack reducing before raising rates, however the decision on whether to raise rates was now “more balanced” for some members. So if the central bank has not ruled out tightening in late 2014 / early 2015, then why would we say that GBP/USD peaked at 1.70 this week? The reason is because is there’s not much in the way of U.K. or U.S. data on the calendar next week that could drive sterling to a fresh 4-year high. While the latest CFTC data shows that most speculators have not given up on their long sterling positions and their belief that the Bank of England will be the next major central bank to raise interest rates, the currency pair needs a strong fundamental catalyst from the U.K. to drive the pair to fresh highs. At the same time, we believe that EUR/GBP is poised for additional losses as euro drifts lower ahead of next month’s ECB meeting.

CAD: Inflation Hits 2% Target for First Time in 2 Years

The Canadian and Australian dollars rebounded against the greenback Friday while the New Zealand dollar extended its losses. The strength of the loonie has been nothing short of impressive with the currency pair shrugging off yet another piece of weak data. Consumer prices grew only 0.3% in the month of April compared to 0.6% the previous month. Core prices also rose at a slightly slower pace last month but the drag on the Canadian dollar was nominal due in part to year over year increase in CPI. For the first time in 2 years, on annualized basis CPI growth hit the central bank’s 2% target, up from 1.5%. The acceleration in inflation was driven by higher energy prices and while Bank of Canada Governor Poloz said he will dismiss the increase as transitory, faster price growth will make it more difficult for the central bank to justify easing even though retail sales and labor market conditions have weakened significantly. The Canadian dollar also received support from the recovery in oil prices. First quarter current account and GDP numbers are scheduled for release next week and these will be the last set of meaningful data before the Bank of Canada’s June 4th monetary policy meeting. While AUD rebounded after a week of losses, the New Zealand dollar extended lower after a drop in consumer confidence. According to ANZ, consumer sentiment fell to a 7 month low on concerns about the impact of higher rates. In the coming week, we don’t have much data from Australia or New Zealand aside from NZ trade balance on Sunday. Given the relatively quiet week, we look for AUD/USD and NZD/USD to consolidate near recent lows.

JPY: Will the BoJ’s Complacency be Tested?

There was very little consistency in the performance of the Japanese Yen Friday. The recovery in USD/JPY continued but the latest gains were modest. The biggest movers were AUD/JPY and CAD/JPY, two currency pairs that benefitted from a rise in the base currency. No Japanese economic data was released overnight and the Cabinet who issued its latest monthly economic report kept their assessment of the economy unchanged. Like the Bank of Japan, they believe that the economy is on a moderate recovery trend but “some weak movements were seen lately due to a reaction after a last-minute rise in demand before a consumption tax increase.” So far the economy appears to be weathering the tax hike well and this strength has made the BoJ more confident in its monetary policy. However the central bank’s optimism could be tested as the economic reports for May and June are released. So far, we’ve only seen one piece of May data, which was the manufacturing PMI index and it showed a slight improvement in activity. Next week we have small business confidence and inflation for May scheduled for release along with April retail sales and unemployment reports. At this stage, there’s no reason to believe that the BoJ will ease in June and the chance of stimulus in July is less than 50%. If the central bank were to ease, it would probably be in the fourth quarter. So while USD/JPY is trading primarily on the market’s appetite for U.S. dollars, inaction by the Bank of Japan creates downside pressure for the currency pair.

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