FX Week In Review: The EUR Bucks Up

Thanks to upside surprises in euro-zone data, the euro ended the week slightly higher against the U.S. dollar. The recent improvements are important and could lead to a sustainable recovery in the currency because the prior sell-off was caused by the rate cut from the European Central Bank and their concerns about the economy. The latest GDP numbers showed the region in recession and if the pessimistic outlook and forecasts by the central bank are reinforced by weaker data going forward, then the ECB would need to follow through on their pledge to ease again which would be negative for euro. However the uptick in the euro-zone PMI and German IFO reports this past week reduces pressure on the central bank and the hence the currency. If these positive surprises continue next week, they will breath new life into the euro because each piece of good news would ease the ECB's concerns.

German unemployment and retail sales figures are the most important releases on the euro-zone calendar next week. Even though manufacturing and service sector activity improved according to the PMI numbers, the details of the report show the first decline in staffing since January. So we don't advise traders to rush into buying euros until seeing next week's labor market and consumer spending figures. If economic activity in Germany begins to improve there be hope for a stronger recovery in the euro because it would help to level the playing field for the ECB and Fed. In the meantime, it is worth noting that the pivotal 1.28 support level in EUR/USD held throughout the week -- making it an increasing significant level for the currency pair. With both the U.S. and U.K. markets closed on Monday, there are no major economic reports scheduled for release and therefore trading should be quiet.

Dollar Likely To Be At The Whim Of Stocks Next Week
While the performance of the U.S. dollar this week has been mixed, between Ben Bernanke's testimony, the FOMC minutes and recent economic reports, the Federal Reserve is getting closer to dialing back asset purchases. This should be positive for the U.S. dollar but with stocks struggling to extend their gains, de-leveraging has driven the greenback lower against the euro and Japanese Yen. Despite better than expected durable goods orders, USD/JPY dropped to 101 and then fell further as the day progressed. Demand for goods made to last for more than a few years rose 3.3% in April after falling 5.9% the prior month. Excluding transportation, orders were still strong but shipments plunged 1.5%, offsetting some of the optimism. At the earliest, we do not expect the Federal Reserve to reduce bond buying until September. With at least three months worth of economic data to go before then, there's plenty of opportunity to get a better look at how the U.S. economy is doing. We know the Chinese economy is slowing and it poses a major risk for global growth. If that is the case, the Fed may opt to delay changes to December but if the U.S. economy proves to be resilient thanks to the confidence instilled by the rally in equities, expectations and positioning for changes in U.S. policy could accelerate. U.S. markets are closed on Monday and the calendar is light on market moving data for the rest of the week. In our opinion, the U.S. consumer confidence report and Chicago PMI release will be the key releases because confidence and manufacturing can be leading indicators for the economy. Overall we do not expect economic data to drive big moves in the dollar. Instead, if there is an increase in volatility it will most likely come from the movements in equities.

JPY: Victim Of Equity-Market Volatility
What a week it has been for Nikkei. After falling 7% on Thursday, the index dropped as much as 3% before ending up 1% by the close of the Tokyo session. These crazy moves in stocks have triggered a tremendous of anxiety in Japan that has caused wild swings for the Yen. For the second day in a row, the Japanese Yen traded higher against the USD, leading many investors to wonder if this pullback will become a deeper reversal. The answer lies in whether the Japanese stock market will continue to fall and based upon the schizophrenic nature of how the Nikkei has traded in recent days, even equity traders are unsure whether the latest sell-off is an attractive buying opportunity. Equity market volatility is generally not good for a country's currency but in the case of Japan, the volatility has led to a reduction in leverage, which has been positive for the Yen. Japanese officials are clearly not happy with the recent volatility in the equity and JGB markets. Last night, Prime Minister Abe reminded us that the central bank is not buying government bonds directly and BoJ Governor Kuroda said their primary focus is deflation and not currency or stock market values. If the volatility continues, government officials may need to offer more than verbal intervention. Next week will be a busy one in Japan with a significant amount of Japanese data on the calendar including industrial production, inflation, employment and manufacturing numbers.

GBP: Reality Check For Sterling
The British pound ended the week lower against the U.S. dollar and euro. This week's economic reports served as a reality check for the currency, which received some interested following better than expected PMI numbers at the beginning of the month. However that enthusiasm is beginning to fade as investors wonder whether the recovery is beginning to lose momentum. The surprisingly deep pull back in retail sales and the continued debate within the central bank about whether or not additional stimulus is necessary has renewed concerns about the outlook for he currency. While Bank of England Governor King declared that the economy is recovering at his final monetary policy meeting, he chose to vote in favor of additional stimulus. The question now becomes how eager incoming BoE Governor Mark Carney is to ease. Carney takes over in July and between now and then we will get a better sense of how the U.K. economy is faring. The U.K. economic calendar is fairly empty next week aside from secondary housing and lending data.

AUD: Deep Losses In Commodity Currencies
It has been a very tough week for the Australian, New Zealand and Canadian dollars, all of which fell to fresh multi-month lows on the back of risk aversion. The U.S. dollar contributed a very small part to the move as these pairs failed to recover even as the greenback gave up its gains towards the end of the week. There were a handful of economic reports but the key release over the past week was the HSBC's Chinese PMI report because it raised fresh concerns about the outlook for the world's second largest economy and cut short the rally in equities. The AUD/USD has been hit particularly hard but NZD/USD also failed to avoid losses. The RBA minutes from the past week revealed that a strong currency was the primary motivation for their rate cut. This means another bout of easing is unlikely given the recent decline in the currency so the primary driver behind AUD weakness is the U.S. dollar and the health of the Chinese economy. While there is not much in the way of Australian data next week, the AUD and NZD will remain in focus as the recent slide has everyone wondering whether its time to buy. We caution against picking tops and bottoms in deep trends but we will also be looking for the currency to find support closer to 95 cents. New Zealand trade numbers were released overnight and the smaller surplus contributed to the sell-off of the NZD. Next week will be all about Canada with a Bank of Canada monetary policy meeting, first quarter GDP and current account numbers on the calendar. As this will be the last meeting led by Mark Carney we expect monetary policy and the tone of the central to remain unchanged.

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