Kathy Lien is the Managing Director of FX Strategy for BK Asset Management.
Will EZ GDP Crush the Euro?
Since the beginning of the month, the euro fluctuated within a relatively narrow 112 pip trading range and during this time, the bottom of the range has been tested on four occasions. The 1.3333 low held each time, but if Thursday’s Eurozone GDP report shows that the region as a whole contracted in the second quarter, this support level could finally be broken. Normally GDP numbers are not big market movers because they are stale and backwards looking but this quarter’s release comes off the heels of a dovish central bank who expressed specific concerns about growth. A decline in Eurozone GDP growth would reinforce the ECB’s worries and widen the gap between Eurozone and U.S. rates. We already know that Italy fell into a recession in the second quarter and while growth in Spain accelerated, the problems are moving north. The Eurozone GDP report would not be so bad for the euro if the region expanded even a little and German GDP growth stayed positive. However the euro will be crushed if there is a contraction for either the Eurozone or its largest economy. If 1.3300 is broken, there is no major support until 1.3190. With short positions at 2-year highs, if GDP surprises to the upside, we could see a very strong rally that could take EUR/USD as high as 1.35 but the odds still favor a softer release.
USD: Weak Retail Sales Leaves Fed Comfortable Dovish
Wednesday’s anemic consumer spending report and this month’s disappointing non-farm payrolls release leaves Federal Reserve Chair Janet Yellen comfortably dovish. We know that the central bank is reluctant to tighten monetary policy early and the latest U.S. economic report hardens their resolve to leave rates on hold for a long period of time after Quantitative Easing ends. At this stage, we do not expect any clarification on the direction of U.S. monetary policy at next week’s Jackson Hole Summit. If we are lucky the next NFP and retail sales reports (both of which are scheduled for release before the September 17th FOMC meeting) will show an improvement, giving policymakers some confidence to provide hints on when rates could rise but if more weakness is seen, we will hear nothing but reluctance from the central bank. U.S. yields dropped to a fresh 1-year low on the prospect of a long period of low rates. The dollar, on the other hand, traded higher against the Japanese Yen and moved in an inconsistent direction against other currencies. For the most part, the market’s appetite for U.S. Treasuries and equities keeps demand for dollars intact. While the pace of U.S. growth leaves a lot to be desired, the outlook for the U.S. economy is still brighter than the Eurozone and other parts of the world. Eventually the downtrend in U.S. yields will come to an end but its not over until it is over.
GBP: 7 Reasons why Sterling was Hit Hard by BoE Quarterly Inflation Report
It’s official! The Bank of England has no plans to raise interest rates early and when this notion became clear, sterling traded sharply lower against all of the major currencies. Investors bailed out of the pound, driving it to a 3-month low versus the U.S. dollar. The decline in the currency actually started with the labor market report. Although the unemployment rate declined and jobless claims fell more than expected, the 0.2% slide in average weekly earnings overshadowed the rest of the report. However some investors still believed that the BoE would be hawkish, which explains why they drove GBP/USD up 40 pips minutes before the Quarterly Inflation Report was released. Unfortunately, as soon as investors saw that the central bank cut its wage growth forecast by half and lowered its Q3 GDP forecast, they brought sterling down quickly and aggressively. Although the BoE raised its 2014 forecasts for GDP and CPI slightly, the downgrades matter more because the central bank made it clear that tightening predicated on wage growth and a reduction in slack. In addition to predicting slower wage growth, they now believe it will take a longer period of time to eliminate the slack in the economy. So in other words, don’t expect an interest rate hike from the BoE anytime soon and the lack of hawkishness in Wednesday’s report should have washed out all of the longs and encouraged fresh shorts – we are looking for further losses in sterling.
1. BoE Cuts 2014 Wage Growth Forecast to 1.25% from 2.5%
2. Says it will take 3 Years to Eliminate Economic Slack (Previous 2-3 Years)
3. Lowers Q3 GDP Forecast to 0.7% from 0.9%
4. No Comment on when Rates will Rise
5. Carney Cites “Heightened Uncertainty” in Economic Slack
6. Says previous forecasts were over optimistic
7. Provides no Threshold on Unemployment or Wage Growth
AUD Soars but Beware of Slowdown in Chinese Lending
The rebound in the Australian and New Zealand dollars raised the possibility of a bottom in AUD and NZD. While the turn in AUD looks a lot stronger than NZD, both currencies benefitted from the weaker U.S. retail sales report, stronger Australian consumer confidence and improvement in risk appetite. The main focus Tuesday night was Chinese retail sales and industrial production numbers but to everyone’s surprise, investors completely ignored the softer releases. Compared to last year, retail sales growth slowed to 12.2% from 12.5% and industrial production growth slowed to 9% from 9.2% but given the overall improvements in Chinese data this quarter, the general belief is that China is still on a solid path to recovery. However the drastic slowdown in Chinese lending should have had a greater impact on the comm dollars. Despite the government’s recent efforts to ease credit, the central bank reported that lending dropped to its lowest monthly level since October 2008, right before the government announced a major stimulus package. Although the world was a completely different place in 2008, this unexpected decline in loan demand is a reflection of de-leveraging that could pose a big risk to the housing market and the broader economy. The PBoC downplayed the data by saying that July is traditionally a slow month for lending and recent changes to the supervision of the shadow-banking sector drove down demand for new loans but nonetheless we are worried about the broader implications. However for the time being AUD and NZD traders are taking the report in stride thanks to a nice jump in Australian consumer confidence. New Zealand retail sales and business PMI index were scheduled for release Wednesday night and odds were that these reports would not support the rally in NZD. USD/CAD ended Wednesday unchanged but beware, Statistics Canada said it found an error in July’s abysmal employment report and will issue a new one on Friday.
JPY: Japanese GDP “Beats” Expectations
The highly anticipated second quarter GDP report from Japan failed to have a significant impact on the Japanese Yen. When the better-than-expected number was released, USD/JPY barely budged, which should not have been a big surprise to our readers because in Tuesday’s note we said a stronger release represents status quo for the Bank of Japan and would therefore have a limited impact on USD/JPY. The Japanese economy contracted by 1.7% in the second quarter, slightly better than the 1.8% contraction predicted by economists. On an annualized, basis, this decline drove GDP growth down 6.8%, the weakest reading since the tsunami in 2011. Although economists anticipated a steeper 7% drop, Wednesday’s better-than-expected report is hardly a reflection of resilience or strength in Japan’s economy. The sales-tax increase obviously had a significant impact on growth with consumer spending dropping a whopping 5.2%, compared to a 3.7% forecast. A more moderate decline in business spending helped to make up for part of the difference. Although the pullback in the economy in Q2 was steep, early indications show a pickup in spending this quarter. So unless Q3 GDP growth also declines, signaling recession in Japan, the BoJ will still be looking for a recovery and express comfort with the current level of monetary policy. Machine orders were scheduled for release Wednesday evening and after 2 straight monthly declines, a rebound is necessary in June to maintain the central bank’s optimism.
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