By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- FX: Its About Risk Aversion Not A Rising Dollar
- EURO: An Extremely Attractive Funding Currency
- NZD: What to Expect from RBNZ
- AUD: Hit by Drop in Business Confidence
- CAD: Oil Prices Decline
- EUR/GBP Drops to the 70 Cent Handle
FX: Its About Risk Aversion Not A Rising Dollar
At first glance the fresh multi-year lows in the euro and Australian dollar along with the steep slide in the New Zealand dollar suggests that there is a voracious appetite for the greenback. While that may be true, Tuesday's intraday reversal in USD/JPY, a decline in U.S. yields and the steep slide in equities tell a different story. Instead of optimism for the U.S. economy, the rise in the dollar reflects risk aversion. Investors are worried that the Federal Reserve is getting closer to raising interest rates. But if that were the real driver of dollar flows, USD/JPY would have participated in the rally instead of erasing all of Tuesday’s gains. The big story, though, was the negative interest rates in Germany. The mere reality that one of the world’s most liquid instruments is now offering a negative yield is making investors nervous about the current market environment. ECB QE is thought to be extremely positive for European stocks, but the DAX and other indices fell across the board on Tuesday. Investors are nervous about the dynamics that have forced the ECB to buy bonds with yields down to -0.2%, including things like the ongoing Greek debt-deal talks and falling oil prices.
Tuesday’s second-tier U.S. economic reports had very little impact on the dollar as the drop in wholesale sales offset the minor increase in small-business confidence, wholesale inventories and job openings, according to Job Openings and Labor Turnover Data from the Bureau of Labor Statistics. Comments from Federal Reserve officials helped to lift the greenback but as non-voting members of the FOMC this year, Mester and Fisher’s views have a limited impact on policy. Nonetheless, Mester said she is comfortable with a rate hike in the first half of the year and Fisher believes that it is better to raise rates early and gradually than to have to raise rates steeply if liftoff is delayed. There are no U.S. economic reports scheduled for release on Wednesday but the dollar should remain bid as we head into next week’s FOMC meeting.
EURO: An Extremely Attractive Funding Currency
It took 24 hours for investors to digest the significance of Quantitative Easing on the euro and European bonds but once they realized the magnitude of the announcement and longevity of the bond-buying program, they turned around and sold euros aggressively. The single currency dropped to its lowest level since April 2003. With bond yields falling to negative levels across the curve in Germany, the euro has become one of the most attractive funding currencies simply because there’s a very good chance that the slide in EUR/USD will extend to 1.05 -- and possibly even parity. Ongoing Greek talks is also unsettling the market because Finance Minister Varoufakis said in a documentary that aired Tuesday that “Clever people in Brussels, in Frankfurt and in Berlin knew back in May 2010 that Greece would never pay back its debts. But they acted as if Greece wasn’t bankrupt, as if it just didn’t have enough liquid funds.” He added that “in this position, to give the most bankrupt of any state the biggest credit in history, like third-class corrupt bankers, was a crime against humanity,” according to a German translation of his comments. There are no details on when his comments were recorded but to this day it remains true because it will be difficult for Greece to meet all of its debt obligations without a haircut. So between QE, Fed tightening and the problems in Greece, the path of least resistance for the EUR/USD is still lower even as speculative short positions continue to hit extreme levels.
NZD: What to Expect from RBNZ
All 3 of the commodity currencies extended their losses against the dollar but the New Zealand dollar continues to be hit the hardest, falling another 1.25 percent against the greenback. Environmental terrorists threatened to poison Fonterra (ASX:FSF)’s infant formula if the New Zealand government does not stop using pesticide 1080 by the end of March. As the world’s largest dairy exporter and New Zealand’s biggest company, this terrorist threat could have broad ramifications for the country’s industry. While Prime Minister John Key said it is extremely difficult and unlikely that anyone would be able to deliberately contaminate the formula during the manufacturing process, this threat could affect international demand for New Zealand milk exports. Hopefully this won’t lead to another Chinese ban that contributed to Fonterra earnings shrinking 45% in FY2014. The RBNZ is not expected to change interest rates on Wednesday afternoon NY Time, Thursday morning local time, but dovish comments could send NZD below 72 cents. When the central bank last met in January, the RBNZ’s cautious outlook on inflation surprised the market. They warned that headline annual inflation could turn negative for a period before moving back toward 2% and indicated that combined with an unjustifiably high exchange rate, fiscal consolidation, reduced dairy payout and the risk of draught, the outlook for growth has now changed. Most importantly, they removed the statement about expecting more tightening and replaced it with the comment that rates could move up OR down depending on data. NZD will be hit hard if the RBNZ suggests that the chance of a rate cut has increased. But if they sound a bit more optimistic, which is unlikely, the currency will squeeze sharply higher. Lower oil prices contributed to the slide in the Canadian dollar while a drop in Australian business confidence sent AUD to fresh 5.5-year lows versus the USD. Australian consumer confidence numbers were scheduled for release Tuesday evening.
EUR/GBP Drops to the 70 Cent Handle
While the British pound traded slightly lower against the U.S. dollar, it continued to rack up gains versus the euro. In the short span of a month, EUR/GBP has fallen more than 350bp, which is significant for the slow-moving pair. Twenty-four hours after the ECB began Quantitative Easing, Bank of England Governor Carney reminded everyone that the next move by Britain will be a rate hike. He said that while inflation could slow further in the coming months, wage growth is starting to pick up, output growth remains solid and, therefore, a gentle rise in the bank rate is consistent with its mandate. The BoE will be the second major central bank to raise rates behind the Fed. And just as the dollar has seen strong gains on the prospect of Fed tightening, sterling will enjoy a solid rally when the BoE is ready to tighten. In the meantime, it should be a choppy and slow rise. U.K. industrial production numbers are scheduled for release Wednesday and the increase in manufacturing activity last month points to stronger numbers.