Waiting For The Central Bankers

Both the dollar and the euro weakened yesterday. The euro is being undermined by political tensions in Portugal, where the government is struggling to survive after two ministers resigned. But investors are unwilling to hold large short EUR positions ahead of today’s European Central Bank (ECB) meeting, hence the euro gained against the dollar. The dollar’s movements were harder to explain, given that both the ADP employment report and the employment component of the ISM were stronger than expected (although the ISM index itself was weaker than expected). Seeing as most of the moves occurred early in the US day and currencies were fairly steady after that, probably it comes down to no more than position-trimming ahead of the Independence Day holiday today in the US and what is likely to be a long (and volatile) weekend for many traders.

Today’s ECB meeting will be the focus of attention. The data out of the Eurozone has been improving recently, but that only means “less bad.” There is less urgency for the ECB Council to take any new extraordinary measures to resuscitate the Eurozone economy, yet there is nowhere near the kind of improvement that would let them start to unwind the measures that they have in place, either. Given the current political problems in Portugal and the sharp rise in interest rates there, plus the refusal of the politicians to agree on a banking union, the ECB will probably want to take some action to calm the markets. ECB officials have been leaning more towards “forward guidance” than before; when Jean-Paul Trichet was ECB President, he frequently said that the ECB never “pre-commits,” but recently, ECB officials have been making more and more promises about how long interest rates will remain low. One tool that they could employ would be more formal “forward guidance” to encourage rates to remain low at the long end as well.

“Forward guidance” was a tool that Mark Carney instituted when he was Bank of Canada Governor, and today may see something along those lines after his first Monetary Policy Committee (MPC) meeting as Bank of England Governor. Given that the six MPC members who have consistently voted against outgoing Gov. King are unlikely to change their mind just because someone new is chairing the meeting, an outright change in policy is unlikely. But Carney could make a statement following the meeting, which would be a break with tradition as usually they do not make any statement when they leave monetary conditions unchanged. With gilt yields rising, he may want to take some step to ensure that the market does not tighten policy before the Bank is ready to do so. Improving the Bank’s communication with the market might help to achieve the MPC’s goals without changing the policy settings.

The likely impact of forward guidance from the ECB and BoE would probably be to push EUR and GBP lower, given that the expected medium-term real interest rate gap between the currencies is one of the main determinants of the exchange rate, as the graphs below show.
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The Market

EUR/USD
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• EUR/USD had a volatile day yesterday plunging to 1.2920 support as Portuguese bond yields rocketed on a reigniting of political risk with the generally weak Eurozone services PMIs adding insult to injury. A rebound materialised thereafter as the US dollar was plummeting versus the yen in a risk-off environment. The best ADP employment change since February, combined with the marginally better-than-anticipated weekly jobless claims and the widest U.S. trade deficit in a year triggered substantial volatility as the markets were trying to absorb the data. A subsequent rebound tested resistance at 1.3030 with the overnight dollar strengthening driving the pair towards 1.2980 support.

• Today sees the release of no US data but volatility is likely during the European trading session from the BoE and ECB meetings. Support and resistance levels are essentially the levels tested the past couple of days as EUR/USD consolidates around 1.3000, waiting for the ECB policies and the non-farm payrolls to provide direction.

• Support below 1.2980 comes at 1.2955 and 1.2920, with resistance at 1.3030, 1.3055 and 1.3075. The announcement of further accommodative policies by the ECB today may drive the pair towards 1.2900 and 1.2875 trendline support, though the markets may be restrained from overreacting in light of the U.S. employment report tomorrow

USD/JPY
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• USD/JPY broke down from 100.80 resistance on the rejuvenation of a risk-off sentiment, plunging to support in the 99.15 – 99.35 area that sees the 50-day MA as well as trendline support for yesterday. A fakeout from 100.00 found resistance at 100.10, before moving overnight to support at 99.70, with resistance thereafter coming at 100.

• Key levels to note for support are 99.70 and the 99.15 – 99.35 well-tested area with resistance seen at 100, 100.40 and more importantly 100.80.

GBP/USD
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GBP/USD was a major gainer yesterday, rebounding from the 1.5125 – 1.5140 support area following the best U.K. service PMI since March 2011, breaking out from significant resistance at 1.5200, finding initial resistance at 1.5270 before spiking to 1.5305, the 38.2% retracement level of the March – May rally.

• With Carney’s first BoE meeting today, the pair is likely to see substantial movement. Resistance above 1.5270 and 1.5305 comes at 1.5345 and 1.5370, the 50-day MA. Strong tested support comes at 1.5200 and in the 1.5125 – 1.5140 area with further support at 1.5040.

Gold

• Gold bulls should note the rather pathetic gains the commodity had amidst the political crises in Portugal and Egypt that triggered a risk-off environment and flight to safety. Resistance was struck twice at $1259 following the yet another weak MBA mortgage applications reading and the weak US services PMI. A breakdown from $1242 - $1244 support was short-lived as it occurred as the Portuguese yields were soaring.

• Support is seen yet again in the $1242 - $1244 area with weak support at $1234 and stronger support at $1224. Resistance above $1259 comes around $1269 and thereafter at $1285.

Oil

• Oil tested resistance at $102 following the strong ADP figure as well as following the greatest decrease in stockpiles in 2013, finding support slightly above $100.50.

• A breakout from $102.00 sees resistance at $102.95 and 103.80, a very significant Fibonacci retracement level. Support below the $100.50 - $100.65 area comes at the $100 mark.

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MARKETS SUMMARY