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EUR Breakout Continues, Japan's Economy Looks Up

By Kathy LienForexJul 23, 2013 05:11PM ET
EUR Breakout Continues, Japan's Economy Looks Up
By Kathy Lien   |  Jul 23, 2013 05:11PM ET
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  • Can The EUR Breakout Be Sustained?
  • AUD CPI, Chinese PMI And RBNZ Rate Decision
  • NZD: What To Expect From The RBNZ
  • CAD: Sharp Rise In Canadian Retail Sales
  • USD Sees More Profit Taking As Stocks Hit New Highs
  • GBP: New Housing Program For UK?
  • JPY: Cabinet Upgrades Economic Outlook
Can The EUR Breakout Be Sustained?
The euro rose to its highest level against the U.S. dollar this month ahead of Wednesday's key economic releases. In order for the breakout in EUR/USD to be sustained, Wednesday's Euro-zone PMI reports need to show stronger activity in both the service and manufacturing sectors. We also want to see better conditions in Germany because weakness in the region's largest economy would raise concerns about whether the recovery in periphery nations is sustainable. Despite the European Central Bank's concerns, economists are looking for improvements all around and the uptick in the euro zone consumer confidence index Tuesday suggests that consumers have grown less pessimistic about the outlook for the economy, the labor market and future finances.

Yet the biggest improvement in confidence over the past few months have been in periphery nations such as Italy and Spain but without a similar improvement in Germany, we are skeptical about the sustainability of the euro-zone recovery. The latest comments from ECB President Draghi suggest that he shares our doubts. The head of the central bank said monetary policy will remain accommodative as long as needed as there are downside risk to their economic outlook. This sentiment was validated by a decline in German industrial production and factory orders. Of course we can be wrong and the index can surprise to the upside, which would help to drive EUR/USD to 1.33. However if our skepticism is validated, the breakout in the EUR/USD can turn into a fake out that leaves the currency pair trading back towards 1.31.

AUD CPI, Chinese PMI And RBNZ Rate Decision
The euro zone is not the only part of the world that has important economic data scheduled for release. Over the next 24 hours, we have Australia's second quarter consumer price report, China's HSBC Flash PMI index, New Zealand's trade balance and the RBNZ rate decision on the calendar. Inflationary pressures in Australia are expected to hold steady but the recent uptick in commodity prices could pressure prices higher. Manufacturing activity in China is also very important to the AUD and NZD because weaker activity for this key trading partner can have a significant impact on the economic outlook for Australia and New Zealand. Between the trade numbers and the RBNZ rate decision, the latter should be more important for New Zealand. Monetary policy decisions always have the potential to move a country's currency but at time when the bias of central banks are diverging, interest rate decisions can affect currencies even when no changes are made. For New Zealand specifically, slower growth in Australia and China could affect the outlook for New Zealand but post earthquake reconstruction has provided underlying support for the economy. New Zealand is still recovering from the 2011 Christchurch earthquake and while the damage from this week's earthquake was limited, it could impact the RBNZ's rate decision. The 6.5 magnitude tremor that was felt in the capitol of Wellington was stronger than the 6.3 magnitude Christchurch earthquake in February 2011 but thankfully no casualties were reported. After the 2011 earthquake initially hit, the RBNZ responded with a 50bp rate cut and the question now is whether the RBNZ feels that easing is necessary. When the central bank last met, they left interest rates unchanged at 2.5% and they cut their 2014 growth forecast from 3.3% to 3%. Since then, we have seen very little improvement in the economy. Consumer spending increased in June but confidence weakened significantly in the month of July. Job advertisements were flat, service sector activity slowed while manufacturing activity expanded. Business confidence ticked up and the housing market saw both improvement and deterioration. Unfortunately credit conditions may have tightened with interest rates on the rise. At the last meeting, the RBNZ expressed specific concerns about the level of the New Zealand dollar.

Central Bank Governor Wheeler talked about how the currency is overvalued and warned of intervention but any currency intervention is expected to be covert because they are only looking to "take tops off dollar peaks where possible." While the slowdown in the region and the recent earthquake increases the risk of a rate cut by the RBNZ, we feel that the economy has not deteriorated enough to warrant easing. Therefore at most, we expect dovish comments from the central bank, which could still be enough to undermine the recovery in NZD/USD.

USD Sees More Profit Taking As Stocks Hit New Highs The U.S. dollar continued to trade lower against all of the major currencies Tuesday on the back of weaker than expected economic data. While the house price index increased in the month of May, the rise fell short of market expectations. The Richmond Fed manufacturing index fell sharply in the month of July, catching the market by surprise. After the solid improvement in NY and Philadelphia manufacturing conditions, economists had been looking for the Richmond Fed index to rise to 9 from 7. Instead the index fell to a one year low of -11 on the back of weaker sales and orders. The Richmond Fed manufacturing index may not be a closely followed report but with such a big disappointment, it is no surprise that the dollar extended losses. At the beginning of the trading day, the Dow Jones Industrial Average and S&P 500 climbed to fresh record highs but concerns about earnings and Tuesday's weaker reports drove the S&P 500 back into negative territory. New home sales are scheduled for release Wednesday and the drop in existing home sales points to a weaker release that could compound the sell-off in the greenback.

GBP: New Housing Program For UK?

The British Pound continued to trade higher against the US dollar but held steady against the euro. Data by the British Bankers' Association revealed that loans for home purchase rose to 37,278 from 36,290, below the estimated forecast of 38,300. BBA said, "Second quarter GDP is expected to have strengthened and as economic conditions improve banks are providing the finance to help growth." UK 10-year gilts fell in response to the uplifting data. GDP is set to be released on Thursday and is forecasted to rise by 0.6%. BBA also added, "However, household savings, though still growing at 5 percent, seem to be slowing." The Funding for Lending Scheme has been beneficial to the housing market, which has been expanding since the program was implemented. Chancellor Osborne gave details of a new scheme that could help riskier borrowers buy their first home. Osborne said the scheme will help boost construction. He said, "The mortgage guarantee will support an increase in high loan-to-value mortgages for people who can't afford large deposits, and it will also boost house building. As of Tuesday, lenders have the detail they need to go away and get ready for next January's launch." The British Chambers of Commerce revealed that exports rose the highest since the recession in the second quarter fueling confidence in a stronger recovery. The export index gained 2.85% from the first quarter.

JPY: Cabinet Upgrades Economic Outlook
It was a mixed day for the Japanese Yen, which strengthened against the dollar but weakened against the euro and commodity currencies. In their monthly economic report, Japan's Cabinet office upgraded its outlook for Japan's economy for the third month in a row, citing signs of a self-sustaining recovery. According to Bank of Japan Governor Kuroda who spoke after the release, ""Our nation's economy is steadily recovering, and (movements in stocks) basically reflect positive movements in the real economy." This optimism is the very reason why the BoJ has refrained from increasing stimulus. While Japan's economy is gaining momentum, the country's expansive monetary easing program should keep the Yen under pressure. The Yen has appeared to have found some support in recent weeks but if U.S. yields hit 2.6% again, we could see a stronger move higher in USD/JPY.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
EUR Breakout Continues, Japan's Economy Looks Up
EUR Breakout Continues, Japan's Economy Looks Up

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