EUR: What To Expect From EU Summit

THE STORIES IN THE CURRENCY MARKET

• EUR: WHAT TO EXPECT FROM EU SUMMIT
• USD: HOW MUCH PAYROLLS WILL MATTER
• GBP: LOOKING AHEAD FOR THE BOE
• NZD: SURPRISE TRADE SURPLUS
• AUD: REACHES FRESH 3 MONTH HIGHS
• CAD: GDP AND EMPLOYMENT NEXT WEEK
• JPY: SELLOFF IN USD/JPY TEMPTS INTERVENTION

EXPECTATIONS FOR UPCOMING FED MEETINGS

EUR: WHAT TO EXPECT FROM EU SUMMIT

European leaders will be gathering in Brussels on Monday for this year’s first EU Summit.  As usual there has been a lot of pomp and circumstance surrounding the meeting with investors wondering if any major decisions will be made on providing a wider safety net for the region. The quick answer is no. According to a draft of the summit’s conclusions, the focus of the meeting will be on growth and job creation.   Leaders of the European Union have come up with various ways to kick start the region’s economy, none of which are particularly innovative.  For example, they plan to shift some of the unused EU funds to create “large scale” youth reemployment schemes and to provide additional financing to small businesses. Unfortunately in an environment where larger European nations are forcing austerity on smaller ones, these programs will do little to counteract the pressure on growth caused by spending cuts and higher taxes. It also fails to address the most immediate problem, which is whether or not Greece will reach a deal with its creditors. European leaders said a Eurozone Summit focused on Greece is not needed because progress is being made with the IIF but in our opinion, they probably want to wash their hands of the problem and leave Greece to solve her own troubles. Of course they cannot avoid dealing with an arm that is quickly turning gangrenous but there is less need now for an emergency solution than a few months ago. Despite the ongoing uncertainty surrounding Greece, the EUR/USD has performed extremely well, shrugging off the latest downgrades by Fitch to rise to its highest levels in more than a month. Following in the footsteps of S&P, Fitch lowered the credit rating of 5 EZ countries and put 8 on negative watch.  Over the past 2 weeks the currency pair has appreciated more than 4 percent or 500 pips which is a sizeable move in all respects. The Federal Reserve’s dovishness played a large role in the EUR/USD ’s strength but for the past month, European bond investors have been unfazed by any negative news flow including S&P’s shocking downgrades. Since the beginning of the year, we have not see a significant increase in the yield of many European bonds (and in fact some declined today) on the hope that a Greek deal can finally be reached. This morning EU Commissioner Rehn revealed that the talks between Greece and its creditors could be concluded by the end of the weekend, in time for Monday’s EU Summit.  Although target dates such as these have come and pass with no resolution more often than we can remember, the strength of the EUR/USD today indicates that some investors believe a deal will happen sooner or later.   In our opinion, this is inevitable. The only questions are how high the coupon rate will be, the amount of participation, how the ECB’s exposure will be treated, if a Collective Action Clause is needed to impose losses on investors who fail to participate and whether a credit event will occur. There is a lot to lose in a CDS trigger, one of the most important of which will be confidence in the products. Investors could also quickly turn on Portugal whose bond yields have already reached unsustainable levels. Portugal has the second highest 5 year CDS spreads in the world right now, next to Greece. If their bond yields continue to rise, they may have to follow in Greece’s footsteps and ask for aid. These are the risks but for the time being, the EUR/USD remains strong and the break above 1.32 means that it is now on its way to 1.34.

USD: HOW MUCH PAYROLLS WILL MATTER

Earlier this week the Federal Reserve planted the kiss of the death on the U.S. dollar and today we continued to see the lingering effects of their plans for ultra-easy monetary policy. Although no one expected the central bank to turn hawkish their message of low for long was received loud and clear.  Even if the U.S. economy sees any major improvements over the next few months, the Fed has no plans to raise interest rates or start unwinding stimulus until 2014 at the earliest. Bernanke made it crystal clear that all they are thinking about right now is the possibility of doing more and not less to jumpstart the economy. This will be a big reason why the dollar will respond more to weak versus strong data. If the economy weakens materially, the Fed may be tempted to respond quickly with QE3 but if the economy improves, they will look at each piece of data with skepticism until it becomes a consistent trend. With non-farm payrolls scheduled for release at the end of next week, this will be an important point to remember. Job growth is expected to be healthy with non-farm payrolls rising by approximately 150k. The unemployment rate may even decline but any improvement will do little to diminish the central bank’s resolve, particularly since they have predicted for a decline in the jobless rate. Aside from non-farm payrolls, personal income, personal spending and consumer confidence numbers will be released along with the ISM manufacturing and non-manufacturing reports.  This morning’s GDP report showed growth accelerating by 2.8 percent in the fourth quarter, which was stronger than Q3 but weaker than expected. At first glance, the data was not terrible, but the devil was in the details. Not only did GDP miss expectations but inventory stockpiling accounted for a large part of growth. This would be good news if demand wasn’t weak. Personal consumption rose a mere 2.0 percent in Q4 vs 2.4 percent expected. The Federal Reserve won't be too concerned but they won't be pleased to see today's data either. Particularly with the GDP deflator, which is an inflation measure falling to its lowest level since Q3 of 2009. Weaker price pressure was one of the main reasons why the Fed stepped up their dovishness this week. Yet the Fed's monetary policy stance would not have had such a negative impact on the dollar if investors were still intimidated by the European sovereign debt crisis. Next week will be another important test for the euro and if there is any reason for investors to turn on the currency, the dollar will benefit from flight to safety.

