Will Yellen Bring Volatility To USD Next Week?

FX: Will Janet Yellen Awaken Volatility Next Week?

Over the past week, there has been a lot of two-way action in the U.S. dollar because investors were primarily focused on policy developments outside of U.S. borders. While the Federal Reserve maintains a steady course of monetary policy that leaves little room for surprises, the ECB, BoE and RBNZ are becoming more active, drawing the market's attention away from the U.S. dollar. This explains why there was such a big divergence in the dollar's performance this past week -- the greenback strengthened versus the euro and Swiss Franc and weakened against the British pound, Japanese Yen, Australian, New Zealand and Canadian dollars. Although the changes over the week have been relatively small, the divergence indicates that FX flows were not being driven by the market's appetite for dollars. It is also hard for investors to get excited about buying or selling the greenback when Treasury yields are just moving back and forth with no clear direction on a daily basis. While that could change in the coming week with the Federal Reserve's monetary policy announcement, chances are the central bank will avoid rocking the boat by clarifying their plans to raise interest rates. Nonetheless, forex traders will be watching the Fed meeting very closely because in addition to the monetary policy announcement, the central bank will be updating its forecasts and Fed Chair Yellen will be delivering a press conference. As the central bank continues down its course of tapering asset purchases, they will want to avoid a spike in yields and there's no reason to risk doing so at a time when economic data has been mixed and not consistently positive. Friday's economic reports for example gave the Fed less reason to tighten with producer prices dropping 0.2% and the University of Michigan consumer confidence index slipping to a 3-month low. So while the FOMC rate decision could be a source of volatility for the forex market in the coming week, we do not expect trading ranges to be broken on the back Yellen's comments.

Will EUR Break 1.35?

For the fourth consecutive trading day, EUR/USD found support above 1.35. This morning's Eurozone economic reports had virtually no impact on the euro. German consumer prices were confirmed to have fallen by 0.1% in the month of May while the Eurozone trade balance rose slightly in April. Unfortunately the improvement in trade won't take the ECB's eye off inflation. Next week starts off with the revisions to May CPI and ends with German producer prices. The German ZEW survey is also scheduled for release but even if sentiment improves, it may not lend much support to the euro. The currency remains in a downtrend versus the U.S. dollar and 1.35 is looking extremely vulnerable. While we have said that low volatility could limit losses in the EUR/USD to 1.34/1.35, if Janet Yellen has anything positive to say about the economy or the Fed raises its forecasts, this zone of support could give way. As for the ECB, the market will soon realize that they are comfortable with recent changes in monetary policy and will want to wait a few months to see how the economy responds before taking additional action. A period of steady policy should help to stabilize the currency but it may be another week or so before the downward momentum in euro begins to ease.

GBP Hits 1.5-Year High vs. EUR on Carney Comments

The British pound traded higher against all of the major currencies Friday on the back of hawkish comments from Bank of England Governor Mark Carney and S&P's decision to upgrade their sovereign outlook for the U.K. from negative to stable. Yesterday afternoon Carney said the central bank could raise rates sooner than the markets expect and the start of rate increases from the BoE is getting nearer. Like Chancellor Osborne, he is worried about the strength of the housing market and feels vigilance is needed to prevent the bubble from popping. While Carney stressed that there is no pre-set course for tightening and the ultimate decision would be data dependent "growth has been stronger and unemployment has fallen faster than we or anyone expected." As a result, the output gap of 1 to 1.5% of GDP could necessitate an earlier move by the central bank. These comments drove sterling to a 1.5 year high against the euro and Swiss Franc. The next level of support for EUR/GBP is around 0.7750. The prospect of accelerated BoE easing should reset monetary policy expectations leading to further gains for the currency. There are no shortages of U.K. event risk next week with the minutes from the most recent Bank of England meeting scheduled for release along with consumer prices and retail sales. Given Carney's recent comments, traders will be looking for the minutes to contain a more optimistic tone.

NZD Retreats on Softer PMI but RBNZ Plans to Hike Another 50bp

After solid gains this past week, the Australian, New Zealand and Canadian dollars took a breather on Friday. All 3 of the commodity currencies retreated slightly despite softer U.S. data and a continued rise in commodity prices. Weaker economic data from New Zealand added pressure to the currency but given the hawkishness of the RBNZ, investors are taking the report with a grain of salt. A huge slump in new orders slowed manufacturing activity in the month of May. The PMI index dropped from 54.4 to 52.7, the lowest level since December 2012. While the drop in new orders is significant, on average, orders remain high which could explain why the RBNZ looked past recent economic reports to not only raised rates but also signal plans to tighten further. Meanwhile RBNZ Assistant Governor McDermott made a lame attempt to talk down the currency. He said traders are mispricing the New Zealand dollar and that it should fall in line with fundamentals and the terms of trade could be the turning point. However it may be difficult for this to happen when he projects rates rising by another 50bp this year. No economic reports were released from Australia and last night's uptick in Chinese retail sales failed to lend support to the currency. Finally, the Canadian dollar traded lower on the back of a surprise decline in manufacturing sales but the decline was limited by the tensions in Iraq and the recent increase in oil prices. The commodity currencies will remain in focus next week with an abundance of important economic reports scheduled for release.

JPY: BoJ Keeps Rates Steady, More Optimism from Kuroda

The Japanese Yen traded lower against all the major currencies Friday thanks in part to the rebound in USD/JPY. As expected, the Bank of Japan left monetary policy unchanged last night. While BoJ Governor Kuroda said they will continue to ease until their target of 2% inflation is reached, he also feels that the negative implications of the consumption tax hike are in line with expectations and with bonuses expected to rise, consumption should remain resilient with the impact of the tax receding after the summer. Ever since the tax was introduced in April, Bank of Japan officials have maintained an optimistic view while economists have been predicting a deep contraction that would eventually warrant additional easing. The BoJ has since been vindicated by recent economic reports that show the economy growing. The central bank's continued optimism indicates that they have no plans to increase stimulus until there is a material slowdown in growth. In other words, BoJ policy won't be triggering a sell-off in the Yen anytime soon -- so if the yen were to fall, it should be driven by an improvement in risk and demand for high beta currencies.

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