Highlights
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RBNZ intervenes to stem Kiwi gains |
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US yields rally sharply, but look to have peaked |
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Shake-out in carry trades looks to be short-term |
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Heavy US data schedule in second half of week |
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Commentary
Brian Dolan, Chief Currency Strategist
The USD had one of it better weeks last week, rising against European currencies and the JPY, while remaining mostly sideways at low levels against the minor dollar pairs. Stronger US data (higher ISM non-manufacturing and narrower trade deficit) and hawkish commentary from Fed Chair Bernanke and other Fed officials saw US 10 year Treasury yields spike to 5.25% from 4.95% at the start of the week, though the weekly close looks to constitute a rejection from the key 5.25% level. Along with the US data and Fed comments, a not-completely unexpected NZ rate hike ignited global fears of higher interest rates which led to a shake-out of speculative positioning across global markets. As a part of this, the US stock market swooned in mid-week, but recovered about half of its losses by the end of the week, reinforcing the idea that the wave of risk reduction might have already run its course.
Despite the run-up in US Treasury yields, Fed Fund futures show no expectation of a Fed rate hike for the remainder of the year, and this makes the Treasury yield rally look suspect. Technical levels were breached and a few big-name institutions revised their forecast of Fed rate cuts to a steady outlook for the rest of 2007, suggesting there was a fair amount of capitulation-selling of bonds that drove the yields to their peak. The USD/Euro yield spread only widened about 8 bps further in favor of the USD, so the move was mostly global, but with a slightly USD-supportive bias. Looking at the USD index, it tested and failed at the 38.2% retracement of the move lower from the end of January at 82.85. A daily close above that level will be needed to see the dollar build on its gains against European currencies.
Over the last several weeks to months, a sense of complacency had infected global financial markets, where risk aversion was at extremely low levels, and carry-trades (sell low-yielding currencies e.g. JPY and CHF/buy higher yielding currencies e.g. NZD, AUD, and GBP) and emerging market investments could do no wrong. Last week's volatility looks to have shaken out many of the short-term speculative positions, so the question is whether the longer-term predisposition of risk-seeking has been altered. I would suggest that the fundamental global economic outlook remains on solid footing and that liquidity remains sufficiently fluid to reestablish prior investment patterns. In other words, I'm viewing this as a short-term set back to otherwise well-entrenched trends rather than the beginning of a larger unwinding of major bets. In the short-term, though, we need to go through the process of testing the market's resolve, which translates to testing the dollar's upside against Europe and the downside of the JPY-crosses.
The RBNZ, New Zealand's central bank, intervened by selling NZD/USD as the NZD was making all-time highs since moving to free-float in 1985. The RBNZ indicated in a statement confirming the intervention that it had acted to stem currency gains that it characterized as "exceptional and unjustified in terms of economic fundamentals." The problem with the RBNZ's decision to intervene is that the direction of monetary policy in New Zealand remains supportive of the currency, undermining the efforts to rein in Kiwi strength. This sets up a classic battle between the Forex market and a central bank, with the market likely to come out on top after a few forays. A pronounced cooling in the NZ economy will be needed for a sustainable shift in NZ monetary policy and an end to the currency's appreciation. In the short-run, however, the market will be extremely cautious of intervention going forward, likely resulting in frequent profit-taking rallies on renewed strength. My outlook remains to buy NZD on dips, with the current lows of 0.7460/70 the immediate support level to watch, and 0.7300 as the longer-term support, but to also be more pro-active in taking profits on further rallies. Rather than a buy-and-hold strategy, the short-term environment favors more active trading. Semi-annual bonus payments in June in Japan are expected to result in another flood of JPY-selling/buying of higher yielders (NZD and AUD) similar to the waves following the start of the current Japanese Fiscal year in April. This should provide a solid base from which to enter long JPY-cross positions, using pullbacks as buying opportunities.
Turning to the data front, the US faces a heavy schedule in the latter half of the week, with only the IBD/TIPP economic optimism survey out on Tuesday. On Wednesday morning, May advance retail sales are out along with import prices, but the key event for the week may be the Fed's Beige Book in the afternoon. The Beige Book will give us the Fed's latest snapshot of how the economy has been developing and the risk given the renewed optimism over the US outlook is that the Beige Book reveals more soft spots (such as housing, consumer spending, or business capital expenditures) than has been evident in other recent data. Thursday's highlight is the May PPI, which is expected to see a steady YoY core reading of 1.5%. Friday's data is heaviest: May CPI; Empire manufacturing; 1Q current account balance; April TIC report; May industrial production and capacity utilization; and the preliminary June Univ. of Michigan consumer sentiment report.
Treasury Sec. Paulson will participate in a panel discussion at a trade conference in Atlanta on Tuesday, but his more important appearance is likely to be in a subsequent joint press conference with US Commerce Sec. Gutierrez. Their focus is likely to be on warning about the risks from rising protectionist sentiment in the US, which tends to be dollar disruptive as the US stands the most to lose from any trade disputes. Paulson will also speak on Thursday on the Treasury's role in national security. Multiple Fed and other speakers are on tap, but only a few look to have something to say on the economy or market themes: former Fed Chair Greenspan is the keynote speaker at a mortgage industry conference on Tuesday afternoon; Treasury's Kimmitt on international investment on Tuesday; NY Fed's Geithner on the Asian economy from Singapore on Wednesday Morning EDT; Fed Chair Bernanke will address a credit conference on Friday, followed by SF Fed's Yellen in the afternoon.
Eurozone data is relatively light this week. Tuesday sees May German wholesale prices and April Eurozone industrial production. Wednesday sees May CPI out of France, Spain and Italy along with 1Q Eurozone employment data. Final May German CPI is due out on Thursday with May Eurozone CPI data. Friday has only April's Eurozone trade balance of note.
UK data sees May CPI released on Tuesday. GBP/USD will no doubt react sharply to the report, which is expected to see price pressures recede as energy prices were lowered on a national basis, but the headline YoY CPI reading is only expected to fall to 2.6% from 2.8%, still well-above the BOE's 2.00% inflation limit, potentially making any GBP sell-off a buying opportunity. The UK's April trade deficit is also slated for Tuesday morning; it's forecast to have remained relatively steady at -7.0 bio. Wednesday sees May employment data, April average earnings and leading indicators. Friday sees May retail sales.
Japanese data see May's CGPI (corporate goods price index) on Tuesday morning in Tokyo, followed by May consumer confidence in the afternoon. Wednesday morning will see the April trade and current account balances, with final April industrial production due out in the afternoon. The BOJ MPC will hold a rate-setting policy meeting beginning on Thursday afternoon, and the rate decision (no change expected) is scheduled for sometime Friday afternoon Tokyo time. Data on Friday starts with the April Tertiary industry index in the morning and sees the final April leading economic index in the afternoon.
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