FX Pairs Fail To Break Key Levels

EUR: Break Of 1.30 Hinges Upon PMIs

With no major U.S. or European economic data on the calendar Monday, currency pairs such as the EUR/USD and USD/JPY failed to break key levels. For EUR/USD, traders are itching for a reason to take the currency pair below 1.30 and for USD/JPY some traders are wondering whether 100 is an impenetrable barrier. For more on USD/JPY you can read the Yen portion of our commentary but overall we continue to think that it is only a matter of time before this resistance level is broken. As for euro, a break of 1.30 hinges upon Tuesday’s euro zone PMI numbers. The euro completely shrugged off the news that Italy has reelected Giorgio Napolitano as President, which should have been positive for the currency. However fear that the central bank could be preparing the market for more stimulus overshadowed elimination of a near-term political risk for the currency. European Central Bank officials are beginning to gather support around the idea of a rate cut or some form of additional easing from the central bank.

As we mentioned least week, the ECB has a history of preparing the market for major changes in monetary policy through a consistent shift in tone by policymakers. Bundesbank President Weidmann said the central bank could cut interest rates if new information warrants it and over the weekend, ECB member Asmussen also said the effectiveness of rate cuts is limited but its still possible to do this if data justified it. ECB member Knot repeated a sentiment shared by Central Bank President Draghi at the last monetary policy meeting. He said “latest round of forecasts of the data coming in have shown that the risks are on the downside.” As a result, this week’s euro-zone PMI and German IFO reports will play a central role in setting expectations for ECB policy and help decide whether the EUR/USD maintains a break below 1.30.Meanwhile it is important to discuss Italy’s political situation as the decision on a President removes a major short term destabilization risk for the euro. After five unsuccessful rounds of elections, Italy finally re-elected Giorgio Napolitano as President. The 87-year old politician is the first in Italy’s to serve a second term in this role and the decision by the electoral college to bring back the old guard is a sign that the current political groups prefer to form a new government than to hold new elections for Prime Minister. Pier Luigi Bersani’s inability to gather support for his two candidates forced him to resign as the leader of the Democratic Party. The PD now needs to nominate a new leader who will likely be more amenable to working with Napolitano. In fact local papers are saying that Napolitano agreed to a second term on the condition that the parties will work on forming a government. The reelection of Napolitano and the departure of Bersani gets Italy one step closer to resolving its political fiasco which should be great news for the euro.

USD: Treading Water As Equities Consolidate

The currency and equity markets were unfazed by another disappointment in U.S. data. Existing home sales dropped 0.6% in March while sales growth the prior month was revised down to 0.2% from 0.8%. This latest economic report shows just how difficult the month of March was for the U.S. economy. Aside from lower demand for housing, job growth and consumer spending were also very weak. However, the impact of the existing home sales report on the dollar was nominal because last week’s Beige Book report showed that the weakness in March did not necessarily extend into April but we will have to wait for next month’s payrolls and retail sales report to be sure. Compared to other countries around the world, the U.S. economic calendar is light on market moving data outside of Friday’s first quarter GDP report. Currencies could take their cue from equities but stocks haven’t budged much since last Thursday. New home sales are scheduled for release on Tuesday and a small increase is expected after a sharp slide in February. The House Price Index and Richmond Fed manufacturing surveys are also on the calendar but the second tier economic reports are not expected to have a large impact on the USD.

GBP: Talk Of FLS Extension

With no U.K. economic data on the calendar Monday, the British pound ended higher against the U.S. dollar and euro. The strength of the GBP can be attributed to expectations for stronger public sector finances as well as hope that the Bank of England and the U.K. Treasury will extend the Funding for Lending Scheme. According to the Financial Times, the government is working on plans to give other financial institutions such as asset based lenders, invoice finance houses and leasing firms access to FLS. The hope is that this would encourage more lending but banks are skeptical as they attribute the lack of demand to the cautious behavior of U.K. businesses and households. The key release for the U.K. this week will be first quarter GDP -- unfortunately unless GDP growth increases by 0.5% or more, we don’t expect a rebound in growth to remove the risk of further stimulus. In addition, the potential for a contraction in GDP should cap gains for the sterling this week.

NZD: Could Drop Further On RBNZ

The New Zealand dollar weakened ahead of tomorrow’s monetary policy announcement. While the Reserve Bank of New Zealand is widely expected to keep interest rates unchanged at 2.5%, comments from the central bank could sound cautious. The NZD/USD is trading not far from its one year high and as an export dependent country the last thing the central bank wants is to encourage further strength in its currency especially after the recent decline in commodity prices. Also, the worst drought in seven decades may finally be over but the damage on the dairy industry and overall economic output has been done and this could lead to a lower growth forecast that could add pressure on the NZD. On top of that, recent disappointments in Australian and Chinese data are additional reasons why the RBNZ could be more dovish than hawkish. Overall, the risk for the NZD/USD ahead of the RBNZ rate decision is to the downside. The Australian and Canadian dollars on the other hand ended the day unchanged. Australian leading indicators and China’s HSBC Flash Manufacturing PMI index are due for release this evening. Slightly weaker Chinese growth could extend the losses in the AUD/USD. The same is true for tomorrow’s Canadian retail sales report -- weaker consumer demand could drive USD/CAD to 1.03

JPY: Potential Triggers For 100 Break This Week

The Japanese Yen traded higher against the U.S. dollar and most of the major currencies after having gapped higher at the Sunday open following the G20 statement which basically validated Japan’s policies. The G20 did not call on Japan to avoid competitive devaluation and instead said the country’s policies are aimed at ending deflation and supporting demand. With the G20’s support we continue to believe that it will only be a matter of time before USD/JPY breaks 100. Yet the currency pair’s second attempted test of this level has been another failure. As we wrote in our note on Friday, three things need to happen for USD/JPY to clear 100:

1. U.S. yields need to stop falling and start rising
2. the Nikkei needs to extend its gains and
3. Japanese investors need to start buying foreign bonds.

According to our colleague Boris Schlossberg, this flow could be coming, “Over the weekend, the Wall Street Journal noted that Japan’s insurance sector which holds more than 3 Trillion dollars in assets may begin to shift part of its portfolios into foreign bonds as they seek higher returns than the ultra low yielding Japanese Government bonds. With the new fiscal year starting April 1, even a 1% shift in the composition of those assets could produce significant capital outflows and drive USD/JPY higher as result.” This week’s Bank of Japan monetary policy meeting, their semi-annual outlook report and the weekly flow of funds data could all be potential catalysts for a break above 100 by satisfying #2 and #3 on our list.

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

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