Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
FX: Here's the Top 5 Events to Watch Next Week
There was quite a bit going on in the forex market this past week but the focus was on the dollar. At the start of the week, rising U.S. yields drove the greenback higher but by the end of the week it was risk aversion that dominated the market's appetite for dollars. Global equities have fallen sharply and their weakness weighed on currencies even though there was a gentle recovery on Friday. In the coming week, we believe there will be less focus on the dollar and more focus on global developments. Non-manufacturing ISM is the only piece of U.S. data with any significance on the calendar during a week when 4 major central banks have monetary policy announcements and 3 countries have employment reports scheduled for release. The top-5 events to watch this week in order of potential market moving-ness are then1) ECB rate decision 2) Chinese trade balance 3) US Non-manufacturing ISM 4) RBA Rate Decision and 5) Australian employment. While the Bank of Japan and the Bank of England will also have monetary policy announcements, no changes are expected which means these events should have very little impact on their respective currencies. The ECB is also expected to leave interest rates unchanged but Mario Draghi's press conference moves the euro frequently. Given the low level of inflation we expect the central bank to maintain a dovish bias and continue to talk about the need for additional stimulus. Chinese trade numbers will probably show further stabilization but economists are looking for a softer release. Typically the U.S. non-manufacturing ISM report is a big market mover because it is a leading indicator for NFPs but since this month's release comes after the payrolls report it should have less impact on the dollar. The RBA will most likely maintain a neutral policy stance but beware of any renewed concerns about the housing market or lower commodity prices. Finally, employment reports from Australia, New Zealand and Canada will definitely have a meaningful impact on their specific currencies.
Disappointing Payrolls Strip Dollar of its Gains
Investors sold dollars Friday on the back of a disappointing non-farm payrolls report. If you read our NFP preview on Thursday, you will know the odds (or more specifically, the leading indicators) were in favor of a soft release but given the strong gains in the greenback and the recent rise in U.S. yields, investors were positioned for a positive number. So when payrolls printed 209k vs. an estimate of 230k, the dollar dropped immediately against all of the major currencies. Not only did payroll growth fall short of expectations but the unemployment rate rose to 6.2% from 6.1% and average hourly earnings growth remained unchanged versus a forecast for a 0.2% rise. If the jobless rate held steady and average hourly earnings increased, the decline in the dollar would have been more modest. While Treasury yields plunged on the report, the question to ask is whether Friday's labor market disappointment is enough to hold the Fed back from laying out their exit strategy in the next 2 months and we think the answer is no. The Fed is scheduled to end Quantitative Easing in October and they will need to layout their plans for what comes next by September. The only difference that Friday's data makes is that they may postpone changing their guidance to the September FOMC meeting instead of the August Jackson Hole Summit. The uptick in unemployment is not unnatural given the sharp improvements we've seen in recent months and while wage inflation slowed according to average hourly earnings, the Employment Cost Index surged in Q2. Nonetheless with market participants long dollars ahead of payrolls, the pullback in the greenback Friday is not unusual even though the University of Michigan consumer sentiment survey was revised higher and manufacturing activity accelerated in the month of July. The only piece of market moving U.S. data next week is the ISM non-manufacturing index and given the early release of NFPs, it may have even less impact on currencies. In other words, we expect non-U.S. data to have a bigger influence on FX trade than U.S. economic reports.
Sterling - 13 Days Without a Rally
Thirteen trading days have now past without a meaning rally in the GBP/USD. This is the longest stretch of weakness that we have seen in sterling since August 2008. In early 2013, there were long periods of sterling weakness but a meaningful rally occurred after 12 days. GBP/USD has obviously become deeply oversold but it is important to understand why the currency is having such a difficult time rallying. This year, speculators built up massive long positions in sterling in anticipation of earlier tightening by the central. On July 1 when sterling broke above 1.71, speculative long positions as measured by the CFTC were at their highest level since 2007. Since then we have seen a significant reduction in long positions that tell us the latest sell-off in sterling is driven by liquidation. U.K. data took a turn for the worse prompting the Bank of England to tone down their hawkishness and speculators to abandon their long positions. While this week's CFTC report shows that traders are still net long sterling, they are significantly less so suggesting that further weakness could require a conscious decision by investors to short the currency. The Bank of England meets next week but no changes in monetary policy are expected which means the rate decision will be a nonevent for the currency. Instead, the PMI services and composite index, industrial production and trade balance will have a more significant impact on sterling trade. Given the drop in the manufacturing PMI index on Friday, most of these reports will probably be weak which means even if we have a recovery in the GBP/USD in the coming week, it could be shallow.
AUD Rebounds on Stronger Australian and Chinese Manufacturing Activity
All three of the commodity currencies rebounded against the U.S. dollar Friday but the recovery is marginal when compared to the steep losses experienced over the past 2 weeks. It is premature to call this a bottom in the comm-dollars -- USD/AUD, USD/NZD, USD/CAD -- especially given the abundance of Australian, New Zealand, Canadian and Chinese economic reports scheduled for release next week. The U.S. dollar may not contribute as much to the moves as it did at the end of July but domestic developments could pressure these currencies lower. The Reserve Bank of Australia has a monetary policy announcement and lower prices could raise fresh concerns about the terms of trade. Retail sales, employment and the service sector PMI are also scheduled for release and we fear that AUD which closed below the 100-day SMA for the first time since March could be vulnerable to additional losses. Labor market data is expected from New Zealand along with two speeches from Finance Minister English. The twice a month dairy auction that created quite a bit of volatility for NZD in past months is scheduled for Tuesday August 5th. Canada's trade, IVEY PMI and employment reports will decide whether USD/CAD hits 1.10. On top of all this, we also have HSBC's composite Chinese PMI index and trade balance on the calendar. Australian and Chinese manufacturing activity accelerated in the month of July and further improvements need to be seen in next week's reports for these currencies to stage a stronger recovery that would make Friday's bounce a bottom for the comm dollars.
JPY: Recovery Begins to Lose Momentum
While there hasn't been much consistency in the performance of the Japanese USD/JPY this week, there has been a lot of consistency in the trend of Japanese data. Between industrial production, retail sales, labor cash earning, jobless rate and last night's manufacturing PMI report, all signs point to a loss of momentum in Japan's recovery following the slowdown in April. One month of softer data may not constitute the beginning of a new trend but it will be something that the Bank of Japan watches very closely. The Bank of Japan is widely expected to leave monetary policy unchanged next week but the minutes may show less optimism. Since the sales tax was increased in April, the central bank was confident that the economy would be able to withstand the negative implications. For a while it appeared that they were right but now investors are getting worried that growth is starting to slow and more stimulus could be necessary. Aside from the BoJ rate decision, the PMI composite index, leading indicators, trade balance and Eco Watchers survey are also scheduled for release.
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