Week of April 10, 2011
Dollar gets slammed on monetary policy outlook
The U.S. dollar has weakened significantly this past week as monetary policy divergences became more prevalent and commodities continued to soar. Precious metals marched higher with gold hitting new record highs while silver broke above $40 and oil topped $110 a barrel. Currencies whose countries export commodities were beneficiaries as highlighted by new post-float highs in AUD/USD which climbed above 1.0500 and multi-year lows in USD/CAD which fell below 0.9600. The ECB lifted rates by 25 bps to 1.25%, the first move on interest rates since May 2009 but no gave indication that it will be the beginning of a series. This is largely different from the Fed’s policy stance which has maintained its commitment to keep rates low for an ‘extended period’. Moreover, while recent speeches by some members of the Fed have suggested cutting short the plan to purchase $600 billion in assets through June, this week’s FOMC Minutes showed little evidence that the idea has gained traction among the FOMC voting members. In the week ahead, FOMC voting members Dudley, Evans, and Yellen are set to deliver speeches and we would note that these members are considered to be dovish. The monetary policy outlook remained the key driver as dollar index sunk to new 16-month lows and though budget talks and a looming government shutdown are viewed mostly political theater and are likely to have little economic impact, it gives investors yet another reason to sell the buck.
The exception to USD weakness has been against the Japanese yen which has continued its sharp reversal lower following the G7 coordinated intervention. Japan was struck with another earthquake, this time around the magnitude of 7.1. While reports of the earthquake were initially met with risk aversion, markets breathed a sigh of relief after tsunami warnings were retracted and resumed their appetite for risk. The week ahead will include the Fed’s Beige Book to give clues on the outlook of the economy, speeches by FOMC voting members, and inflation data. We would anticipate a stabilization in the buck as investors take profit ahead of key levels and events.
ECB keeps its cards close to its chest
So the ECB hiked rates as anticipated but the question now for investors is what they will do next. The market thinks there will be a further two hikes before the end of the year with the next hike coming in July, according to the Eonia swaps market.
The 11 per cent increase in the euro versus the dollar since the start of this year suggests that a lot of the expected ECB tightening is already priced into the single currency. So if things stay as they are then the euro may lose its yield advantage and could come under pressure. This would happen if investors think the ECB may not deliver as much policy normalisation as they originally anticipated.
However, on the back of last week’s meeting we know two things: firstly that the ECB has not yet decided if this will be the start of a rate hiking cycle, and secondly, that the future trajectory for interest rates depends on inflation since price stability is the ECB’s sole mandate.
So this week’s second inflation reading will be crucial for interest rate expectations in the currency bloc. The first reading saw inflation rise to 2.6 per cent in March from 2.4 per cent in February. Above target inflation is unacceptable to ECB policy makers and March’s price data most likely sealed Thursday’s rate hike. We will get the regional breakdown of the inflation figures on Thursday. We already know that inflation in Germany rose to 2.2 per cent while even debt-laden peripheral nations have experienced inflation pressures including Ireland, where EU harmonised inflation jumped from 0.9 per cent in February to 1.2 per cent in March.
It is the large jumps in inflation that the ECB want to avoid, and right now price pressures continue to build as energy prices surge to multi-year highs. If we see an upward revision to inflation next week then a rate hike before July becomes a possibility.
We think that dips in EURUSD will remain fairly shallow and a weekly close above 1.4420/30 may herald further gains to 1.4700 then 1.5000. But a caveat to this is the dollar. Arguably weakness in the greenback is pushing the euro higher and any swift resolution to the US’s budget impasse could see a reversal in short dollar positions and thus weigh on the euro in the short-term. In the long-term the direction of EURUSD depends on the clarity provided by the Fed about its intentions regarding monetary policy normalisation.
The UK: pricing out a rate hike
It wasn’t that long ago that the UK was considered the first of the major central banks to hike interest rates. Yet that seems like a long time ago now. The ECB has moved first and the UK’s growth outlook has deteriorated sharply. This has weighed on interest rate expectations and 3-month Sonia rates (GBP inter-bank swap rates that follow interest rate expectations closely) have fallen sharply.
The market is increasingly coming to the conclusion that the Bank of England won’t hike interest rates at their next meeting in May, and instead will wait until August to do so. This is consistent with our call and we expect the BOE to remain on hold this quarter.
