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FX: Will the Turnaround in Risk Last?

Kathy Lien, Director of Currency Research, GFT





  04/25 Meeting 06/20 Meeting
NO CHANGE 46.0% 43.2%
CUT TO 0BP 54.0% 53.5%
HIKE TO 50BP 0.0% 3.3%
CUT TO 75BP 0.0% 0.0%



Taking a look at the price action in the currency and equity markets, many investors may be wondering if the rally is finally over.  This is the second day of losses for most currencies and the third straight day of losses for the S&P 500.  The “all is now better” mentality is fading from the market quickly and replaced with renewed concerns about the sustainability of global growth.  Better than expected U.S. economic data failed to offset the series of negative economic reports released overnight. If the U.S. recovery was more mature and on firmer footing, slower growth in China and Europe would not be as damaging to risk appetite but unfortunately the U.S. recovery is still at its initial stages.  Even U.S. central bank officials have expressed skepticism about the pace of improvement and warned that unemployment remains very high.  U.S. equities had a very nice run that was fueled by liquidity injections, improvements in U.S. data and Apple.  Based on recent comments from policymakers, the need for further liquidity has diminished after the Greek default.  Of course, if the troubles in Spain or Italy magnify, another long term refinancing operation from the ECB will be needed but for the time being, most central banks have made it clear that they are comfortable with the current level of monetary stimulus.  In this case, there will not be further liquidity injections to fuel the rally in equities and currencies.  All the good news from Apple is out already and so speculation about what the company will do next should subside.  This leaves us with only U.S. data to fuel the rise and unfortunately this week’s economic reports are not market moving enough to carry the rally in equities. 


Jobless claims dropped to its lowest level since February 2008.  Weekly claims fell 5k to 348k after a revision to the prior's week report.  The level of jobless claims is consistent with continued job growth in the U.S. economy and as long as claims remain below 375k on a weekly basis, there is no reason for the Fed to be overly concerned.  Leading indicators rose 0.7 percent last month, up from 0.2 percent in January.  This fifth consecutive monthly improvement confirms that the U.S. economy is recovering.  With stocks rising sharply in February, jobless claims declining and yields moving higher, not only had we anticipated the improvement in leading indicators, but we believe that the index will rise even further in the month of March.  Only two out of the ten economic indicators tracked by the report declined and that was consumer expectations and new orders.  House price growth on the other hand was flat in the month of January which is not much surprise considering the slow pace of improvement in the housing market in general.  New home sales are due for release on Friday and a rebound is expected after a soft reading in January.  Unfortunately if the existing home sales report can be a guide, then there is a good chance new home sales may fall short of expectations. 


Whether the sell-off in currencies and equities this week is a correction within an overall uptrend or a full blown reversal remains to be seen but for the time being without a positive catalyst, it appears this loss in momentum is here to stay.  Better than expected U.S. economic data and risk aversion is a win-win for the U.S. dollar. The string of weaker economic data outside of the U.S. has made America appear like a shining star to investors. 48 hours ago, we penned a report talking about how the dollar can't lose even if the U.S. recovery loses momentum because the outlook for other countries is worse and so far this holds true.


The euro continued to weaken against the U.S. dollar as concerns about sovereign risk was compounded by fear of weak growth.  The biggest event risk this week for the euro was today’s flash PMI numbers and the reports painted a very grim picture about the current state of the Eurozone economy.   Manufacturing and service sector activity in the region contracted in the month of March, leaving the composite PMI index at 48.7, down from 49.3 in February. German and French manufacturing activity led the decline but service sector activity also slowed. The PMIs have a decent correlation with GDP and at face value, the drop in the PMI index points to a 0.3 to 0.5 percent contraction in first quarter Eurozone GDP growth. If GDP tips lower this quarter, the Eurozone would fall into a technical recession that could be difficult to rise from given the amount of austerity governments are planning this year.  The reality of slower growth and the prospect of tougher times ahead should have triggered a deeper sell-off in the EUR/USD than what was seen today. The resilience of the euro is surprising but we believe that it should only be a matter time before the currency pair tests 1.30.   If Italian and Spanish bond yields continue to rise, the EUR/USD will have a tough time recovering because not only has funding abilities come into question but the stability seen after the Greek default be replaced by fresh volatility.  If the problems stem from Europe, the euro will bear the most pain. 


