Renewed risk aversion made the US dollar and Japanese yen the big winners on Wednesday, and the fundamental fallout from Cyprus and upcoming German economic data may is now likely to decide the near-term fate of EURUSD.
After a brief pause on Tuesday, the euro extended its losses, dropping to a fresh one-month low against the US dollar (USD). Taking a look at the EURUSD daily chart, there's no question that this breakdown is significant and paves the way further losses. However, it is rarely that simple.
Most of the selloff happened during the first half of the European trading session, and since then, the currency pair only tread water, leaving traders to wonder if there is enough momentum for a further push lower.
On a technical basis, there is little reason to question the selloff in EURUSD, but on a fundamental basis, the key to the currency pair's next direction lies in the hands of Germany and Cyprus.
2 Possible Scenarios for EURUSD
Wednesday’s euro selloff was triggered by the decline in Eurozone confidence. Concerns about the fallout from the Italian elections and political gridlock in Italy caused the region's overall economic confidence index to drop from 91.1 to 90.0 in the month of March. This decline should not be a huge surprise to readers, however, as we warned about it here previoulsy.
See also: The New Epicenter for Eurozone Problems
Looking ahead, the next test will be Thursday’s German retail sales and unemployment numbers. Economists are looking for a sizeable pullback in German retail sales after a nice increase the month prior, but labor market conditions are expected to improve, as the PMI reports showing the strongest pace of job growth since January 2012.
If the consensus is right and Thursday's economic reports show improvement in the German economy, the EURUSD could rebound and aim for a retest of 1.29. However, if the data disappoints, it could be just the catalyst the EURUSD needs for a move down to 1.26. Without such a catalyst, it may be difficult for the currency pair to extend to that level.
3 Safe Shelters from Cyprus Bank Risk
Meanwhile, banks re-open in Cyprus on Thursday, but with a withdrawal limit of EUR 300. Capital controls have also been announced, and they will include limits on credit card transactions (EUR 5000 per month) and a maximum withdrawal for trips out of the country (EUR 3000 per trip).
While Cyprus is gearing up to reopen its banks, investors remain worried about the Eurozone as a whole and have turned to both the dollar and Japanese yen (JPY) for safety. In addition, based on the big moves in German bonds, it is clear that investors in Europe are turning to the bonds of the strongest Eurozone economy for safety as well. Ten-year German bund yields are trading at the lowest level since August. If German economic data continues to weaken, investors may start to wonder if putting their money in German bonds is the best idea.
See related: 4 Catalysts for Renewed Risk Aversion
Fed Hints at the Event That Might End QE
US stocks just won’t go down without a fight. After sinking more than 100 points at the open, the Dow Jones Industrial Average closed down only 35 points, or 0.25%, while the S&P 500 dropped a mere 0.09%. The resilience of US equities helped to limit the slide in currencies, but the dollar and yen still ended Wednesday higher against all the majors.
Fed Presidents—and even the doves—appear to be relatively optimistic about the outlook for the US economy. Minneapolis Fed President Narayana Kocherlakota said he was pleased with the recent strength in the labor market and sees an ongoing, modest US recovery. Boston Fed President Eric Rosengren, who is typically one of the more dovish members of the Federal Open Market Committee (FOMC), felt that monetary accommodation could be reduced.
Even Chicago Fed President Charles Evans sees a pretty good outlook for the US economy, though he warned that the central bank could still increase quantitative easing (QE) if job growth falters. Evans wants to see six months of job growth in excess of 200k, a metric that we believe Fed Chairman Ben Bernanke shares as well, so FX traders should perhaps look for that before anticipating any withdrawal of QE in the US.
The only US economic report released Wednesday morning was pending home sales, which fell 0.4% in the month of February after rising a downwardly revised 3.8% the previous month. While January was a very good month for the US housing market, existing, new, and pending home sales all gave back some gains in February.
Revisions to Q4 GDP are scheduled for release on Thursday along with weekly jobless claims and the Chicago PMI report. GDP is actually expected to be revised higher, which would be good news for the dollar.
