Will USD Awake From Its Coma?

Will USD Dollar Awake From Its Coma?

Buckle up everyone because the U.S. dollar is back in play next week.  With first quarter GDP numbers, a FOMC rate decision and non-farm payrolls scheduled for release, it should be an exciting week in the foreign exchange market, which is a welcome departure from the recent lethargic price action in the dollar. However while we hate to be a buzz kill, this week's U.S. economic reports may not induce as much volatility in currencies as everyone is hoping for.  There will be a reaction to each one of these event risks and we certainly expect the trading range in EUR/USD, USD/JPY and GBP/USD to expand beyond last week's narrow 75-point band but we don't anticipate a massive breakout.  GDP is a stale and backwards looking release, Janet Yellen does not have a press conference scheduled after this month's FOMC meeting and non-farm payrolls will rise at a slow and steady pace.  The Federal Reserve is widely expected to taper asset purchases by another $10 billion this month.  Given recent economic reports, there's no reason for the central bank to accelerate or slow the unwinding of Quantitative Easing meaning that the chance of a surprise is slim.  As a result, Treasury yields could continue their downward course even if the central bank reduces monthly bond buying.  For yields to reverse course, the FOMC statement would need to be more hawkish and/or the unemployment rate would need to decline to 6.5% or better. Otherwise, the dollar may have tough time coming out of its coma. Aside from next week's U.S. economic reports, we will also be closely watching the conflict between Russia and Ukraine because an intensification of tensions could certainly rile up the currency market.  If Russia decides to embark on a full military invasion of Eastern Ukraine, we could see a deep sell-off in currencies and equities.

Euro Refuses to Fall

What we have learned from the price action of the euro this week is that it refuses to fall.  The European Central Bank may be worried about a strong currency and spent time outlining the various tools at their disposal to increase stimulus but without any action, investors find it hard to believe that they will follow through on their threats. So instead, they have bid on the currency on the back of stronger Eurozone data and the continued decline in U.S. yields.  At the same time, the euro is supported by the region's massive current account surplus and the return of portfolio flows into countries like Spain and Italy.  The crisis in Ukraine poses a threat to Europe but so far the euro has taken the rise in tensions in stride.  The most important economic reports scheduled for release from Europe next week are German consumer prices, retail sales and unemployment numbers.  Aside from these releases, Eurozone confidence and CPI is also on the calendar.  While important, these reports will most likely take a back seat to U.S. data. 

GBP: Post Retail Sales Rally Fizzles

The British pound ended the day unchanged against the U.S. dollar and euro despite stronger than expected retail sales figures. Economists had been looking for a decline in consumer spending but demand increased 0.1% in the March.  While this report printed above expectations, the knee jerk rally fizzled quickly and part of that has to do with the sharp downward revision in February.  Overall, retail sales growth in the first quarter is slower compared to Q4, which means that GDP growth could be softer but expectations are not high and trade activity improved, offsetting the slower pace of growth between January and March.  Nonetheless, sterling refuses to fall.  For the past 8 trading days, the currency hovered near its 4-year highs versus the dollar. In the coming week, we have first quarter GDP and the manufacturing PMI index scheduled for release.  These Tier 1 economic reports could be just the catalyst that the currency pair is waiting for to break out of this week's tight 77 pip trading range. 

USD/CAD Edges Higher as Oil Prices Fall

There were no economic reports released from the 3 commodity-producing countries on Friday and as a result, trading was extremely quiet.  USD/CAD continued to edge higher due in part to the sell-off in oil prices. The price of crude declined 4 out of the last 5 trading days and has fallen approximately 4% over this period.  Gold prices continued to rebound, providing support to the Australian and  New Zealand dollars. A holiday in both countries led to thin trading in AUD and NZD. The 2 most important things that we have learned from this past week's developments down under is that consumer prices are growing at a slightly slower pace in Australia and the Reserve Bank of New Zealand's enthusiasm for raising interest rates in June pared back slightly.   This should be bearish for AUD and NZD but the sell-off is expected to be limited. The focus will be on the U.S. dollar next week but Australia still has manufacturing PMI and producer prices scheduled for release.  New Zealand will also report its latest trade numbers and Canada follows with February GDP.

JPY: No Progress on TPP Talks Between Obama and Abe

The steep sell-off in U.S. equities drove the Japanese Yen higher against all of the major currencies. Growing tensions between Russia and the Ukraine is making investors nervous and when that happens market participants are quick to unwind yen funded trades.  Throughout this week, Japanese assets received no support from President Obama's high profile visit to Japan where the U.S. deepened its military commitment but failed to reach a trade agreement.  Both leaders ended the meeting without a compromise on tariffs and market access.  This is a key step to concluding the Trans-Pacific Partnership that would help remove tariffs among other things and improve trade relations between U.S., Japan, Australia, Vietnam and Malaysia.  Overnight, Japan released its latest consumer price report and while inflation increased across the nation, core prices grew at a slower than expected pace nationally as well as in Tokyo. It's a not a big deal because the forecast were high and even with the miss on a year over year basis, core CPI growth in Japan's largest city rose 2.0%, up from 0.4% the previous month.  For Japan as a whole, CPI growth accelerated to 1.6% from 1.5%.  Retail sales, manufacturing PMI, industrial production, housing starts and the jobless rate are among the key pieces of economic data scheduled for release in the coming week. The Bank of Japan also has a monetary policy announcement but no changes are expected which means the rate decision will most likely be a nonevent for the Japanese Yen. 

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