THE STORIES IN THE CURRENCY MARKET
- ECB MEETING WILL BE CLOSE CALL FOR EUR
- USD: PAY ATTENTION TO THE FED SPEAKERS
- GBP: ACTIVITY TO PICK UP WED
- CAD: BOC LEAVES RATES UNCHANGED
- AUD: RBA CUTS BY 25BP
- NZD: HOLDS STEADY
- JPY: AZUMI TALKS G7 MEETING
EXPECTATIONS FOR UPCOMING FED MEETINGS
|CURRENT US INTEREST RATE: 0.25%|
|06/20 Meeting||08/01 Meeting|
|CUT TO 0.00%||36.0%||36.0%|
|HIKE TO 0.50%||0.0%||0.0%|
One of the most important event risks this week is Wednesday’s European Central Bank monetary policy announcement. The near term outlook for EUR/USD hinges on the ECB’s degree of proactiveness. Throughout Europe’s sovereign debt crisis, the ECB has only been reactive but after avoiding the issue for weeks and constantly passing the ball back to politicians, ECB President Draghi will have no choice but to address the deterioration in economic data, the strain on Spanish finances and the decline in asset markets around the world. Based upon recent developments in the financial markets and the economy, the ECB should ease quickly and aggressively. However the decision will not be an easy one because Mario Draghi is extremely close in succeeding on his attempts to pressure European politicians into action. If he waits a few more weeks, we will probably get an announcement from G20 leaders. As a result, tomorrow’s ECB meeting will be a very close call because the ECB needs to ease but there are advantages to waiting. In addition to the monetary policy announcement and ECB President Draghi’s press conference, the central bank will also release its latest quarterly inflation and GDP forecasts – both of which are expected to be lowered.
Why the ECB Should Ease Now
Recent economic indicators show deepening recessionary conditions in the Eurozone economy. According to the PMI reports, service and manufacturing activity last month contracted at its fastest pace in nearly 3 years. Consumer demand is also weak with retail sales dropping 1.0 percent in April while the outlook is grim with the German IFO report falling to a 6 month low. Thanks to stronger German growth, the Eurozone as a whole is not technically in recession but this is slightly distorting because a number of Eurozone nations including Spain, Italy, and Greece are deep in recession. The Organization of Economic Co-operation and Development warned earlier this month that the region risks falling to a “severe recession” with growth contracting by as much as 2 percent. Rising borrowing costs across the region makes it more expensive for countries to service their debt and increases the need for greater austerity. The request to commit greater capital to the rescue of other nations only adds to the burden of healthier nations. The decline in financial markets also cuts into growth while the decline in commodity prices caps inflationary pressures. In other words, the ECB has every reason to ease but there advantages to holding off until July.
The Advantages of Waiting
By holding off another month, the ECB will have the luxury of incorporating the outcome of the Greek elections into their decision as well as any responses from the G20. They will also have a better sense of how Spain will manage their banking and fiscal challenges. At the same time, it leaves the pressure on European politicians. There ECB could always ease between meetings if it is necessary but waiting could save them a few bullets. Looser monetary policy is still needed but the central bank could opt for a more modest dose of stimulus.
How Can the ECB Help?
The European Central Bank still has quite a bit of tools at their disposal. They can expand their long term refinancing operation, cut interest rates and / or leave asset purchases unsterilized. None of these will resolve Europe’s fiscal problems but could stabilize the financial markets. While interest rates are at 1 percent, the ECB still has room to ease according to IMF Managing Director Christine Lagarde who called on the central bank to act. The last two rounds of 3 year refinancing operations helped to prevent a deeper crisis which means another 1 year refinancing operation is also an option. What we know for certain is that the ECB will continue to provide unlimited liquidity at its regular refinancing operations. In our opinion, they will hold off until July but prepare the market for more easing by hinting of additional action next month, which would still be negative for the euro but the weakness could be temporarily if the ECB’s support successfully stabilizes the financial markets.
The U.S. dollar traded higher against all of the major currencies with the exception of the AUD which benefitted from the RBA's decision to cut interest rates by 25 instead of 50bp. Following last week's abysmal non-farm payrolls report, it was a surprise to see service activity grow at a faster pace in May. The ISM non-manufacturing index rose from 53.5 to 53.7 last month. While the increase was modest, it is nonetheless encouraging to see evidence of growth in some part of the U.S. economy. Stronger inventory, orders and business activity led the rise while the drop in the employment was consistent with the deterioration payroll growth. Yet the uptick in service sector activity may not be enough to convince Federal Reserve officials that another round of asset purchases is not necessary. The Fed’s Beige Book report is scheduled for release tomorrow and we still expect individual Fed districts to report a slowdown in the U.S. recovery. Fed Presidents Lockhart, Tarullo, Williams and Yellen will also speak on the current and future state of the economy at various times on Wednesday. As voting members of the FOMC, their views are particularly important because these are the people who will make the decision about implementing QE3. On Thursday, Fed Chairman Ben Bernanke will be speaking on the economic outlook and if he was prepared to take more balance sheet actions in April, there is no question that he has become a bigger champion of QE3 since then. We expect nothing but dovish comments from Bernanke come Thursday, which could explain why we are seeing more two way action in the EUR/USD versus the one way downtrend which best characterizes the moves in the currency for the past month.
