FX: Where Is The Action?

THE STORIES IN THE CURRENCY MARKET

• FX: WHERE IS THE ACTION?
• USD: DOWNWARD REVISION OFFSETS UPSIDE SURPRISE IN EXISTING HOMES
• GBP: BOE WASN’T OPPOSED TO A LARGER INCREASE
• AUD: POLITICAL TROUBLE IN AUSTRALIA
• NZD: RECONSTRUCTION HAPPENING
• CAD: HOVERING AROUND PARITY
• USDJPY SLIPS TO 7 MONTH LOW

EXPECTATIONS FOR UPCOMING FED MEETINGS

FX: WHERE IS THE ACTION?

Over the past 24 hours, there has been very little action or volatility in the EUR/USD.  Considering how much investors have been focused on Europe, the lack of fresh development with regards to Greece has everyone at the edge of their seats.  News that rating agency Fitch downgraded Greece’s sovereign debt rating from CCC to C didn’t help the euro but it didn’t hurt it either because Fitch only lowered their rating to Moody’s levels. With this in mind, Fitch now views a Greek default as “highly likely in the near term.”  The rating agency waited for the outcome of the Eurogroup meeting before making the decision and the fact that they still downgraded Greece after the approval of a second bailout package means they have very little confidence that concessions made by both sides will be enough to avoid default.   The Greek Parliament’s Finance Committee has apparently approved the debt swap bill but a final vote still needs to occur in their plenary session.  There is a very good chance that Greece could suffer from a restrictive default and if that occurred, the next question becomes whether or not payments on credit default swaps will need to be made.  Considering the mess that a credit event trigger on CDS’ would create for the market, we believe that Greece will succeed in convincing its creditors that a default is only  a temporary technicality because a second bailout will provide them with enough to make their March bond repayments and avoid anything disorderly.

While the EUR/USD consolidates, other currencies and commodities enjoyed greater volatility.  EUR/GBP broke out of an 8 week long consolidation to rise to its highest level this year.  According to the Bank of England minutes, monetary policy committee members weren’t opposed to raising asset purchases by a larger amount but chose not to do so because they did not want send the wrong message to the market. USD/JPY on the other hand continued to soar, breaking above 80 in the process. Since the beginning of the month, USD/JPY closed higher almost every single day with very little retracement.  The action was not limited to currencies.  The price of gold is quickly closing in on its record high.  Although crude prices fell slightly today, it is up 10 percent since February 6^th.  Concerns over Iran’s nuclear program have sent oil prices sharply higher and unfortunately this has translated into higher gas prices around the world. 

The tight consolidation in the EUR/USD is not going to last forever.  According to the latest Eurozone PMI numbers, growth is slowing.  The enemy of growth is austerity and unfortunately belt tightening measures across the region is finally beginning to eat into growth.  Both the manufacturing and service sector contracted in the month of January – the fact that Germany and France grew suggests that the pullback in the rest of region has been significant enough to drag the overall index lower.  The German IFO report is scheduled for release tomorrow and the drop in the PMI indices points to the risk of a pullback in business confidence. 

USD: DOWNWARD REVISION OFFSETS UPSIDE SURPRISE IN EXISTING HOMES

The U.S. dollar strengthened against every major currency today outside of the euro and Swiss Franc.  The decline in stocks suggests that investors are running out of optimism. With no new catalyst to encourage more risk taking, we can only hope this is a pause and not the beginning of an exhaustion driven turn.  It has been a quiet week for U.S. economic data and today's existing home sales report is one of the few numbers on the calendar.  According to the National Association of Realtors, sales of previously owned homes slowed in the month January.  A total of 4.57 million units were sold last month, compared to 4.38 million units the prior month.  Although this was much stronger than expected, when taking the sharp downward revision to the December numbers into consideration, the surprise is not nearly as good. Existing home sales rose 4.3 percent in January but in December sales declined by 0.5 percent versus a prior estimate of 5 percent growth. The average price of a home sold also fell, reflecting continued weakness in the housing market. A recovery in housing tends to lag the recovery in the overall economy and even though there are signs that the market may have bottomed, it will be a long time before we see any real momentum. Nonetheless subdued growth in existing home sales has not stopped USD/JPY from powering higher.  The currency pair broke above 80 and is currently enjoying its longest running uptrend in almost a year. USD/JPY has reached its highest levels in 7 months thanks to growing interest rate differentials.  Over the past few weeks we have seen a steady rise in U.S. yields, which has helped to create demand for U.S. dollars.  At the same time, the Bank of Japan's recent increase in monetary stimulus killed demand for the Japanese Yen.  However traders need to be careful because the rally in USD/JPY reflects a shift in interest rate expectations. Fed fund futures are pricing in 15bp of tightening over the next 12 months which is far more ambitious than what the Fed has planned.  The U.S. central bank made it clear that they have no plans to raise rates over the next 2 years and even if they eventually change their minds, it will not be this quickly.  At the same time, Japan's fiscal year ends next month and typically we see stronger demand for Yen going into yearend as Japanese firms repatriate their funds. Repatriation activity could halt the rally in USD/JPY.

