A stronger US dollar and Japanese yen, and weakness in the British pound, euro, and commodity currencies were well documented, but the big rally in the Chinese yuan caught the markets largely by surprise.
With the US dollar (USD) trading higher against all major currencies on Wednesday, it is easy to attribute the move to the Fed’s more positive Beige Book report. Many people feared that given the recent weakness in US data, the Beige Book would paint an ugly picture of the current state of the US economy, but thankfully, it did not.
According to a summary of the reports from the 12 Fed districts, consumer spending grew modestly while employment conditions remained unchanged or improved. This is good news because it suggests that the weakness seen in March did not extend into April. Of course, it is still too early to draw any conclusions, but it is safe to say that the Beige Book results could have been far worse.
What is interesting, though, is that equities and bonds did not respond nearly as well to the report. The S&P 500 held onto its losses, while the ten-year US Treasury yield dropped to a year-to-date low. This indicates that investors in other markets are skeptical about the optimism from the Beige Book and are worried about the global recovery in general. As a result, they have piled back into the US dollar, which has become the preferred safe haven after the Bank of Japan (BoJ) monetary policy decision increased the risk of holding the Japanese yen (JPY).
Jobless claims, the Philadelphia Fed survey, and leading indicators report are scheduled for release on Thursday. Based on the decline in the Empire State survey, we could be looking at the possibility of weaker data from Philly as well.
Meanwhile, with the sharp selloff in the euro (EUR) and the focus on the ongoing developments in Boston, traders may have missed the big move in the Chinese yuan. The People's Bank of China (PBoC) set the yuan at a rate of 6.1727, which is its strongest level in 19 years. According to the Vice Governor of the central bank, the plan is to increase the floating band of the yuan further and allow the exchange rate to be more market-oriented going forward.
Nonetheless, US Treasuries did not react well to the announcement. Treasury Secretary Lew said that that China's move to more exchange rate flexibility has slowed. Part of the reason we could be seeing unusual strength in the yuan is because the G20 finance ministers and central bankers will begin their meeting Thursday, and China is notorious for allowing its currency to strengthen before these key events.
ECB Rate-Cut Rumors Sink the Euro
Wednesday’s worst-performing currency was the euro, which dropped more than 1% against the US dollar. No major economic reports were released, but the combination of dovish comments from a European Central Bank (ECB) official and more positive Beige Book results from the Fed were enough to drive EURUSD sharply lower.
While the euro began to sell off two hours into the European trading session, the bulk of the move occurred around 10 am ET. Just when the Bank of Canada (BoC) was delivering its monetary policy decision, the euro was hit hard by the decline in US stocks and comments from ECB policymaker and Bundesbank President Jens Weidmann, who said the central bank could cut interest rates if new information warrants it.
If the ECB is serious about cutting rates, it would be a significant enough catalyst for this selloff in the euro to last. We know that economic data out of the Eurozone has taken a turn for the worse, and the simultaneous slowdown in the US and China could hurt the region more by negatively affecting export demand. German stocks haven't been holding up nearly as well as US equities, and this only adds to the ongoing pressure for austerity within the Eurozone economy.
The ECB is a central bank that likes to prepare the market for any potential changes in monetary policy, which is why Weidmann's comments are so important, because they could be the first of many to follow.
A rate cut is clearly on the table, and if next week's IFO and PMI reports confirm the need for additional easing, the ECB could start to lay a stronger foundation for cutting interest rates in May or June.
British Pound Hit by Labor, Retail Data
The British pound (GBP) fell sharply against the US dollar today on the back of mixed UK employment numbers. According to the claimant count report, jobless claims fell for the fifth month in a row, which should have been good news for the GBP because fewer people were claiming jobless benefits, but unfortunately, the unemployment rate rose to 7.9% from 7.8%. Average weekly earnings growth also slowed to 0.8% from 1.2%, which was the slowest pace of growth in 11 months.
As indicated by our colleague, Boris Schlossberg, "Overall, the number of people out of work in the UK rose 70,000 in the three months to February—the highest increase since the September-to-November period in 2011." The growing evidence of weakness in the UK economy increases the odds of more stimulus from the Bank of England (BoE) this year.
Retail sales are scheduled for release on Thursday, and economists are already looking for a decline. Based on a survey conducted by the British Retail Consortium, consumer spending growth slowed significantly between February and March. If retail sales misses expectations, sterling should extend its losses against the USD and EUR.
Meanwhile, the Bank of England minutes provided no new insight into how soon the BoE could ease as concerns about inflation overshadowed worries about growth in the month of April. The committee voted 6-3 to leave monetary policy unchanged this month, and BoE Governor Mervyn King, as well as monetary policy committee members Miles and Fisher, were the dissenters.
Bank of Canada (BoC) Holds Steady; CAD Doesn’t
The recovery in the Canadian (CAD), Australian (AUD), and New Zealand (NZD) dollars were extremely short-lived, as all three currencies resumed their losses against the greenback. As expected, the Bank of Canada left interest rates unchanged at 1%. However, the CAD fell because the central bank downgraded their 2013 GDP forecast and upgraded their 2014 forecast. The upward revision would have been good if not for the fact that the downward revision for 2013 (from 2% to 1.5%) far exceeded the 0.1% upward revision for 2014.
As a result, the Canadian dollar sold off even as the Bank of Canada repeated that a modest withdrawal of stimulus would likely be required in the future. The central bank felt that there is "material slack" in the economy, and for this reason, interest rates at current levels remain appropriate. The BoC has moved further away from a rate hike, and this slight shift in stance was enough to drive USDCAD to a high just shy of 1.03.
Consumer prices in New Zealand increased 0.4% in the first quarter, but the NZD failed to benefit from the data because price growth fell short of expectations. Even if it exceeded the market's forecast of 0.5%, we are not sure if it would have helped the NZD all that much considering that the AUD ignored an increase in leading indicators. New Zealand consumer confidence and Australian business confidence numbers were scheduled for release Wednesday evening.
USD/JPY Weathers News and Data
The resilience in USDJPY is impressive and can be attributed to the Fed’s Beige Book, which did not sound as pessimistic as many feared. The rest of the yen crosses, on the other hand, fell victim to the selloff in risk.
The latest Japanese consumer confidence report was a bit of a surprise. While confidence increased in the month of March, the improvement was much smaller than expected, and in fact, was nominal. Considering how much the weak currency, bold stimulus, and rise in equities should be helping Japan’s economy, we expected a much larger improvement in sentiment.
Unfortunately, the Japanese are still very worried about income growth and don't think that overall prosperity has improved all that much. Nonetheless, we still expect the new trade numbers due out Wednesday night to show that certain areas of Japan's economy are benefitting from the weak yen. The country's deficit should continue to shrink after reaching a record high in January.
By Kathy Lien of BK Asset Management