Continued deleveraging and US dollar losses—especially versus the yen—were Monday’s top stories, but with the RBA monetary policy announcement due out, AUDUSD should take center stage on Tuesday.
Monday’s US dollar (USD) selloff can best be described as another case of deleveraging. The greenback fell aggressively after US economic data surprised to the downside, giving investors more reason to reduce their positioning.
Since the US dollar was bought throughout the rally, it has now been sold as investors cut their overall exposure. The breakdown in the greenback drove USDJPY below 100, the EURUSD above 1.30, and the AUDUSD above .9700.
While a slowdown in service sector activity accompanied by a decline in job growth is needed for the Federal Reserve to reconsider its plans to dial back asset purchases, the deterioration in manufacturing activity is definitely not what the central bank or the market wanted to see.
Equity and bond traders weren't fazed by the report the way currency traders were, but this misalignment between financial market performance and economic data is one that investors should watch very carefully.
There are a multitude of key US reports on the economic calendar this week, and if they all surprise to the downside, it will be hard for the Fed to convince the market that asset purchases will be tapered off in the coming months.
See related: The Dollar’s Biggest Event Risk This Week
No US data is scheduled for release on Tuesday, but the abundance of data expected on Wednesday will keep the dollar in focus. In the meantime, both USDJPY and EURUSD could take a break before extending their latest moves.
As we have seen, it didn't take much to trigger additional deleveraging in the markets, so traders need to keep an eye on key levels. As long as US stocks don't crash, any decline in the dollar will be slow, but if stocks see another day like Friday, then USDJPY could find itself at 98 and EURUSD could go to 1.32.
See also: 2 Potential Game-Changers for EUR/USD
Monday’s Top Story: USD/JPY Breaks 100
The USDJPY may not have seen the biggest daily move, but its break of the key 100 level was Monday’s biggest headline.
After spending about three weeks above this level, the series of lower highs and lower lows made it seem that a break was inevitable, and the disappointing ISM report was the straw that broke the USDJPY’s back, driving the pair to a low of 98.97.
We continue to be amazed by the ability of European and US investors to ignore the ongoing deleveraging in Tokyo. Despite heavy recent losses in the Nikkei, so far, we haven't seen much contagion, although we are worried that we will see it soon.
Still, US markets continue to perform well, and the Dow Jones Industrial Average has recovered 50% of Friday's losses. Between the volatility in the yen, and that seen in the Japanese equity and bond markets, the Bank of Japan (BoJ) may realistically consider increasing the frequency of asset purchases in order to renew the rallies when it meets next week.
The FX Focal Point for Tuesday
Over the next 24 hours, the Australian dollar (AUD) will be a central focus for FX traders because of the Reserve Bank of Australia (RBA) monetary policy announcement.
The AUD staged a very strong rally against all major currencies on Monday, rising more than 2% against the US dollar and over 1% against the euro. Better-than-expected Australian and Chinese data played a large role in that rally, but US dollar weakness drove the AUDUSD above 97 cents.
The RBA meets Monday night, and we believe that the outlook for Australia's economy could compound the gains in the AUD. The last time the RBA met, it cut interest rates by 25 basis points (bps), citing the strength of the Australian dollar as primary motivation for the decision. Since then, the AUD has plunged as much as 9% and is currently down 7.5% against the US dollar.
We are also starting to see some improvements in the Australian and Chinese economies, with data from the manufacturing sector data surprising to the upside for both countries. As a result, we believe the RBA could shift to neutral, as the lower currency provides its own source of stimulus for the economy.
If we are right, optimistic comments could extend the rally in AUDUSD. However, if the RBA remains dovish and concerned about downside risks, Monday's gains could disappear in a flash.
The New Zealand dollar (NZD) and Canadian dollar (CAD) also performed well despite the lack of domestic data. This was due in part to the rebound in gold and oil prices, both of which were up about 1.5% on Monday.
GBP Nears 3-Month High vs. EUR
The British pound (GBP) traded higher against the US dollar and euro following better-than-expected manufacturing PMI numbers. According to the latest report, manufacturing activity increased at a faster pace in the month of May, and what made the numbers even more positive for sterling was the upward revision in April.
Originally, a contraction was reported, but we now learned that the sector grew slightly in the first month of the quarter. The third straight month of improvement should ease concerns for the Bank of England (BoE), which meets later this week, but with no policy changes likely, the meeting looks like a non-event for GBPUSD.
By Kathy Lien of BK Asset Management