By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- AUD – Will the RBA Cut Interest Rates?
- CAD Shrugs Off Drop in IVEY PMI
- NZD – Oil Prices Jump 5.8%
- Dollar Bulls Back in Control
- GBP: How to Trade the UK Election
- Euro Back Below 1.10
AUD – Will the RBA Cut Interest Rates?
One of the most important event risks this week will be Monday night’s Reserve Bank of Australia monetary policy announcement. The market is pricing in an 80% chance of easing by the central bank but only 13 out of 30 -- or 43% -- of the economists surveyed by Bloomberg expect a 25bp rate cut. The decision will be a close one and with the divergence in views, we have no doubt that there will be a big reaction in the Australian dollar. When the central bank lowered interest rates in February, they maintained a dovish bias and reiterated their pledge to increase stimulus in March. Two months have past since their last rate cut and there are still plenty of areas of concern.
According to the table below, the trade deficit nearly doubled in February as slower growth in China and falling commodity prices dragged exports lower. Unfortunately the price of iron ore -- one of Australia’s most important exports -- continued to fall, hitting a record low on Friday. Manufacturing activity has also been weak with most data out of China surprising to the downside. While there were pockets of improvements including an uptick in retail sales, improvement in the labor market and acceleration in service-sector activity, the Australian economy needs another round of stimulus in order to find firmer footing. To leave rates unchanged in April would simply be delaying an inevitable change and there’s enough deterioration to justify an immediate rate cut. If the RBA lowers rates and maintains a dovish bias, AUD/USD will break 75 cents and AUD/NZD will take out parity. If they cut but shift to neutral, which is less likely given the outlook for iron ore, the Australian dollar will still decline and there would be a knee-jerk recovery. Still, it should end up lower than its pre-RBA levels. Should the central bank leave rates unchanged, we expect AUD to trade higher regardless of their bias but of course the gains would be more limited than no cut followed by a shift to a neutral bias. Taking all of these scenarios into consideration, the odds strongly favor a decline in the Australian dollar after the RBA rate decision.
Dollar Bulls Back in Control
Dollar bulls were back in control Monday with the greenback turning higher during the North American trading session. The mighty buck erased nearly all of its post non-farm payroll losses to end the day in positive territory. While Monday morning’s U.S. economic reports were satisfactory with Markit Economics reporting stronger economic activity and the ISM non-manufacturing index meeting expectations, the dollar’s strength cannot be attributed to these reports. Instead, it was thin trading volume and the surge in Treasury yields that lifted the greenback. We are surprised by the extent of the day’s volatility given how currencies tend to consolidate Easter Monday. Nonetheless, stocks and bond yields started to move higher and by midday, the greenback followed suit. However we are not surprised by the dollar’s strength because one month of weak payrolls will not change the Federal Reserve’s plans to tighten. On a month-to-month basis, the absolute amount of job growth can be volatile. It is important to look at the unemployment rate, which remained unchanged and earnings, which increased last month. The moves in the financial markets tell us that equity, bond and FX traders share our view and we expect the dollar to avoid further losses this week.
GBP: How to Trade the UK Election
The U.K. general election is a month away but the prospect of a divided government means that sterling should be sold on a rally to 1.50. We expect the British pound to fall further in the weeks ahead with GBP/USD falling to a fresh 4-year low after the election. What makes this election different from 2010 is the potential power grab by smaller parties that could lead to more difficulty in forming a coalition. It is almost assured that the Conservative Party will fail to secure enough seats and if that leads to a hung parliament, it will translate into more losses for the currency. Sterling 3-month option volatiles are at a 3-year high but it could rise even further like it did in 2010. Five years ago volatility jumped to 17% in the days after the election and not only did GBP/USD fall 400 pips on election day, but it dropped another 500 pips in the 2 weeks that followed.
Euro Back Below 1.10
The euro dropped back below 1.10 on the back of the broad based dollar rally. No Eurozone economic reports were released Monday because of the holiday in Europe but progress on Greek reforms helped to lift the currency. It now seems that Greece will be able to meet its IMF payment this week. However traders should be careful because the Eurogroup will be holding a meeting on April 8 and April 9. Chances are they will be discussing Greece, which means that headlines related to the country’s debt troubles will continue to affect the currency. 1.1050 remains the key resistance level for the currency and even after the strong NFP report, this level has held.