Highlights
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G7/8 meeting unlikely to produce any currency pronouncements (outside of the Yuan) |
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JPY crosses remain favored, JPY weakness to be reinforced by G7 apathy |
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Equity markets are stratospheric and at risk |
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Eurozone confidence indicators, Bank of England minutes are key data |
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Commentary
Brian Dolan, Chief Currency Strategist
The dollar has finished another choppy week of consolidation, closing roughly unchanged vs. the Euro and about 1 yen higher against the JPY. Carry trades continue to be the main source of reliable trade opportunities, with JPY crosses persistently testing important psychological levels, such as 164.00 in EUR/JPY and 240.00 in GBP/JPY. US Treasury yields jumped about 10 bps higher as the bond market continued to cover bets on a near-term US rate cut. The data out of the US this week was the proverbial glass half full/empty, allowing traders to draw from it what they wanted. Overall, the market appears to have abandoned its extreme pessimism over the US economic outlook, but in my opinion, just at the moment when the US economy is displaying signs of a soft patch directly ahead.
US housing starts surprised by increasing, but building permits, the leading edge of the home construction cycle, fell to levels not seen since June 1997—hardly a promising sign. The NAHB housing index similarly fell back to the lows of the current cycle at 30, suggesting the housing market remains heavily weighed down by excessive inventory and unlikely to recover in any meaningful fashion this year. The primary bright spots in the US economy are emanating from the manufacturing sector (e.g. stronger industrial production, Phila. Fed), but this is due more to increased exports stemming from strong global demand and the lower US dollar, rather than a meaningful signal that US manufacturing is undergoing a structural rebound. On the contrary, the US manufacturing sector continues to contract in a long-term structural decline and is not a large enough foundation to sustain the expected slowdown in personal consumption. Higher oil and gasoline pump prices are expected to have a more significant impact in the coming weeks and months, and will be more evident in May's retail sales and durable goods reports. On the bright side, US equity market gains and solid labor markets are temporarily sustaining US consumer confidence, but global equity markets are increasingly looking bubble-ish and at risk of sharp reversals.
The Chinese central bank, the Peoples Bank of China (PBOC), announced on Friday that it was widening the daily trading band in which the Yuan is allowed to fluctuate from 0.3% (either side) to 0.5%. The PBOC also raised its benchmark interest rate 18 bps to 6.57% and raised bank reserve requirements, in continuing efforts to rein in an economy expanding at more than 10%. The change to the Yuan trading band is an attempt to mollify critics in the US and elsewhere that China is not doing enough to allow the Yuan to appreciate. The attempt has clearly failed, as US legislators roundly criticized the move as symbolic and insufficient to stem rising trade protectionism. The Yuan had never traded more than 0.22% under the prior 0.3% band, so expectations are low that China will actually allow the Yuan to appreciate anywhere near the 0.5%. The currency market reacted by briefly buying JPY, sending USD/JPY lower, but the move was retraced in a matter of hours. Selling JPY strength/buying USD/JPY and JPY-crosses on dips remains the preferred strategy going forward.
The G7/8 finance ministers are meeting today and tomorrow in Germany, minus US Treasury Sec. Paulson and central bankers, and this makes any significant currency developments highly unlikely. Comments from Japanese Fin. Min. Omi today suggested that German Fin. Min. Steinbrueck did not express any concern about the level of EUR/JPY, which accelerated the cross's post-PBOC recovery. The increasing reluctance of national finance officials to rock the currency boat suggests next week could see significant gains in USD/JPY and the JPY-crosses. US Treasury Sec Paulson will be meeting with China's Vice Premier Wu starting on Tuesday next week, and barring substantial Yuan appreciation in the meantime, there appears to be little forthcoming to upset the resurgence of the carry trade.
Getting back to the immediate market outlook for the US economy and the dollar overall, I am looking for increasing pessimism on the US outlook to re-assert itself and the key price indicator will be a drop in the US dollar index below 81.75 (roughly 1.3600 in EUR/USD equivalent) which would break the current bear flag consolidation and signal fresh weakness in the US dollar. Until that level breaks, I expect consolidation trading to continue, which should allow JPY-crosses to continue to grind higher, with an equity market collapse the greatest risk to this outlook. The telling sign for me has been the dollar's minimal recovery against European currencies despite the surge in Treasury yields and stock prices and relatively positive economic data.
Turning to the data and event calendar for next week, data out of the US is mostly light until the end of the week. On Tuesday, the Richmond Fed index is scheduled in the morning; Paulson begins meetings with Chinese officials; and Fed's Lacker (hawkish) speaks on inflation in the NY evening. Wednesday sees MBA mortgage applications as the only data release, with Treasury Sec. Paulson briefing the media on the China discussion in the New York afternoon. Thursday sees April durable goods orders, weekly jobless claims, and April new home sales. Friday sees only April existing home sales.
In the Eurozone, several ECB speakers are scheduled throughout the week (see Economic Calendar), but the highlights are likely to be various confidence indices. German and Eurozone ZEW confidence for May are out on Tuesday, along with Eurozone March trade balance and construction output. Wednesday sees March Eurozone industrial new orders. On Thursday, final 1Q German GDP leads off, but the highlight will be May German IFO. Friday sees the April German import price index and the June GfK consumer confidence reading, along with French April consumer spending. Friday also sees the release of the KOF Swiss leading indicator.
UK data starts out with Rightmove house prices for May on Sunday night, followed by money supply and bank lending data on Monday morning. On Wednesday, the Bank of England will release the minutes of its most recent MPC meeting and they will be critical for market expectations on the timing of future rate hikes. Thursday sees preliminary 1Q total business investment and the May CBI industrial trends (manufacturing sector) survey. On Friday, 1Q GDP and private consumption is set to be announced.
Japanese events kick off with BOJ MPC minutes being released on Tuesday afternoon in Tokyo along with the Cabinet Office's May economic assessment. Wednesday morning sees the release of the March All-Industry Activity Index. Thursday morning in Tokyo sees the April trade balance. And Friday morning will see April national CPI and May Tokyo-area CPI readings, which are expected to remain mostly flat on a core ex-fresh food basis.
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