It has been a busy morning in the foreign exchange market for traders focused on anything but the euro. EUR/USD has been stuck in an extremely tight 50 pip trading range since yesterday's North American close. Weaker than expected Eurozone PMI numbers and rating agency Fitch's decision to downgrade Greece's sovereign debt rating to C from CCC failed to deal a blow to the euro. Signs of slower economic activity and the deteriorating attractiveness of Greek bonds failed to hurt the euro as investors hold out hope that Greece will successfully receive its second bailout by March 20th and avoid default. There are still a number loose ends that need to be tied up along with a heavy dose of unanswered questions - all of which poses a risk to the euro but for the time being, the fact that the EUR/USD holds near its year to date highs is a sign that investors err on the side optimism.
This is a very quiet week for U.S. economic data and today's existing home sales report was 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 data 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 have 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 year end as Japanese firms repatriate their funds. Repatriation activity could halt the rally in USD/JPY. Across the Atlantic, the British pound sold off aggressively after the Bank of England minutes revealed that 2 MPC members voted in favor of a larger increase in asset purchases. It appears that most monetary policy committee members were neutral on an increase of 50 vs. 75 billion but chose the former because it was in line with market expectations and they feared doing more would send the wrong message to the market. In the Eurozone, manufacturing and service sector activity contracted in the month of January, raising concerns about slower growth to come.
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