By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Will RBA Cut 25bp, Driving AUD to 5 Yr Lows?
- NZD: Watch Out for Dairy Auction
- Dollar Bulls March on Despite Weaker Data
- Euro Bounces on Positive Data
- Sterling Fails to Benefit from Stronger PMI
Will RBA Cut 25bp, Driving AUD to 5 Yr Lows?
The are no shortages of important events and data on this week's FX calendar and one of the most market moving is likely to be Monday night's Reserve Bank of Australia monetary policy announcement. Four major central banks are meeting this week and only one (the RBA) is expected to change interest rates. The Australian dollar traded lower on Monday, signaling that investors were positioning for a rate cut even though 18 out of the 29 economists surveyed by Bloomberg were expecting the RBA to ease. A rate cut is not a done deal. Taking a look at the table below, there has been just as much improvement as deterioration in Australia's economy. While the labor market weakened, private capital expenditures plunged and manufacturing activity in February contracted at its fastest pace since July 2013, retail sales, consumer confidence, home loans, business confidence, trade, service and construction sector activity improved since the last monetary policy. In other words, there isn't enough broad-based deterioration to warrant back-to-back 25bp rate cuts. It is also hard to dissect how the RBA will interpret this weekend's surprise rate cut from China. Easing by China reduces the pressure on the RBA to take similar action but at the same time, China's decision was motivated by weaker manufacturing and inflation data. The bottom-line is that it will be a close call. If the RBA cuts rates, it should drive the AUD/USD to fresh 5.5-year lows below 0.7626. If they leave rates unchanged, a short-squeeze-driven rally should drive the currency pair toward 78 cents. How much further it extends beyond that level will be determined by forward guidance. If the RBA chooses to forgo a back-to-back rate cut, we still expect the central bank to maintain a dovish bias, leaving another round of easing in 2015 on the table. Aside from AUD, the Canadian and New Zealand dollars will also be in play Tuesday with Canadian GDP and another dairy auction for New Zealand on the calendar.
Dollar Bulls March on Despite Weaker Data
The U.S. dollar powered higher Monday despite another round of weaker data. The market's relentless appetite for U.S. dollars is impressive considering that the latest economic reports harden our view that the Federal Reserve will raise interest rates in September and not in June. In fact, Rabobank pushed out its forecast for Fed tightening to December on the premise that the stronger dollar will delay a rate hike. While we do not believe that they will wait until year-end to raise rates, we agree that they are in no rush to tighten. Personal income, personal spending, the ISM manufacturing index and construction spending all surprised to the downside, leaving the rise in U.S. yields as the only explanation for the strength of the greenback. Manufacturing activity has been particularly weak with all of the regional and national reports surprising to the downside. Spending also contracted for 2 months in a row but the silver lining is that Americans are saving at the fastest pace since 2012. Weaker U.S. data does not support the rise in yields but record-breaking moves in equities could be driving investors out of bonds and into stocks. But that's a weak argument at best. We are still waiting for a pullback in the dollar before reloading our long positions. Meanwhile USD/JPY broke through 120 after a massive option expiration and the break coincided with a broad-based intraday rally in the greenback. There are no major U.S. economic reports scheduled for release on Tuesday but as the week progresses, the dollar will take its cue from Fed-speak and labor-market reports. Since non-farm payrolls are not scheduled for release until Friday, this should be one of those weeks where global data/events are just as important as U.S. data.
Euro Bounces on Positive Data
The euro may have ended Monday unchanged against the U.S. dollar but the currency pair rebounded nicely from its intraday lows. The tides could finally be shifting with Eurozone data surprising the upside and U.S. data falling short of expectations. Easy monetary policy, the weakness of the euro and low energy prices could finally be lending support to the Eurozone economy. Last week, ECB President Draghi said he saw the first signs of confidence in the economy and on Monday we learned that consumer prices fell less than expected in February and that the unemployment rate dropped to 11.2% from 11.3%. Manufacturing activity in Germany was stronger than initially anticipated but activity in the Eurozone was revised slightly lower. There are a number of Eurozone economic reports scheduled for release this week, most of which we believe will show further stabilization in the Eurozone economy. However the most important event risk will be the European Central Bank's monetary policy meeting. No changes are expected but the ECB will provide details on its Quantitative Easing program. QE is scheduled to begin in March and one of the greatest challenges for the central bank is finding enough government bonds to buy. If you recall, the ECB committed to buying 60 billion euros each month until September 2016. Some of the details that we expect from Mario Draghi include the exact date of when asset purchases will begin, how long they will last, the breadth of bonds purchased and whether National Central Banks can buy other country's bonds or only their own. EUR/USD trades will be most sensitive to the ECB's latest economic forecasts. We expect the central bank to raise its growth outlook but lower its inflation forecast.
Sterling Fails to Benefit from Stronger PMI
The British pound traded sharply lower against the U.S. dollar Monday despite better-than-expected manufacturing data. We are actually extremely surprised by the weakness in sterling given the importance of the PMI index and the fact that it rose to the strongest level in 7 months. The service sector may encompass a wider part of the U.K. economy than manufacturing but the three PMI numbers scheduled for release this week are central to shaping the market's expectations for BoE tightening. Still, we don't need to dig deep to find a reason for sterling's weakness as Monday's housing-market reports surprised to the downside. House prices fell 0.1% in February according to Nationwide and mortgage approvals rose less than anticipated. We don't feel that this weakness is material enough to affect the chance of tightening by the BoE in 2015 and therefore we view the current decline in sterling as an opportunity to buy the currency pair at a lower level.