Economic data has been largely weak with only a couple of upside surprises. One was service sector data for March, yet we believe this was an anomaly and service sector activity played catch-up after weather-related disruption in January and February.
But, while we think the BOE may be on hold longer than the market currently expects, there are a couple of important caveats to remember. The first is the Q1 GDP release on 27 April. This is the deal-breaker in our view. Lacklustre quarterly growth – something below 0.8 per cent would be viewed as a disappointment – would make a rate hike less likely in the current environment.
Another risk is the May Inflation Report. We think the economic backdrop, the impact of austerity measures and weak wage growth will be enough for the Bank to maintain its cautious stance in May. The Bank tends to hike rates after an Inflation Report, so the next logical date for an increase in rates would be August – after the Bank’s summer Report.
This makes the pound a sell on rallies in our opinion. It has already tested 1.6400 highs, but we think it is vulnerable to a pullback especially versus the dollar and the euro since a lot of its recent strength was fuelled by rate hike expectations. With this major source of support gone, sterling strength is likely to be curtailed going forward.
Will the BoC do anything Loonie next week?
On April 12th the Bank of Canada will announce their interest rate decision. By nearly all measures the market is expecting them to remain on hold at 1.00%, but their statement will be closely watched for any potential changes to their accommodative stance. As a result of rising food and energy prices economists have begun to shift their inflation forecasts higher for 2011 and 2012, however immediate pricing pressures continue to remain subdued. Nevertheless, such a backdrop makes the BoC’s job that much more challenging as they begin to deliberate on the path of future rate hikes.
On Wednesday the BoC will release the April Monetary Policy Report. The MPR is going to provide further economic incite and will likely touch upon turmoil in the Middle East and earthquake/tsunami in Japan – which has caused a rise in oil (energy) prices, as well as provide a slightly more optimistic bias regarding GDP over the coming quarters. While the stronger CAD has restrained Canadian exports, something Governor Carney continues to highlight, it will be unable to keep the BoC on the sidelines for too much longer. Going forward we believe the BoC is likely to remain on hold until the beginning of the 3rd quarter, where we expect a rate hike of 25bps at each meeting through the end of 2011 (July, Sept., Oct. & Dec.).
The CAD has been one of the strongest commodity currencies since the beginning on 2011, appreciating roughly 4.4% year to date, as it has benefitted from strong domestic fundamentals, improving global growth and rapidly rising oil prices. Just today crude oil (WTI) made fresh multi-year highs around $112.55/60,and firm demand from both emerging & developed economies, as well as ongoing unrest in the MENA region will likely to continue to support the ‘black-gold’ going forward. Therefore, while commodities remain strong and the U.S. dollar remains offered, we’ll look to be a seller of USD/CAD on rallies towards 0.9625/35 and 0.9680/00 in the week ahead.
Key data and events to watch next week
The greenback remains on the offer, driven fundamentally by widening rate differentials between the U.S. and other CBs. The USD Index broke below its short term bear flag formation to fresh yearly lows just above the 75.00 figure. Additionally, USD weakness is being confirmed by other asset groups - gold broke above the key 1450 level, also the neckline of an inverted H&S pattern suggesting a measured move objective to the 1550/75 area. Technical developments this week suggest the greenback’s woes may continue but considering the steep rate of USD declines, pullbacks should be expected and may provide better value for those looking to establish USD shorts.
EUR/USD: The ECB’s 25bp hike to the main refi rate may be a historic step as the central bank could be initiating a tightening cycle before the Fed for the first time. Uncertain Fed policy direction continues to weigh on the buck elevating EUR/USD above key technical levels. The most significant being the weekly close above primary downtrend resistance (around 1.4300) suggesting sustainable EUR strength in the weeks ahead. 1.4450 (61.8% retracement for the 1.6035/50-1.1875/80 decline) , however, is proving to be a formidable hurdle as EUR strength was capped into it on Friday trading. Below 1.4300 sees additional support into the 1.4250 pivot which may provide decent value for EUR longs as the medium term technical outlook has now shifted to the upside.
