FX: The Next 24 Hours

Next 24 Hours – British Pound, Turkish Lira in Play

Over the next 24 hours the focus of the foreign exchange market will be the British pound and Turkish Lira. Fourth quarter GDP numbers are scheduled for release from the U.K. and we believe there’s scope for an upside surprise. With retail sales and trade activity improving significantly towards the end of the year, GDP growth is expected to jump from an annualized pace of 1.9% to 2.8%. Last week, Bank of England Governor Carney warned about the problems posed by a strong currency and while we have seen a pullback in PMIs, other economic reports reinforce the broader recovery in the U.K. economy. If Tuesday’s Q4 GDP numbers surprise to the upside, sterling could hit a fresh 2.5 year high against the U.S. dollar. 2014 will be a year of continued growth in the U.K. with economic activity supported by housing, banking and the global economy. The U.K. government did a fantastic job of propping up the housing market in 2013 with the Funding for Lending Scheme and the Help to Buy program. Their pledge to keep interest rates low will keep mortgage rates cheap, driving property prices higher and attracting foreign investment in 2014. The U.K. government understands that reflating the housing market is the key to keeping the economy supported and consumers feeling optimistic. After writing off significant amounts of bad debt, the banking sector is also expected to report stronger earnings and dividends this year while a stronger global environment will solidify the recovery and help the U.K. economy reach the Bank of England’s 2.8% growth target for 2014, which is significantly higher than the 1.6% growth expected for 2013.

Turkey is the wildcard. Monday it announced an emergency monetary policy meeting. The market is waiting with bated breath to see what the central bank will do to stem the slide in their currency. We expect the central bank to raise interest rates but there’s always the possibility of a more creative option. The larger to the rate hike, the more support it will provide to the Lira. The market is expecting a minimum of 100bp in tightening and possibly even 200bp. Their goal is to restore confidence in their currency and if they are effective, it will bolster risk appetite across the financial markets and drive USD/TRY and EUR/TRY lower.

Dollar: Rise in US Yields Reflects Taper Expectations

There was very little consistency in the performance of the dollar over the past 24 hours. The greenback strengthened against the euro, Japanese Yen, Canadian dollar and Swiss Franc but weakened against the British pound, Australian and New Zealand dollars. The rebound in U.S. yields and sell-off in U.S. stocks suggests that investors are preparing for another round of tapering this week from the Federal Reserve. New home sales was the only piece of U.S. data released Monday and unfortunately sales declined for the second month in a row by 7%. The housing market weakened towards the end of the year but this is always a soft period for real estate. Durable goods and consumer confidence numbers are scheduled for release Tuesday and they are not expected to have a dramatic impact on the dollar although the Consumer Confidence Board’s report could follow the University of Michigan’s index lower. Meanwhile emerging market central banks are getting desperate and their latest attempts to drive up the value of their currencies helped risk appetite in the foreign exchange market recover. The Federal Reserve has a monetary policy meeting this week and the sell-off in emerging market assets will make their decision to continue reducing asset purchases difficult. However based on the rebound in U.S. yields, investors expect the latest announcements from Argentina and Turkey’s emergency monetary policy meeting Tuesday to keep the Fed on track to taper.

After devaluing their currency last week, Argentina took further measures on Friday to prevent outflows. The government eased capital controls by allowing Argentines to buy dollars as long as they earn a minimum of 7,200 pesos per month but restricting their purchases to $2,000 per month. They also lowered the tax on dollar purchases from 35% to 20%. The announcement was made several days ago but it didn't take effect until Monday. Unfortunately the impact on the currency has been nominal because many investors fear these steps will backfire because it makes imports more expensive and raises the risk of inflation in a country that is already dealing with significant price pressures. Prices of refrigerators have already gone up as much as 30% since the devaluation. Turkey said Monday morning it will hold an emergency meeting Tuesday and a big announcement is expected to follow.

Aside from the desperate actions of emerging market central banks whose currencies and reserves are falling, risk appetite also recovered after China Credit Trust announced that they secured funding that would avoid the near term risk of default. Stronger business confidence in Germany also eased concerns about the outlook for the Eurozone but the initial gains in the euro have since evaporated. According to noted Fed watcher Jon Hilsenrath, the sell-off in emerging market won’t stop the Ben Bernanke from tapering because the impact on U.S. assets have been small. He argues that stocks are falling from high levels and interest rates are under control. However if the Fed decides to provide more support to the U.S. and the global economy by keeping asset purchases unchanged this month, we could see a relief rally in emerging and developed currencies.

EUR: Shrugs Off IFO Hit by EUR/TRY Selling

Better than expected German business confidence failed to have a lasting impact on the euro. When the data was initially released, the euro traded higher but the currency made a U-turn almost immediately to trade at its lowest level of the day right before the North American open. German businesses grew more optimistic in the month of January about current and future economic conditions with the expectations component of the report rising to its strongest level since March 2011. This should be good news for the Eurozone and euro but the single currency failed to rally on the news. A rise in U.S. yields can be partially blamed for the weakness along with the sell-off in U.S. stocks but that should have hit all currencies and not just the euro. Instead, the main reason for EUR weakness was EUR/TRY selling. As mentioned earlier, the market is gearing up for a major announcement from Turkey’s central bank and this expectation caused a significant amount of short covering in the long EUR/TRY trade. Over the next 24 hours, the Turkish Lira will remain in focus and drive demand for euros.

AUD: Rebounds on China Banking Sector News

While the Australian and New Zealand dollars recovered strongly against the U.S. dollar, the Canadian dollar gave up its earlier gains to end the day lower against the greenback. No economic reports were released from Canada but the slide in oil prices contributed to the reversal in the loonie. Of all the major currencies, the outlook for Canada is one of the most dismal and if conditions do not improve soon, the Bank of Canada consider cutting rates more seriously. We already know that they would like to see a weaker loonie and so far, investors have obliged. With no Canadian economic reports scheduled for release until Friday, the outlook for USD/CAD hinges on the Federal Reserve’s monetary policy decision. If the Fed tapers this month, USD/CAD could be poised for further gains. Thanks to the news that China Trust secured funding to avoid a credit event, the Australian dollar is the day’s best performing currency. New Zealand was the only commodity producing country with economic data and despite the rally in AUD/NZD, New Zealand’s economy continues to grow with service sector activity expanding in the month of December. The Reserve Bank of Australia meets this week and while we do not expect a rate hike, hawkish comments should keep NZD bid.

JPY: Trade Deficit Hits Record High in 2013

Thanks to the recovery in risk appetite, USD/JPY shrugged off the 2.5% slide in the Nikkei overnight to trade higher against all of the major currencies. AUD/JPY was the best performing yen pair, rising more than 1%. A number of tier 1 economic reports are scheduled for release from Japan this week starting with last night’s trade balance. On an adjusted basis, Japan’s trade deficit continued to expand in the month of December with export growth slowing to 15.3% from 18.4% and import growth accelerating to 24.7% from 21.1%. On an annualized basis, the country’s deficit reached a record high in 2013 of 11.5 trillion yen. The fact that the deficit continued to rise in December despite USD/JPY’s move from 101 to 105 is a sign of the country’s structural changes including its improvement in domestic demand and reliance on external energy supplies. The corporate service price index is due for release this afternoon along with small business confidence. We continue to expect improvements in Japan’s economy ahead of the consumption tax hike in April. While these reports are important, the outlook for USD/JPY and other Yen crosses will continue to ride on the market’s appetite for risk. If Turkey’s announcement pleases the market on Tuesday, USD/JPY should extend higher. If they disappoint, the Yen crosses could resume their slide.

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