THE STORIES IN THE CURRENCY MARKET
- EOD BREAKDOWN IN EUR
- USD: AT THE WHIM OF RISK APPETITE
- GBP: SOFTER INFLATION, BOE MINUTES
- NZD: SOFTER INFLATIONARY PRESSURES
- AUD: OIL AND GOLD PRICES PLUNGE
- CAD: RETAIL SALES ON TAP
- JPY: SOME OPTIMISM FROM BOJ?
EXPECTATIONS FOR UPCOMING FED MEETINGS
|CURRENT US INTEREST RATE: 0.25%|
|06/20 Meeting||07/31 Meeting|
|CUT TO 0 BP||36.0%||35.3%|
|HIKE TO 50BP||0.0%||1.3%|
Investors dumped euros ahead of Wednesday’s European Union summit. After rallying for 2 consecutive trading days, the euro failed to sustain its gains which tell us that investors do not expect much from the meeting. In fact with the recent recovery nearly eliminated by today’s slide, EUR/USD short positions should still be at record levels. Skepticism about the EU Summit is well justified and it would be a mistake for anyone to expect otherwise. First and foremost, tomorrow’s meeting is an informal dinner called by European Council President Van Rompuy. In his open letter to Heads of State and Governments, he said point blank, that this is not the stage “to draw conclusions or take decisions but to prepare politically for decisions at the June meeting in the best possible manner.” In other words, he is telling us not to expect any policy decisions. Instead it is suppose to be an “open and informal exchange of views on how we can boost growth and jobs across the EU.” Undoubtedly, French President Hollande will use this as an opportunity to pressure German Chancellor Merkel to consider a real fix for Europe in the form of eurobonds, deposit insurance and increasing the effectiveness of the EIB. Unfortunately these deeply unpopular policies will require German taxpayers to assume greater risk for distressed nations, something they vehemently oppose. The possibility of more head butting between Merkel and Hollande has driven investors to sell euros ahead of the EU Summit. Even though we don’t expect much, the world will be listening closely for any hint of cooperation. If Merkel shows any willingness to compromise with Hollande’s demands, EUR/USD will rally but if she refuses to budge even an inch on Eurobonds, the EUR/USD could come under further selling pressure. We don't expect Germany to cave and for any decisions to be made before the formal EU Summit which will be held after the Greek elections in late June. With this in mind however, it is important to have stops in place because the market is EXTREMELY short euros and it so won’t take much to trigger a massive short squeeze.
Aside from the possibility of a disappointing EU Summit, comments from former Greek Prime Minister Papademos also sent the EUR/USD tumbling. According to Papapdemos, preparations for euro exit are being considered. In our opinion, the EUR/USD overreacted to comments from a FORMER and not current Prime Minister. Secondly, with the world talking about a Grexit, it would be shocking if the Greek government has or is not currently considering it. We are sure that it has been discussed officially or unofficially but whether they choose to leave the euro remains an open question. Therefore positioning ahead of the EU Summit and the typical pre NY close flows from algos are the best explanation and most likely reasons for the end of day breakdown in euro. In the last hour of trading, the Dow Jones Industrial Average fell as much as 70 points and ended the day flat. At the same time, the EUR/USD experienced a similarly violent move. The year to date low of 1.2625 remains the main support level for the currency pair.
With headline risk to spook the markets and less than 24 hours to go before the EU Summit, the U.S. dollar traded higher against all of the majors. Aside from what has been mentioned in the EUR portion of our commentary, Fitch also cut Japan’s credit rating by one notch while Egan-Jones, an independent rating agency cut Spain’s rating from BB+ to BB-. Considering that S&P lowered Spain’s rating less than 2 weeks after Egan-Jones made a similar move back in April, this is one action not to be ignored. The U.S. has been mostly spared from bad news with existing home sales rising 3.4 percent in the month of April. Not only has demand recovered after 2 months of lower sales but the median price of a home sold also rose the most in 6 years. Housing demand is still weak but at least home sales are moving in the right direction. Manufacturing activity in the Richmond region rose at its slowest pace in 5 months which is consistent with the deterioration in Philadelphia. Fed President Lockhart spoke again today and he repeated that the bar remains high for another round of QE, a view that we share as well. New home sales are scheduled for release tomorrow and a rebound is expected after an abysmal March. This week’s U.S. economic reports are all second tier which means that risk appetite will continue to determine the dollar’s trend.
