By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Where to Buy USD/JPY
- CAD: What to Expect from the Bank of Canada
- AUD Soars after RBA Leaves Rates Unchanged
- NZD: Dairy Prices Continue to Rise
- GBP: So Far Two out of Three…
- Euro: More Green Shoots
Where to Buy USD/JPY
With very little U.S. data on the calendar, the dollar traded lower against most of the major currencies Tuesday. Our readers should not be surprised by this move as we had been looking for recent data disappointments to catch up to the dollar. Eventually we expect USD/JPY to break above its 7.5-year high of 120.47 -- but now is not the time. Monday’s surge in demand for the currency was partially driven by a large option expiration. Once the flows faded, USD/JPY dropped back below 120. Wednesday’s Beige Book report from the Federal Reserve will most likely describe the U.S. economy as improving but we would be surprised if it did not also acknowledge the recent slowdown in the recovery. A number of softer economic reports were released last week and on Monday we learned that personal income, spending and manufacturing activity also missed expectations. On Tuesday, Investors Business Daily reported an increase in consumer sentiment but the Fed is much more interested in consumption than confidence. The most important piece of data on the U.S. calendar Wednesday is the non-manufacturing ISM report. If service-sector activity slows alongside the manufacturing sector, it will reinforce our view that the Federal Reserve is in no rush to raise interest rates. The only reason why USD/JPY is still trading above 119 is because of the hope that the Fed could change its forward guidance on March 18 and raise interest rates in June. We believe that the majority of voters on the FOMC are not interested in raising interest rates so quickly. When the seats on the Federal Open Market Committee rotated this year, we were left with a more dovish central bank. Fed President Evans is speaking Wednesday and as one of the most cautious members of the committee, his views are not expected to support the dollar. We are looking to buy USD/JPY below 119 for another run up to 120.50.
CAD: What to Expect from the Bank of Canada
All 3 of the commodity currencies traded higher against the U.S. dollar Tuesday with the Australian dollar leading the gains after the Reserve Bank of Australia left interest rates unchanged at 2.25%. The Bank of Canada is the next major central bank to meet this week and it is also expected to keep interest rates steady. Originally the market had anticipated another round of easing but last week, BoC Governor Poloz called the January cut an insurance move, which indicated that there is no need for a back-to-back rate cut. In fact Tuesday morning’s stronger-than-expected GDP numbers reinforced our view that rates will remain unchanged. Canada’s economy grew 0.3% in December, driving the annualized quarterly rate down to only 2.4% instead of the market’s 2% forecast. Taking a look at the table below, there has also been as much improvement as deterioration in Canada’s economy since the January meeting. In fact, oil prices are higher than where they were the last time the central bank convened. While we believe that the BoC will leave rates unchanged, they will also maintain a dovish bias, which should limit the gains in the Canadian dollar. This is exactly the way the Reserve Bank of Australia felt Monday night when it left rates unchanged but said that further easing may be appropriate in the months ahead, which means it's still inclined to lower interest rates although it did not feel that back-to-back easing was necessary. The Australian dollar remains in play with PMI services and GDP numbers scheduled for release this evening. As for the New Zealand dollar, traders were encouraged by the continued increase in dairy prices. While the price of milk settled only 1.1% higher at Tuesday’s Global Dairy Auction, this marked the 6 consecutive auction at which prices increased, reflecting a bottom in the country’s most important commodity.
GBP: So Far Two out of Three…
The British pound traded only slightly higher against the U.S. dollar Tuesday. We continue to be surprised by sterling’s struggle to rally especially on a day when the dollar fell sharply against the Japanese Yen and commodity currencies. So far two out of the three PMI numbers surprised to the upside, reflecting improvements in the U.K. economy. On Monday, the PMI manufacturing index rose to 54.1 from 53.1 and on Tuesday the PMI Construction index rose to 60 from 59.1. The PMI services report -- the most important of the three -- is scheduled to be released on Wednesday. If all 3 increased, it may be difficult for sterling bears to remain in control. Another reason why we are surprised by the weakness in sterling versus the dollar is because the 10-year U.K.-U.S. yield spread is moving higher. U.K. ten-year yields for example rose 5bp today while U.S. rates of the same tenure only increased 2bp. As a result, we continue to look for a recovery in GBP/USD especially given the hawkish comments from Bank of England officials.
Euro: More Green Shoots
Like the British pound, the euro failed to rally despite better-than-expected economic data. Retail sales in Germany jumped 2.9%, while the level of unemployment in Spain dropped 13.5k. Improvements are beginning to show up in the periphery as well as the core, reinforcing Mario Draghi’s cautious optimism. The pickup in spending continues a series of positive surprises from Germany including consumer confidence, employment and manufacturing activity. Inflation on the other hand remains a tricky problem as Eurozone producer prices dropped 0.9% in January. The brighter outlook for growth and weaker outlook for prices is the same message that we expect from the European Central Bank on Thursday. Asset purchases are expected to begin this month. One of the greatest challenges for the ECB is finding enough bonds to buy. There is a strong argument that the holders of European bonds will not be as willing to sell as holders of U.S. Treasuries. The ECB has promised to buy 60 billion euros a month but individual sovereign markets can be very small, so it will be interesting to see how much the central bank can really get done.