Potential EUR/USD Breakout On PMI

Potential EUR/USD Breakout On PMI

The euro ended Wednesday unchanged against the U.S. dollar ahead of key euro zone economic reports. PMI numbers for the month of January are scheduled for release and they tend to provide the most up-to-date look at how the economy is performing. Based on the ZEW survey, investors are very optimistic about the outlook for Europe but the International Monetary Fund clearly doesn’t share that view. European currencies fell sharply, Wednesday, after the Fund cut its euro-zone and U.K.-growth forecasts. While the IMF expects the global economy to perform better this year than last, a potential contraction in euro-zone growth led them to downgrade its 2013 global growth forecast to 3.5 from 3.6%. The IMF isn’t drinking the kool-aid -- it don’t believe that the rise in German stocks and the decline in European bond yields will boost business and consumer spending enough for the euro zone to grow this year. Their dire forecast for a 0.2% contraction in euro-zone growth sent the EUR/USD tumbling. High unemployment and a 1.5% decline in GDP is expected to contribute the most to weaker growth but Germany, the region’s largest economy is also expected to grow a mere 0.6% versus a prior forecast of 0.9% this year. Concern about euro-zone growth is why Thursday’s PMI numbers are so important because they will provide a more accurate assessment of actual business activity. Both service and manufacturing sector PMI are expected to increase which would lend support to the euro. However if the PMI reports show a deeper contraction in service and manufacturing activity, leading to an overall drop in the composite index, the EUR/USD could break its range low of 1.3264. The currency pair has traded within a relatively tight 150 pip range since January 11 and a surprise in PMI could be significant enough to take the currency pair out of its range.

USD: Best Performing Western Nation In 2013?

While U.S. stocks climbed to fresh five-year highs, Wednesday, on the back of the House vote to temporarily suspend the debt limit until May 19, the performance of the dollar was mixed. The greenback appreciated against the Canadian and Australian dollars but its value was unchanged against the euro, British pound, Swiss Franc and Japanese Yen. The successful passage of a debt limit extension was a given considering that the bill was drafted by House Republicans -- to reject the bill would have been a complete embarrassment for the party. The next stop is to the Senate who will most likely approve it and pass it onto the President to sign. This bill gives Congress ample breathing room to work out a deal that will hopefully involve a combination of spending cuts and tax hikes. Congress will certainly need the additional time because Democrats and Republicans are still miles apart on a key issues. The only piece of U.S. data released was the House Price Index and price growth remained unchanged at 0.6% -- the report barely put a dent in the greenback. Jobless claims are due Thursday along with leading indicators. Given the sharp unexpected improvement in claims last week, that will be the number to watch. If jobless claims remain below 350K, we could see a nice risk rally in the FX market. However if claims snap back to 365K or higher, then investors will attribute last week’s improvement to a short-term anomaly. Meanwhile the U.S. is expected to be the fastest growing western nation this year with growth expanding by 2% according to the IMF’s projections. The IMF left its forecast for U.S. growth unchanged, saying that it is broadly on track.

GBP: Surprise Improvement In Labor Market

Thanks to stronger-than-expected labor market numbers, the British pound stabilized against the U.S. dollar and euro. According to our colleague Boris Schlossberg, who wrote about Wednesday’s U.K. events extensively saying, UK claimant count printed at -12.1K versus 0.4K expected -- much better than forecast. The data from the month prior was revised lower as well to -8.9K while the unemployment rate declined to 7.7%. Employment rose 90,000 during the quarter through November, taking the total of people in work to 29.7 million, the ONS said. That’s the highest since records began in 1971. The employment rate of 71.4% is at the highest since February-April 2009. The upbeat news on the labor front provided a rare bit of good news for the UK economy which has been plagued by chronically weak demand which will likely show yet another contraction in GDP in Q4 of 2012. One reason for the better than expected labor data is that wage growth has been exceedingly modest. Wages increased at only 1.5% versus 1.6% forecast. Still an increase in jobs should translate into better demand as the year proceeds and should put UK GDP back in positive territory in Q1 of this year. In addition to the labor data, the market also saw the release of the MPC minutes, which showed no surprise as the committee voted unanimously to keep rates unchanged and 8-1 to keep QE at GBP375 Billion. The MPC also noted that sterling’s exchange rate may be higher than warranted in order to rebalance the UK economy. However, the pair has come off nearly five big figures since the meeting, so the market did not react to the news. After such heavy selling, cable is due for a bounce and the today’s positive economic results along with more supportive risk flows could provide the impetus for a rally towards 1.5900.

CAD Collapses After BoC Tones Down Hawkishness

The Canadian dollar dropped to a two-year low against the U.S. dollar Wednesday after the Bank of Canada’s monetary policy announcement. While the central bank did not abandon its desire to raise interest rates, its motivation to do so has decreased. Interest rates were left unchanged at 1% and according to the BoC, higher interest rates are less imminent. Concerns about a weaker global economic outlook, persistent currency strength and weaker consumer spending led the central bank to reduce its 2013 GDP forecasts from 2.3% to 2.0%. Growth in 2014 was revised higher but that did not draw away from the fact that the BoC expects weaker growth in the near term. Apparently, the central bank does not believe that the strong job growth experienced over the past few months will translate into stronger support for the economy. Central bank Governor Carney elaborated on the decision shortly thereafter, saying that the direction of interest rate moves is clear but the timing has changed. The Australian dollar also lost value on the back of lower inflationary pressures. CPI grew a mere 0.2% in Q4 compared to 1.4% growth in the prior quarter. On an annualized basis, CPI still increased from 2% to 2.2% but this was weaker than expected and lower than the RBA’s projections. No major economic reports are expected from the commodity producing countries Thursday but Chinese HSBC Flash Manufacturing PMI numbers could have a big impact on the AUD and NZD.

JPY: Weak Yen To Provide Some Relief For Trade

While profit taking on short Yen positions translated into another day of losses for USD/JPY, the sell-off has been shallow, which is surprising considering that U.S. bond yields have fallen and the Bank of Japan won’t be shifting to open-ended asset purchases for another year. The resilience of USD/JPY is a reflection of Japan’s long-term strategy. While the Japanese didn’t quite live up to expectations this week, they will still be increasing stimulus at a time when other central banks will consider winding down their own programs. The rallies in U.S. stocks also helped the Yen funded carry trades maintain its luster, which is why the decline in AUD/JPY and NZD/JPY were so modest. Unlike other countries whose growth outlook was downgraded by the IMF, the agency kept its outlook and forecasts for Japan unchanged because it believes the government’s stimulus programs will boost growth in the near term and pull the country out of a short-lived recession. According to the BoJ’s monthly economic report, the economy remains relatively weak, which is why it decided that additional stimulus was necessary. Japanese trade numbers are scheduled for release and economists are looking for a smaller trade deficit. The Yen started to weaken in November but that was too early to benefit trade activity. The sell-off gained momentum in December and hopefully that helped to boost exports and narrow the trade gap. If Japan failed to see any relief in trade activity in December, the USD/JPY could resume its rise.

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