The formal release of the G20 statement may clear the way for continued Japanese yen weakness, while upcoming central bank announcements and data are likely to impact the euro and key commodity currencies in the coming week.
USD/JPY Traders Await Final G20 Statement
The final G20 communique will be released on Saturday (Feb. 16), but according to the draft, Japan will be spared from being singled out for using monetary and fiscal policies to weaken the nation’s currency. USDJPY edged higher Friday on the back of release, but the modest rally suggests that traders are trying to be cautious until the final statement is made public. If the G20 gives the all clear, USDJPY will be on its way to stronger gains.
As we suspected, too many countries are also guilty of participating in the “currency war,” so it would be hypocritical of them to single out Japan. According to a "senior G20 source," China has Japan's back on this one because any reference to targeting exchange rates was not acceptable to the world's second largest economy. The G20 still felt that excessive FX volatility should be avoided and could say the same for competitive devaluation, but what set the G20 draft apart from the G7 statement is that there was no mention of targeting FX rates. Less constraint on currencies means less restriction on the USDJPY rally.
Even after the G20 meeting passes this weekend, the term “currency war” will be here to stay. Policymakers have been so afraid of giving any merit to the idea of a currency war that they could end up fanning the fire. Most likely, the Japanese yen (JPY) will continue to weaken, and as it does, other countries whose currencies become less competitive will fight back.
The next step for the yen is the nomination of a new Bank of Japan (BoJ) Governor. According to local papers, ToshiroMuto is the leading contender. While he is the least dovish of the three candidates under consideration, he is still expected to ease monetary policy shortly after taking office. Barring any surprises from the G20 this weekend, it should only be a matter of time before 95 is taken out in USDJPY.
EUR: All Eyes on ECB Staff Forecasts
The euro may have ended the day unchanged against the U.S. dollar, but the steadiness in the currency masks a strong intraday reversal that occurred after the draft G20 statement was released. While the focus for the G20 was on the Japanese yen, investors interpreted the lack of specific criticism about Japan's policies to mean a free pass for euro bulls.
The European Central Bank (ECB) attempts to downplay the significance of currency wars and their concerns about the euro have done nothing but help the currency. All of the comments from ECB President Mario Draghi, Bundesbank head Jens Weidmann, and ECB member Joerg Asmussen suggests that the euro is fairly valued. While this doesn't suggest that they are comfortable with further gains in the euro, the green light for the yen will also mean demand for EURJPY. ECB President Draghi's comment that the exchange rate is important to growth confirms that the central bank is watching the currency carefully. Draghi will be speaking next week at the quarterly hearing on the ECB before European Parliament, where he could again mention currencies.
There are a number of Eurozone economic reports on the calendar next week, including the German IFO data, but the most important release, in our opinion, will be the European Commission's economic growth forecasts. If forecasts for growth or inflation are revised lower, the euro could resume its slide; however, If forecasts remain unchanged, it would likely add fuel to the EURUSD rally.
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US Dollar Boosted by Strong Economic Data
The U.S. dollar traded higher against all major currencies except for the British pound (GBP) on Friday, which is interesting considering that the biggest disappointment in economic data today came out of the U.K. As expected, U.S. data took a back seat to the G20, but a handful of U.S. economic reports were released.
Starting with the Empire State manufacturing survey and the Treasury International Capital Flow report, manufacturing conditions in the NY region rebounded strongly in the month of February. The index jumped from -7.78 to a nine-month high of 10.04 last month. While manufacturing conditions in the NY region can be volatile, the data is nonetheless encouraging and consistent with Fed Chairman Ben Bernanke's comment that a stronger U.S. economy is helping the global economy.
The Treasury International Capital flow report showed foreigners buying $64.2 billion worth of U.S. assets, up from $52.4B the previous month. Approximately 40% of that demand was for U.S. Treasuries. The data also shows that foreign investors were lured back into U.S. assets thanks to the strong performance of U.S. stocks.
The continuous rise in the S&P 500 made Americans more optimistic in the month of February, as the University of Michigan Consumer Confidence index rose to 76.3 from 73.8. The only disappointment was industrial production, which fell 0.1% in January.
The minutes from the most recent Federal Reserve meeting is scheduled for release next week, and we expect comments about the potential phasing out of asset purchases to resurface. According to Cleveland Fed President Sandra Pianalto, if the economy picks up, the central bank will have to taper down asset buying. She is not a voting member of the Federal Open Market Committee (FOMC) this year, so while she may believe that the central bank should start thinking about what to do when the economy recovers, it may not be a view shared by her peers who have an official say on monetary policy in 2013.
British Pound Shrugs Off Fourth Month of Negative Retail Sales
The British pound rebounded against the U.S. dollar and euro despite a surprise decline in consumer spending. Retail sales fell 0.6% in January, extending the contraction in spending for a fourth consecutive month. In fact, retail sales have now fallen five of the last six months, which explains why Bank of England (BoE) Governor Mervyn King maintained a negative outlook on the economy even though inflation forecasts were increased.
While heavy snowfall can be blamed for part of the decline, the trend for consumer spending is still very weak. Unless there is a significant recovery in February or March, retail sales won't provide much support to first quarter GDP growth.
The minutes from the most recent Bank of England meeting will be released next week along with employment numbers. We expect the BoE to remain dovish and keep the door open for additional easing. The labor market, however, appears to have improved according to latest PMI reports. While there was a small recovery in the GBP on Friday and there's a possibility for further short covering, the trend in the sterling is still lower.
NZD Defends Key Price Level
The New Zealand (NZD), Australian (AUD), and Canadian (CAD) dollars all fell sharply against the greenback despite better-than-expected economic data. There is an incredible amount of defense happening around the 85-cent level in the NZDUSD. The currency pair climbed to a fresh one-and-a-half-year high of 0.8544 in the early Asian trading session after strong retail sales numbers and an increase in non-resident bond holdings.
Consumer spending in New Zealand rose the most in six years, and it is this consistent improvement in New Zealand data that has encouraged foreigners to increase their share of New Zealand bonds to 66.7% from 64%. Yet, when European and U.S. traders joined the markets, they sold the currency aggressively.
Unfortunately, there's nothing to explain the move outside of the potential for option- or stop-related defense below the September 2011 high of 0.8545.
The Australian dollar also fell sharply as gold prices tumbled. The Canadian dollar, on the other hand, failed to benefit from stronger-than-expected existing home sales, which rose 1.3% last month. This may have been due partially to the sharp decline in manufacturing sales, which may cause a bigger problem for Canada.
In the week ahead, the minutes from the Reserve Bank of Australia’s (RBA) latest monetary policy meeting and Canadian retail sales are the most important economic reports scheduled for release from the three commodity-producing countries.
By Kathy Lien of BK Asset Management