By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Thanks to the Bank of Japan, we’ve had a very exciting end to the first trading month of the year. 2016 started and ended with a bang after Japan’s central bank pulled out all of the stops by dropping interest rates below zero. They have now become the 4th country with negative rates (next to Denmark, Switzerland, Sweden) and the 5th including the Eurozone. Most investors expected the BoJ to be dovish, some were even looking for more QE but they reached deeper into their toolbox and rolled out negative interest rates. This decision took USD/JPY from 118.50 to its 200-day SMA at 121.70. A 400-pip move is typical after such a major announcement -- back in October 2014 USD/JPY jumped more than 300 pips after the BoJ surprised the market with a new round of Quantitative Easing. On Friday, they not only lowered interest rates, but also pushed out their timeline for reaching their inflation target and warned that more actions could be taken including changing the quantity and quality of asset purchases as well as cutting rates further. Since the BoJ did not increase the size of its QE program, this could be the next option if the economy weakens further. But adopting this radical form of monetary policy is a sign of the country’s desperation. They are finally recognizing the negative impact that volatility in the financial markets, the sharp decline in inflation and the slowdown in China will have on Japan’s economy. In Thursday’s note, we talked about how much Japan’s economy deteriorated since the December meeting, but the drop in the Nikkei, rise in the Yen and speculative positioning also played a big role in the BoJ’s decision. Looking ahead, the yen should be sold on rallies.
Next Week: 8 Major Event Risks
- Chinese PMI
- UK PMI
- RBA Rate Decision
- German Labor Report
- NZ Labor Report
- BoE Rate Decision and Quarterly Report
- US Nonfarm Payrolls
- Canadian Employment Report
Each one of these reports has the power to trigger big moves in currencies, but together we can expect continued expansions in volatility.
Although U.S. nonfarm payrolls is the most high-profile report on next week’s calendar, we find Australia and the U.K.’s monetary policy announcements far more interesting because after the BoJ’s actions, everyone is wondering who will be next. Neither the RBA nor the BoE are expected to change monetary policy but a dovish bias from both could drive AUD and GBP lower. With the Chinese economy slowing and commodity prices falling, it may be difficult for the RBA to maintain a brave face. AUD and NZD traded lower Friday but we believe that those rallies will fade soon. China’s official PMI report is not expected to be particularly ugly, as the government will do everything in its power to prevent further losses in equity markets.
The Bank of England on the other hand has every reason to lower its inflation forecasts and signal to the market that interest rates may not increase until the end of the year at the earliest. Given the sharp fall in retail sales and trade activity in the fourth quarter, we are still surprised by the uptick in GDP. We prefer to put greater weight on Bank of England Governor Carney’s dovish comments and the likelihood of the BoE minutes and Quarterly Inflation report echoing that tone. GBP/USD traded lower Friday and we are looking for further losses in the currency pair.
Of course the focus will also be on the U.S. dollar because not only do we have the employment report at the end of the week, but also personal income and spending, ADP and the ISM manufacturing report on the calendar. However with all of the other Tier-1 economic reports scheduled for release and the lack of the ISM non-manufacturing index, don’t expect the dollar to capture the market’s attention until Thursday. Also a weak nonfarm payrolls report will have a larger impact on the greenback than a strong one because it will reinforce the market’s suspicion that Federal Reserve shares the concerns of other major central banks. Friday’s BoJ decision and the ECB’s recent dovishness puts significant pressure on the Fed to delay tightening, even though personal consumption growth accelerated according to the fourth quarter GDP report. Growth slowed to 0.7% from 2% at the end of last year, which was slightly worse than expected. But considering that investors braced for an even weaker release, it was good enough to prevent a significant drop in USD/JPY.
USD/CAD traded lower Friday on the back of stronger GDP numbers and higher oil prices. Canada’s economy expanded 0.3% in November up from 0% the month prior but the real key is oil, which continues to show signs of a bottom -- but 1.40 is proving to be a key level for USD/CAD. Like the U.S., Canada has employment and manufacturing PMI numbers scheduled for release next week. Both of these reports will be out on Friday, which means that for most of the week, USD/CAD will be driven by the oil.
Finally, we bumped the euro down to the bottom of Friday’s report because EUR/USD has been the most boring pair to trade. It has remained stuck in a narrow 1.0700 to 1.10 trading range and is likely to be bounded by these levels for some time. The decline in German consumer consumption, drop in French CPI and slowdown in French GDP growth was completely overshadowed by the BoJ’s rate decision. The euro did not benefit from the improvement in risk appetite, which should not surprise our readers because the currency behaved exactly the same way in October 2014. Compared to other major economies, the Eurozone has a lighter economic calendar with less market-moving data. German unemployment numbers are the main release along with revisions to PMIs.