GBP: BOE WASN’T OPPOSED TO A LARGER INCREASE

The British pound weakened against both the U.S. dollar and the euro as the minutes from the most recent monetary policy meeting showed members voting for greater stimulus.  Bank of England policy makers Adam Posen and David Miles favored boosting asset purchases by 75 billion pounds ($118 billion) but the majority argued such a move might provoke alarm in the economy.  The other 7 members of the Monetary Policy Committee, including Governor Mervyn King were not opposed to the idea of a larger increase but opted for a smaller 50 billion pound rise to 325 billion pounds because of market expectations.  Opting for a larger boost “risked sending a signal that the committee thought the economic situation was weaker than it was.”  The minutes revealed slight optimism that the economic data near the end of 2011 was more positive than expected.  However, the economy still struggles due to the extent of deleveraging required.  The risk of a “prolonged period of depressed demand causing inflation to fall materially below” the central bank’s 2 percent target leaves the door open for more quantitative easing.  The minutes also reveal that for some policy makers, the probability of inflation exceeding the target was “slightly higher than shown in the projection” in the central bank’s Inflation Report last week. Those members said a “case could be made for maintaining the stance of policy at this meeting.”  In other words, the MPC is still very divided on future monetary policy.  Mortgage approvals and industrial order expectations are due for release tomorrow and revised GDP will be released on Friday.  Revised GDP is expected to be in line with last quarter’s contraction of 0.2 percent.

AUD: POLITICAL TROUBLE IN AUSTRALIA

The Canadian, Australian, and New Zealand dollars all weakened against the greenback.  This morning former Australian Prime Minister Kevin Rudd, announced his resignation as foreign minister on a visit to Washington yesterday, saying the “overriding question” for the Labor party is who is best placed to defeat opposition leader Tony Abbot at the election, due in 2013.  Tensions escalated after remarks by Gillard in an interview last week set off a public spat between supporters of the two, by reviving debate over her toppling Rudd two years ago.  At stake for Labor is survival of an administration that’s unveiled unprecedented taxes on natural resources and fees to address climate change -- an agenda Gillard calls “nation-changing reform” that has proved unpopular with voters.  Rudd’s challenge to Gillard has increased political tensions in Australia and is putting pressure on the AUD/USD.  Political trouble is never good for a currency.  Gillard is calling for a vote on Monday.   The Canadian dollar on the other hand lost steam, falling below parity with its U.S. counterpart for the first time in four days as risk appetite ebbed and stocks and commodities fell.  A year after an earthquake wrecked New Zealand’s second-largest city, the first steel piles are appearing downtown; signs of a reconstruction that Westpac Banking Corp. says will spur inflation and end record-low interest rates.  After 12 months of demolition, clearing and temporary repairs, hampered by more than 5,700 aftershocks, a NZ$20 billion ($17 billion) reconstruction program is gaining momentum, moving from the rebuilding of suburban homes to the offices and malls downtown. While that will bolster spending and create jobs, it will also drive up prices and wage costs.  It is going to put pressure on resources, pressure on inflation and could eventually require higher interest rates.

USDJPY SLIPS TO 7 MONTH LOW

The Japanese yen weakened against all the major currencies with the exception of the British pound.  Japanese supermarket sales contracted 1.2 percent in January in line with expectations.  This follows a 0.6 percent contraction in December and the figure has been depressed as a strong yen hurt consumers.  However, there has been a parabolic move in USD/JPY sending the yen tumbling to its lowest level against the dollar in over seven months, driven by recent monetary easing in Japan, a rise in oil prices, and interest rate differentials.  The pair is highly correlated with the yield on U.S. treasuries, especially at the short end, which have risen lately.  The yen has also been falling since the Bank of Japan’s surprise announcement to boost its asset buying program last week.  The BoJ also set an inflation target, a move that could set the stage for more asset purchases, or quantitative easing, by the central bank.  A rise in oil prices has also been a factor since Japan lost a great deal of nuclear power after last year’s earthquake and tsunami.  Additionally, three Japanese insurance companies have assessed that they will have to pay $5.7 billion to flood claims in Thailand.  The MS&AM Insurance Group Holdings, Tokyo Marine Holdings, and NKSJ Insurance said that the compensation will be the third largest amount they have to pay after the tsunami incident in March 2011 and the typhoon disaster in 1991.  Payments on flood insurance will require selling Yen and converting their funds into Thai Baht.  As a result of the massive insurance claims, MS&AD and NKSJ are each expected to experience a loss of at least 1.3 billion dollars.  The corporate services price index is scheduled for release tomorrow and expectations are for a near-flat reading.  The index rose by a small 0.1 percent in December.

EUR/USD: Currency in Play for Next 24 Hours

Our currency pair in play for Thursday is EUR/USD.  We expect the German IFO report on business climate, current assessment, and expectations at 4:00 AM ET / 9:00 GMT.  Then from the United States, we expect the December house price index and fourth quarter house price purchase index at 10:00 AM ET / 15:00 GMT.

Lately, the EUR/USD has been trapped in a range but it remains in an uptrend according to our double Bollinger bands.  EUR/USD is also hovering not far from its year to date high.  The nearest level of support is at 1.3168, where the 20-day SMA lies.  Should the pair fall below that level, more significant support will be found at 1.3040, where the lower second standard deviation Bollinger band lies.  To the upside, first resistance is at 1.3300, where the 100-day SMA and upper second standard deviation Bollinger band converge.  Should the pair break out from that price, heavier resistance will be found at 1.3500, the 38.2% Fibonacci retracement of the May 2011 high to January 2012 sell-off.