Like the euro, the British pound suffered from weaker economic data.  Retail sales dropped 0.8 percent in the month of February after rising a downwardly revised 0.6 percent in January.  Consumer demand is not as healthy as economists had initially believed and this weakness in consumption could explain the central bank’s dovishness.  According to the recently released Bank of England minutes, some monetary policy committee members favored a further increase in asset purchases.  Given today’s retail sales report, the central bank may need to do more to support the U.K. economy.  What made the retail sales report particularly bad was the fact that spending less auto fuel also declined 0.8 percent.  A drop in demand was seen across all retailers which is consistent with the two consecutive monthly declines reported by the British Retail Consortium. If retail sales fail to rebound in March, consumer demand could be a net drag on first quarter GDP.  Considering the disappointments in U.K. data this week and the more dovish MPC minutes, the sell-off in the GBP/USD has been mild.  Although we think that the GBP/USD could be headed lower, this resilience, like that of the EUR/USD cannot be ignored.  Nationwide consumer confidence numbers are due for release this evening followed by BBA Loans for House Purchases.  No major changes are expected in sentiment but with the U.K. government’s recent increase in stamp tax on homes valued more than GBP2 million, the number of loans for house purchases could decline going forward.


The Australian, New Zealand, Canadian dollars weakened against the greenback today. As economic growth in China continues to slow, traders pulled back on riskier bets driving the loonie below parity against the greenback. Chinese manufacturing has been contracting for the last five consecutive months according to the latest PMI report. What is bad for China is bad for all of the commodity producing countries. Meanwhile Canadian retail sales increased 0.5 percent versus 1.8 percent expected. According to Statistics Canada, the increase was supported by a healthy auto sector. Core spending decreased 0.5 percent versus a forecasted 0.5 percent expansion. In addition to the weaker retail print, the softer factory and wholesale data hinted at a possible decline in the economic activity in January. As the Bank of Canada relies on the household to contribute over half of the country’s projected growth this year, the slowdown in consumer spending could raise some concerns for the Canadian economy. Also on the central bank’s watch list is the consumer prices due out tomorrow. With the bank noting stronger than expected inflationary pressure, the data could be one of the main contributing factors to BoC’s next rate hike. In New Zealand, the economy grew 0.3 percent in the last quarter of 2011, half of the rate forecasted. The chance of a rate hike in December has fallen to 40 percent according to swap prices from Westpac. Despite the quarterly fluctuation, finance minister Bill English remained optimistic. English said New Zealand was expected to post solid growth in the longer term as a massive rebuilding program in earthquake-hit Christchurch gained momentum. Looking forward, both Aussie and kiwi could trade mostly on sentiment with no major economic releases on the docket.

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The Japanese yen rose against all of the major currencies today. As the slowing Chinese economy raised concerns for the global recovery, risk aversion flows boosted safe haven assets such as the Yen.  Japan’s trade data also provided a jolt of strength to the Japanese yen. Japan printed a 32.9 billion yen surplus versus a forecasted deficit of 110 billion yen. The unexpected uptick in trade data could be signaling a rebound in the Japanese economy. Finance Minister Jun Azumi said strong exports to the US were a key factor behind the increase. Moreover, Japanese exports reaped the benefits of a weakening currency as the yen declined from the post-WWII record high. Nonetheless, the shortage of energy overhangs the recovery in Japan. Imports of petroleum products and liquefied natural gas increased by 26.8 and 53.8 percent, respectively. As energy demand picks up seasonally, the Japanese economy is faced with heavy reliance on importing fossil fuels. Bank of Japan board member Yoshihisa Morimoto warned that the geopolitical risk linked to Iran could continue to prop up energy prices. Higher crude oil prices would affect the BOJ's recovery scenario that Japan's economy should return to a moderate recovery path in the first half of fiscal 2012, Morimoto said. Furthermore, "if the operations of all domestic nuclear power plants are suspended, electricity supply will become severe this summer and affect economic activity.” While the February trade number printed a rosier picture for Japan, the recovery remains vulnerable going forward. With no economic release scheduled for tomorrow, the price action in the yen will largely hinge on the news flows from both sides of the Atlantic

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USD/CAD: Currency in Play for Next 24 Hours

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Our currency pair in play for the next 24 hours will be USD/CAD. The economic release we expect from Canada is consumer prices at 7:00AM ET/ 11:00 GMT. From the US, we have new home sales at 10:00AM ET/ 14:00 GMT.


After today’s rally, USD/CAD is currently trading in an uptrend which we determined using the double Bollinger Bands. The closest resistance is at 1.0050 where the pair has tested multiple times in February. With a break above, USD/CAD could target the 38.2% Fibonacci level at 1.0178. We drew our Fib from a swing low in July 2011 to a record high in October. On the downside, the 20-day SMA could provide support at 0.9928. Should the pair decline further, the swing low in February could serve at the second support level at 0.9841.