GBP/USD: The BoE remained on hold as expected and with rate differentials driving FX, the uncertain outlook for UK rates has seen the sterling underperform relative to other majors against the buck. GBP/USD, however, looks set to close above its respective primary trendline which technically suggests a potential reversal for the primary decline from the 2.1160 peaks. 1.6500 is likely to be a psychological barrier ahead of the key 1.6825/50 daily horizontal pivot. Immediate support may be seen into 1.6275/00, broken trendline resistance, ahead of the key 1.5975/1.6000 daily pivot.
AUD/USD: Commodities have been screaming higher which has seen commodity currencies benefit substantially. AUD/USD posted post-float record highs on a seemingly daily basis this week and looks set to close near weekly highs around 1.0540/50. The 1.0600 figure is likely to provide some technical hurdles to further Aussie strength but if commodity upside continues, the 1.0900 measured move objective for the symmetrical triangle breakout may be in view next. Downside corrections may find meaningful support into the rising trendline around 1.0450 ahead of the 2010 1.0255/60 highs.
USD/JPY: Another earthquake in Japan saw USD/JPY upside capped ahead of the all-important 85.50 barrier. Rumored options related stops above 85.50 were never hit as the declining trendline from the 2007 124.10/15 peaks and the 55-week SMA effectively stunted further JPY weakness against the greenback. Immediate support may be seen into the 84.50 daily pivot ahead of 83.50 which sees the 200-day sma converge with broken daily triangle tops. Considering uncertain USD monetary policy, USD/JPY is likely to underperform relative to other JPY pairs.
EUR/JPY: With loose BoJ monetary policy now a given for the foreseeable future and the ECB possibly embarking on a tightening cycle, EUR/JPY blew through a number of key technical levels this week. 120.00, psychological barrier and Feb. 2010 lows, proved to be no match for the pair. Furthermore, EUR/JPY has managed to close above weekly Ichimoku cloud tops ( 121.90/00) suggesting upside trend continuation may be sustainable and should be a level of immediate support on downside corrections. Below may find more meaningful support into the Feb. 2010 lows around the 120.00 figure which may provide value for EUR/JPY longs.
Key data and events to watch in the week ahead
United States: Monday – Fed’s Yellen and Dudley speak Tuesday – Mar. Import Price Index, Feb. Trade Balance, Apr. IBD/TIPP Economic Optimism, Fed’s Tarullo to speak Wednesday – Mar. Retail Sales, Feb. Business Inventories, Fed’s Beige Book Thursday – Weekly Jobless Claims, Mar. PPI, Fed’s Duke, Plosser and Tarullo speak Friday – Mar. CPI, Industrial Production and Capacity Utilization, Apr. Empire Manufacturing, Feb. Net TIC Flows, Apr. prelim U. of Michigan Confidence, Fed’s Evans speaks
Eurozone: Tuesday – Mar. final German CPI, Apr. EZ and German ZEW Survey, ECB’s Stark speaks Wednesday – Mar. German Wholesale Price Index, Feb. EZ Industrial Production Friday – Mar. EZ CPI, Feb. EZ Trade Balance, ECB’s Constancio speaks
United Kingdom: Monday – Mar. RICS House Price Balance Tuesday – Feb. Trade Balance figures, Mar. CPI, RPI Wednesday – Mar. Claimant Count Rate, Jobless Claims Change, Feb. Avg. Weekly Earnings, ILO Unemployment, Mar. Nationwide Consumer Confidence
Japan: Monday – Feb. Machine Orders Tuesday – Mar. prelim Machine Tool Orders Wednesday – Mar. Domestic CGPI Friday – Feb. final Industrial Production and Capacity Utilization
Canada: Tuesday – Feb. New Housing Price Index, Feb. International Merchandise Trade, Bank of Canada Announces Interest Rates Wednesday – BOC Monetary Policy Report Thursday – Feb. Manufacturing Sales
Australia & New Zealand: Tuesday – NZ Finance Minister English speaks, Mar. AU NAB Business Confidence and Conditions Wednesday – Mar. NZ Food Prices, Apr. AU Westpac Consumer Confidence, Apr. AU DEWR Skilled Vacancies Thursday – RBA Governor Stevens to speak, Mar. NZ Business NZ PMI
China: Sunday – Mar. Trade Balance Friday – Mar. Industrial Production, Retail Sales, CPI, PPI, Industrial Production, Fixed Assets Investment, 1Q GDP
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