GBP: LOOKING AHEAD FOR THE BOE

The British pound rose against the U.S. dollar but weakened against the euro. There was little in the way of U.K. economic data today which explains the currency’s mixed price action. Next week will also be a quiet one in the U.K. with manufacturing PMI, mortgage approvals, and construction PMI scheduled for release. The U.K. economy is particularly sensitive to the ebbs and tides of the Eurozone economy and having contracted in the fourth quarter, it could slip into recession if Eurozone growth slows materially this year. As admitted by U.K. Treasurer Osborne, “Britain has substantial economic problems and debt built up over the past 10 years.” This is a key reason why the government is actively practicing austerity by raising taxes and cutting spending. Austerity was suppose to be over in 2015 but has since been extended to 2017. Life will not be easy in the U.K., which is why the Bank of England may opt to support the economy by increasing monetary stimulus. Given the improvement in the CBI Industrial Trends survey, which measures industrial activity, we expect a similar uptick in the manufacturing PMI index. However even if that occurs, it is unlikely to change the central bank’s mind about the need for easier monetary policy.

NZD: SURPRISE TRADE SURPLUS

All three commodity currencies continued to strengthen versus the US dollar with both Australian and New Zealand dollars making new 3-month records. Despite the selloff in equities, the weakness in the greenback made the comm. dollars more attractive. The unexpected trade surplus from New Zealand also helped in the gain of the kiwi. The trade balance came in at 338M versus the expected -74M. The surplus was mainly buoyed by the increase in exports of dairy products. According to the report, “December 2011 was a record month for milk powder, butter, and cheese exports, with quantities and values both reaching new highs.” However, the growth prospect for New Zealand has been pared back amid earthquake reconstruction delays. The increase in gross domestic product this year will be less than the 3 percent forecast in December, Bollard told reporters after a speech in Christchurch today. In addition, the fallout in the Asia-Pacific region from Europe’s sovereign-debt crisis would also be a drag on the economy. As the market expects Governor Bollard to keep the interest rate on hold until 2013, the employment data from New Zealand next week could reflect more weakness in the economy. Meanwhile in Australia, the federal opposition believes the Reserve Bank of Australia should do most of the heavy lifting if the local economy needs a boost in the face of a souring global economy. With its interest highest among the developed countries, the RBA has some leeway to stimulate the Australian economy through monetary policy. Market participants are predicting a further cut in the cash rate, after the reductions in November and December to 4.25 per cent, when the RBA meets on February 7. Nonetheless, the Australian Treasurer Wayne Swan told the Australian Financial Review on Friday that Australians should take a more balanced view of the economic outlook. "I think there's just a tendency out there in our public discussion to focus far too heavily on all the risk being on the downside," he told the newspaper. The economic releases next week could also provide further signs into the Australian economy – business confidence on Monday, home sales on Tuesday, and trade balance on Wednesday. Lastly, most of the loonie’s strength was boosted by the rises in commodity prices this week. Looking forward to next week, the loonie could see more volatility with GDP numbers on Tuesday and employment data on Friday.

JPY: SELLOFF IN USD/JPY TEMPTS INTERVENTION

The U.S. dollar fell sharply against the Japanese Yen today, pushing all of the Yen crosses lower in the process. Over the past 4 trading days, USD/JPY has experienced more volatility than over the past month. With the pair closing in on its 2 month low, the rapid and strong move in the Yen will pressure the Bank of Japan to intervene. There is probably a hearty debate going on right now in the Ministry of Finance but unless USD/JPY falls below 76, it may be difficult to find enough consensus for intervention. The latest economic reports show much the Japanese economy has suffered from a strong currency.   Consumer prices fell for yet another month in December while large retail sales dropped 0.4 percent. Although general retail sales increased, the rise was smaller than expected. According to the minutes of the BoJ meeting, policymakers saw a possible delay in economic recovery. If conditions worsen, they may take further steps to jumpstart the economy.

EUR/USD: Currency in Play for Next 24 Hours

The currency pair in play for Monday will be EUR/USD. The economic releases that we expect from the Eurozone are business climate, consumer and economic confidence at 5:00AM ET/ 10:00GMT with the German CPI and EU economic summit throughout the day. From the US, we expect the personal spending and core PCE price index at 8:30AM ET/ 13:30 GMT.

EUR/USD currently trades in an uptrend, which we determined using the Bollinger Bands. The nearest resistance is at the 100-day SMA – 1.3373. If broken, the 38.2% Fibonacci level could provide further resistance at 1.3508. We drew our Fibonacci retracements from the swing high in May 2011 to the low on January 13^th. On the downside, the pair’s collapse could be supported at 1.3079, the 50-day SMA.  A break below that level, EUR/USD could target 1.2840, the low on Jan 19.