This is a big week for the British pound and the economic reports are starting to come in. This morning we learned that the annualized pace of consumer price growth slowed from 3.5 to 3.0 percent last month even as CPI rose 0.6 percent on a monthly basis. Inflation is receding at a faster pace than economists anticipated, putting pressure on the pound. With oil prices falling steeply in May, we expect this trend to continue. As a result, policymakers are beginning to shift course and retracting their views that inflation may exceed expectations. Tomorrow's BoE minutes could show Adam Posen once again voting in favor of more easing which would be consistent with the IMF's calls for more stimulus from the central bank. This morning, the IMF warned that the dangers posed by the euro crisis to the UK economy are large and could lead to lasting damage caused by a persistently large output gap. They encouraged the Bank to ease further through Quantitative Easing or an interest rate cut. We don't think the BoE will take any action before Greece makes a decision about the euro but in the meantime, like the EUR, the GBP should remain under pressure. Aside from the BoE minutes, the Office for National Statistics will also be releasing retail sales figures. Consumer spending is expected to fall sharply after rising 1.5 percent in April. According to the British Retail Consortium, retail sales dropped the most in more than a year last month due to poor weather and consumer caution. Weaker confidence numbers also confirm that the British are worried about the outlook for their economy, making it difficult to pull the trigger on non-essential spending.
The Canadian, Australian and New Zealand dollar all lost ground to the greenback today. Traders sold off risky assets ahead of the meeting between European leaders. Despite the sell-off in the comm. dollar, the economies Down Under remain relatively stronger than its peers. While Organization for Economic Cooperation and Development (OECD) slashed its growth outlook of Australia, the country’s economy is one of the most robust among the developed world. "Sustained by exports and mining-sector investments, growth could speed up to 3 percent in 2012 and 3.75 percent in 2013,” OECD said in its report. Nonetheless, slowing demand in China and deteriorating European debt crisis could pose more downside risks to the economy. This report is in line with central bank’s estimate. Earlier this month, the Reserve Bank of Australia cut its growth forecast to 3 percent for the year, and the bank saw underlying inflation in its target band of 2-3 percent. Thus, RBA has more room to operate with a well contained price level. Meanwhile, Reserve Bank of New Zealand reported easing pressure in consumer prices as inflation expectations for the next 24 months dropped to 2.4 percent from 2.5 percent. The subsiding price pressure allowed the central bank to hold its overnight rate at the historical low of 2.5 percent. The bank has kept the benchmark rate steady since March 2011. While most economists expect the Reserve Bank of New Zealand to keep the Official Cash Rate on hold at 2.5% until March 2013, some say there is a chance of a rate cut before the end of 2012. Looking ahead, we have leading index from Australia and retail sales from Canada. Thanks to a strong labor market, economists expect consumer spending to grow by 0.5 percent increase in the month of March.
It was a mixed day for the Japanese Yen which weakened against the U.S. dollar, British pound and Canadian dollar but strengthened against the euro, Australian and New Zealand dollars. The biggest story overnight was Fitch's decision to downgrade Japan's credit rating, leaving Bank of Japan officials with plenty to talk about at their monetary policy meeting. Although the Japanese feel that their economy is on the path to recovery, a deteriorating current account balance, weak fiscal position and an aging population that will only worsen these imbalances in the coming years, prompted a decision by Fitch decided to cut Japan's rating one notch to A+ from AA-. What makes this decision important is that in this specific case, Fitch is the trailblazer. They are the first to take the axe on Japan by dropping the country's rating below S&P and Moody's levels. Since S&P already has the country on negative outlook, we would not be surprised if they took a similar move. Although the downgrade provides yet another headache for the Japanese, they will be happy to see the Yen weaken but with risk aversion at such elevated levels, the downgrade will not be enough to carve out a bottom for USD/JPY. Meanwhile we do not expect any additional action from the Bank of Japan this evening. Having increased stimulus twice this year, the central bank will want to sit back and let the economy absorb the liquidity. There is a mild possibility that the central bank could sound a tad more optimistic after having upgraded its economic assessment for the first time in 9 months last week.
EUR/GBP: Currency in Play for Next 24 Hours
EUR/GBP will be our currency pair in play for the next 24 hours. From eurozone, we expect the current account at 4:00AM ET/ 8:00 GMT. The releases from UK include MPC meeting minutes and retail sales at 4:30AM ET/ 8:30 GMT and CBI order expectation at 6:00AM ET/ 10:00 GMT. Furthermore, European leaders will be meeting in Brussels at the EU Economic Summit.
EUR/GBP currently remains in the range-trading zone, which we determine using our double Bollinger Bands. The lower first std. dev. Bollinger Band could serve as the first support at 0.8013. A break below, the pair could target the record low on May 16th – 0.7951. On the flip side, the pair’s rise could face some resistance at today’s high of 0.8101. If EUR/GBP climbed higher, the 200-day SMA could contain the pair’s rally at 0.8199.