Highlights
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Eurozone finance ministers meet next week |
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G8 meeting next week unlikely to mention currencies |
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Central bank rate decisions from RBA, RBNZ, ECB and BOE |
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US economic data show rebound alongside receding inflation |
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Commentary
Brian Dolan, Chief Currency Strategist
The currency market remains hemmed in, with the USD continuing to range against European currencies and probe higher against the JPY. The minor dollar pairs (AUD, CAD, NZD) saw the USD weaken, with gains in the CAD continuing relentlessly after the BOC signaled it might need to raise rates in July. My much hoped-for breakout from recent ranges failed to materialize yet again, but the more it goes on the larger the break out is likely to be. We had a lot of data out this week from the US and rather than providing the spark to light a new directional trend, it mainly served to reinforce the existing consolidation. US Treasury yields made new highs for the year, with the 10 year note yield set to close around 4.95%, up nearly 6 bps on Friday alone. Importantly, though, the interest rate differential between the USD and most other major currencies held steady, meaning interest rates are moving higher across the board. Gold reversed course on Friday, rallying over $10/oz and ended the downside correction that dominated most of May.
The data that came out of the US this past week was mostly mixed, with some bright spots (such as NFP, Chicago PMI, CB Consumer Confidence, ISM manufacturing) being offset by some weaker reports (personal income, ABC and U. of Michigan confidence, lower core PCE, existing home sales, and revised 1Q GDP). The emerging picture of the US economic outlook going forward is that growth is certainly rebounding from sluggish 1Q levels, but that housing markets remain a drag, and limit the upside outlook for the US. The US interest rate picture similarly remains on hold. Renewed growth prospects and inflation readings at the upper end of the Fed's comfort zone rule out a rate cut in the foreseeable future (Fed Funds futures are showing steady rates for the rest of 2007), while weakness in the housing and manufacturing sectors and overall sense of tentativeness eliminate the prospect of a rate hike as well. The outlook elsewhere is more clearly biased toward higher interest rates, soon, and for this reason I continue to favor an overall return to USD weakness in the near-term, mostly against European and commodity currencies, while a drop in USD/JPY remains a possibility as outlined in the weekly strategy.
We may have received some early signs of a return to USD weakness in the form of a rebound in gold prices and a return to strength in the commodity currencies. The rally in gold stemmed from an ECB announcement that it would not sell any more gold through September, which aided the AUD, CAD and NZD rallies. Those smaller dollar pairs frequently act as a leading indicator for the larger dollar pairs, and gold has a relatively solid long-term inverse relationship to the dollar. Also, I would note that the US dollar index tested its highs for the current recovery at 82.60, but was rejected again, generating a short-term double top in the process.
Next week will see the annual G8 summit meeting of heads of state and government in Heiligendamm, Germany. The bulk of the meeting will focus on larger global issues, such as global warming, energy security and aid to Africa. Currencies are unlikely to be a topic for formal discussion, and any mention of them is likely to be confined to the standard 'exchange rates should reflect economic fundamentals.' However, to the extent that currencies might be an issue, the risk is that Asian currencies (Chinese Yuan and JPY) will be urged to be more flexible, which would hurt USD/JPY the most. Also next week, the Eurozone group of finance ministers will gather for their monthly meeting. Recent comments suggest that most in the Eurozone are unfazed by the Euro's strength, and this should allow the single currency to remain steady to firmer.
There are no less than four central bank rate setting meetings next week, and while only one is expected to result in a change in interest rates, the other three are in play and there is at least some risk that they may surprise with rate hikes. On Tuesday evening EDT/Wednesday morning local time, the RBA is expected to hold rates steady at 6.25%, but the bias and potential are for higher rates in the future.
On Wednesday, the main event will be an expected 1/4% ECB rate hike to 4.00%. The focus will of course be on ECB pres. Trichet's press conference after the announcement. Comments from various ECB officials this week that rates remain historically low and accommodative suggest that further rate hikes are in store, but the timing is far less certain. Markets will be hanging on Trichet's every word to get a sense of when the next rate hike is expected, and Trichet will be doing his best to remain open-ended and non-committal on the timing. I look for the overall outcome to be on the hawkish side and Euro-supportive; should Trichet offer any indication of urgency or timing for additional rate hikes, the Euro move will be more explosive.
On Wednesday evening EDT/Thursday morning local time, the RBNZ will announce its decision. Market forecasts are for a steady 7.75%, but the bias is toward higher rates and at least one local bank is calling for a hike to 8.00% at next week's the June meeting (if not, then at the next meeting in July).
On Thursday morning, the Bank of England is expected to hold rates steady at 5.5% after hiking 1/4% at last month's meeting. It's not unheard of to have back-to-back rate hikes, but the circumstances tend to be more extreme than current conditions, and comments from MPC member Blanchflower this week suggested he was content to wait. But his vote to hike last month was the first time he voted for a rate hike since joining, so it suggests there is some sense of urgency among the MPC after CPI rose above the BOE's inflation target. If the Bank of England holds steady next week, the focus will shift to speculation of a July 5 BOE rate hike and likely still support GBP in the process.
US data next week is on the light side, with the highlights being factory orders on Monday; May ISM non-manufacturing on Tuesday; non-farm productivity and unit labor costs on Wednesday; weekly jobless claims and wholesale inventories on Thursday and April's trade deficit on Friday. Fed speakers include a video broadcast of Chairman Bernanke to an IMF conference in South Africa on Tuesday. He is slated to discuss the US housing market and the US economy in prepared remarks, with audience Q&A to follow. On Wednesday, Richmond Fed pres. Lacker (non-voter) and KC Fed pres. Hoenig will separately speak on the US economic and monetary policy outlook. Other Fed speakers are scheduled, but are not expected to address the economy or interest rates. US Treasury Sec. Paulson will speak on US-China economic relations on Monday.
Eurozone data starts off with April PPI on Monday. Eurozone finance ministers will begin gathering Monday evening and meet again on Tuesday, so be alert for comments. Tuesday also sees service sector PMI's from Eurozone, Germany, France and Italy along with April Eurozone retail sales. G8 officials are meeting on Thursday and Friday, and a German government briefing on the meeting will take place on Wednesday morning European-time. April German factory orders are also due out on Wednesday, followed by the ECB rate announcement. Friday will see French and German trade balances for April along with April German industrial production.
Japanese data begins on Monday morning Tokyo time with 1Q capital spending and monetary base data. The next item is preliminary April leading economic index on Wednesday afternoon Tokyo time. Thursday morning will see official reserve assets in the morning, followed by preliminary May machine tool orders in the afternoon. Friday morning will see money supply and bank lending data for May in the Tokyo morning, followed by the May Economy watchers survey in the afternoon.
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