Sterling: Will GDP Show Triple-Dip Recession?

For the past two weeks, the British pound consolidated quietly between 1.52 and 1.54 waiting for a reason to breakout but sterling traders need not wait any longer as Thursday's first quarter GDP report poses a major risk to the recent consolidation. It is no secret that the U.K. economy is weak but the question before us is whether the U.K. fell back into recession in the first quarter and if so, will the Bank of England finally ease. Based on economist expectations, GDP grew 0.1% in Q1 and we agree that the economy expanded between January and March because retail sales and trade activity improved.

However, not everyone is sure that a triple-dip recession has been averted and the skepticism of Bank of England policymaker Weale who must have a good read on the economy has us worried. Weale said earlier this week that there is a risk GDP declined in Q1 and if he is right that would mean the U.K. economy fell into a triple-dip recession. Under that scenario, it will be extremely difficult for the Bank of England to justify keeping monetary policy on hold if growth contracts for a fifth out of the last six quarters. A drop in GDP growth should drive the GBP/USD below 1.52 and send the pair towards 1.50. With the recent decline in commodity prices and increase in the value of the GBP, the central bank has less to be worried about when it comes to inflation and its about time that they focus on boosting growth. Even if a triple-dip recession is avoided and unless GDP grew by 0.5% or more, we don't expect the GBP/USD to break above 1.54. For BoE Governor King, the real question is whether he wants to announce a major change in monetary policy so close to the end of his term. He will only lead three more BoE meetings before handing his post over to Mark Carney. Then again, the data could show that the U.K. economy can't wait any longer for stimulus.

USD: Shrugs Off Weaker Durable Goods
It was a quiet day in the foreign exchange market with the U.S. dollar ending the day slightly lower against most of the major currencies. The only U.S. economic report released Wednesday was durable goods orders, which plunged 5.7% in the month of March after rising a downwardly revised 4.3% in February. Weaker economic data continues to leave the USD and U.S. equities unfazed. At a time when investors are focused on the possibility of a rate cut in Europe, steady monetary policy in the U.S. boosts the dollar's attractiveness. Remember the Federal Reserve is now talking about when asset purchases should be tapered and not increased. Nonetheless, the latest economic report confirms that March was a difficult month in the U.S. economy. Excluding transportation orders, durable goods fell for the second month in a row by 1.4%. It is clear that a break of 100 in USD/JPY this week won't be triggered by U.S. data. The main catalyst will be the Bank of Japan's monetary policy meeting and their semi-annual report on the economy. If USD/JPY doesn't break 100 after Thursday night's event risks, then it will most likely continue to hold below this key level until next week's FOMC rate decision and non-farm payrolls report. Friday's U.S. GDP report is important but given the market's lofty expectations for 3.0% growth in Q1, a downside surprise would not be shocking.

EUR: Remarkably Resilient Despite Weak IFO
The resilience of the euro has been remarkable. Between the lower German IFO, PMI and ZEW surveys, the euro should be trading much lower. However each time the currency tried to break below 1.30, it bounced back quickly. The rise in European equities, expectations for Japanese purchases of European bonds and political progress in Italy is helping the currency but we think it is only a matter of time before further losses are seen. According to the German IFO report, business confidence tumbled in the month of April, as businesses grew less optimistic about the current and future state of the economy. Loan demand also declined in the first quarter because of economic uncertainty, adding to the growing reasons for why the ECB could ease. Of the 35 economists surveyed by Bloomberg, 22 expect a 25bp rate cut at the next meeting. This is only a small majority but given how much euro-zone data has deteriorated, the best case scenario for next week's ECB meeting are dovish comments from the central bank which in of itself is bad for the euro. If the ECB doesn't ease in May, they will set expectations for a rate cut in June. While there are no major euro zone economic reports between now and the ECB meeting next Thursday, the euro could start selling off at the beginning of next week (if not sooner) on the mere expectation for more stimulus. In other words, we don't think EUR/USD will be able to hold 1.30 for much longer. A number of ECB policymakers will be speaking Thursday, so keep an eye out for more rate cut talk.

AUD: CPI Growth Misses, Leaves RBA Room To Ease
The best-performing currency Wednesday was the New Zealand dollar, which benefitted from the Reserve Bank of New Zealand's less dovish comments. Compared to other central banks such as the ECB, BoE and perhaps even the RBA who are considering cutting interest rates, the RBNZ is comfortably on hold and the prospective of steady monetary policy is providing underlying support for NZD/USD. The Australian and Canadian dollars also edged higher even though a smaller than expected increase in Australian consumer prices gives the RBA more room to ease if they choose to do so. While they have said there is scope to ease, we don't think they have their hands on the button like the ECB. Instead, we believe the RBA will wait for more evidence of weaker consumer consumption or labor market growth before pulling the trigger on another round of easing. Consumer prices increased 0.4% in the first quarter, pushing the annualized pace of growth up to 2.5% - economists were looking for a rise to 2.8%. Considering that commodity prices plunged in April, the RBA won't be fazed by the uptick in CPI. No Australian or New Zealand data is due for release Thursday but Canada has average weekly earnings, which are expected to have increased slightly in the month of February.

JPY: Will Investment Data Finally Show Shift In Demand?
The Japanese Yen ended the day lower against all of the major currencies. While the Nikkei climbed to fresh five-year highs overnight, U.S. bond yields continued to fall, limiting the rally in USD/JPY. Overnight, USD/JPY made another attempt towards 100 but the rally failed at 99.76. Each successive high in USD/JPY has failed at a lower level, which suggests that it will take big news for the pair to break this level. Wednesday's report on Japanese purchases of foreign bonds is/was the first real opportunity for USD/JPY to burst higher. Since the Bank of Japan's easing, there has been no evidence of the Japanese diversifying into foreign bonds, a critical assumption for anyone who has sold Yen. If the Ministry of Finance's report this evening shows that diversification is finally happening, it could be just the catalyst that USD/JPY needs to break above its key level. However if the data shows that demand is still anemic or worse continued to decline, USD/JPY could extend its losses. Don't expect a big sell-off however as the BoJ rate decision, comments for central bank governor Kuroda and the release of their semi-annual outlook report on Friday poses upside risk for the currency pair.

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