The British pound ended the North American trading session slightly lower against the U.S. dollar but higher against the euro. U.K. markets remained closed for second consecutive trading. When London traders return to the office, we should see an increase in volatility particularly since the ECB meeting will be meeting tomorrow. On Monday afternoon, Egan-Jones Ratings Co. lowered the UK’s sovereign rating from AA to AA- on concerns about the country’s rising debt level. The independent rating agency, which some say is the only one with credibility is concerned about the U.K.’s vulnerability to the spread of the European crisis. The Bank of England will be meeting on Thursday to discuss the status of the global economy. The sovereign rating along with the recent UK PMI numbers will make policy makers keen to consider easing the monetary policy. Tonight at 19:01 ET / 23:01 GMT we have the BRC Shop Price Index (YoY), and Lloyds Business Barometer.
The Canadian and New Zealand dollars ended the day lower against the greenback while the Australian dollar ended higher. This morning, the Bank of Canada left interest rates unchanged at 1 percent. While the BoC sounded far more concerned about the outlook for the global economy, the fact that they still believe removing stimulus may become appropriate was enough to drive the Canadian dollar higher against the greenback but the gains were given up by the end of the day. The BoC remains one of the most hawkish central banks in the world and their optimistic perspective is surprising considering the sharp decline in oil prices and Canadian stocks. Even as they admit that the global growth outlook has weakened in recent weeks, emerging markets are slowing more than forecast, the strong currency is hurting exports, the risks from the European crisis are materializing and cheaper gasoline prices will drag inflation below 2 percent, the BoC still believes that a small amount of spare capacity leaves the door open to remove stimulus. Considering that Canada's central bank had nothing but negative things to say about the outlook for the global economy, the chance of a rate hike is slim. We believe that the BoC will leave interest rates unchanged for the rest of the year. Last night, the RBA cut interest rates by 25bp to 3.5 percent. The move was widely anticipated but the AUD/USD rallied because some investors had anticipated a stronger move. The central bank cited “further weakening in Europe and some further moderation in growth in China" as the reason for their decision. To everyone’s surprise, service sector activity improved in May, which could also explain why the RBA opted for a smaller rate cut. Tonight, Australian first quarter GDP numbers are due for release and slightly faster growth is expected.
The Japanese yen traded lower against all of the major currencies. The currency slowly depreciated after Japanese Finance Minister Jun Azumi confirmed agreement among the G7 nations to assist on extreme currency moves. G7 officials agree on involving the collective nations to help combat the unstable global economy. This is the second day in a row where the yen weakened against the major currencies and if this trend continues there could finally be some relief for the export sector. The G7 meeting in general was a major disappointment because a statement wasn’t released. Their lips are sealed which tells us that they are either working on something big or failed to reach an agreement. We obviously hope for the former and judging from the price action in currencies this morning, other investors do as well. At this stage, there is a reasonable chance that G20 leaders will announce greater support either from Europe internally and/or the IMF. Spain has become as much of a problem as Greece and for this reason policymakers can't turn a blind eye for much longer. No major economic reports were released from Japan but from China we had the HSBC Services PMI report that showed activity increasing slightly. The index rose from 54.7 to 54.1 which indicate signs of expansion in the economy. The data makes helped to offset some of the negative sentiment from the Non-Manufacturing PMI index released on Saturday which showed China’s non-manufacturing industries expanding at its slowest pace in more than a year as exports diminished and weakness in real estate. There are no Japanese economic reports scheduled for release from Japan today.
EUR/USD: Currency in Play for Next 24 Hours
The currency pair in play for the next 24 hours will be the EURUSD. Final Eurozone Q1 GDP will be released at 5:00 ET / 9:00 GMT followed by German Industrial Production at 6:00 ET / 10:00 GMT. Come 7:45 ET / 11:45 GMT the ECB will announce its Rate Decision. Then at 14:00 ET / 18:00 GMT, the U.S. will release the Fed Beige Book report
EURUSD is trading in a range according to our Double Bollinger Bands. The nearest support level is today’s low of 1.2409. Should this level break then the second support will be at the year to date low at 1.2287. On the upside the first resistance will be at 1.2620 which is May 23rd and 25th high. Should that pair break out of that level, heavier resistance will be encountered at 1.2824, where the May 20th high and upper first standard deviation Bollinger Band lies.