More: See the complete Economic Calendar
British Pound (GBP) Loses Some of Its Recent Luster
The British pound (GBP) rebounded against the euro but continued to trade lower against the US dollar on the back of weak economic data. The excitement that we saw last week is now beginning to fade, but before returning to pessimism, let us remember that these latest reports were from the fourth quarter and are therefore quite stale.
While the UK's current account deficit narrowed in Q4, the absolute numbers for the third and fourth quarters were far worse than anticipated. Economists expected the deficit to narrow from -12.8 billion to -12.5 billion, but instead, Q3 figures were revised to -15.1 billion with the deficit narrowing to only -14 billion in the fourth quarter. Annualized GDP growth was also revised lower to 0.2% from 0.3%.
Domestic demand was less of a drag in the final numbers, but higher imports pushed trade activity lower. Regardless of how you slice it, there's no escaping the fact that the UK economy experienced extremely anemic growth last year. The only hope now is for a stronger recovery in the first half of 2013.
Consumer confidence, nationwide house prices, and the index of services are due for release on Thursday, and unless there are major surprises, we don't expect these reports to have a significant impact on the GBP. While lower highs and lower lows point to the possibility of further weakness in the GBPUSD, we don't expect a big selloff.
Data Surprise Spurs Canadian Dollar (CAD) to New Recent High
The Canadian dollar (CAD) recovered earlier losses to end the day unchanged against the greenback while the Australian (AUD) and New Zealand (NZD) dollars finally gave up some gains after rising for five straight days.
Hotter-than-expected consumer prices in Canada spared the loonie from losses. CPI jumped 1.2% in the month of February, which was the strongest increase since 1982. Annualized price growth increased by the same amount, while seasonally adjusted prices rose by a more modest 0.4%. For the Bank of Canada (BoC), higher inflationary pressures will encourage a steady hawkish bias. Between the recent rise in oil prices and stronger data, the CAD has risen to a one-month high.
The Australian dollar, on the other hand, was hit by Reserve Bank of Australia (RBA) Board member Jillian Broadbent's comment that AUD strength has been pretty painful, but she nonetheless expects the currency to remain elevated, and that thankfully, Australian corporations have been adapting well.
While her comments overall were relatively optimistic, the RBA Financial Stability report was more balanced. The twice-yearly review found financial conditions improving significantly, but the RBA felt that it is too early to say if the improvement in sentiment can be sustained. They also indicated that some industries were weighed down by the stronger currency and softer demand and that lower mining investment could dampen economic activity.
For the AUDUSD to crack above 1.05, we needed unambiguously positive comments from the RBA, and unfortunately, we did not receive them. With this in mind, the AUDUSD would need to drop below 1.04 to negate the uptrend. Australian job vacancies and TD Securities Inflation report is scheduled for release Wednesday evening.
As for the NZDUSD, lower business confidence and activity in the month of March stalled the recent rally, but a rebound in building permits could help restore the uptrend.
Japan’s Abe Talks Monetary Policy
The Japanese yen traded higher against all major currencies on Wednesday. With no Japanese data on the economic calendar, the yen took its cue from the level of risk appetite. Prime Minister Shinzo Abe gave a speech where he expressed his satisfaction with the recent yen weakness.
Abe said the recent move is a plus for the economy overall and the excessive strength is finally being corrected. The most interesting part of the speech was his comment that officials are watching import prices carefully.
Commodity prices are on the rise again, and the weakness of the yen exacerbates the pain. As a net importer of oil, Japan's efforts to promote growth are hampered by rising import prices. In February alone, import prices increased 13.2%. While higher import prices helps the government beat deflation, if wages are not increasing at the same pace, the higher cost of living creates a net drag on the economy. Therefore, if import prices rise too quickly without an accompanying increase in wages, the Japanese government may have to slow the decline in the yen.
Retail sales are scheduled for release on Wednesday evening, and consumer spending is expected to increase after falling 0.2% the previous month. Bank of Japan (BoJ) Governor Haruhiko Kuroda will be speaking again as well, so we will be watching for his comments to impact USDJPY.
By Kathy Lien of BK Asset Management