US equities are at record highs as the first quarter of 2013 draws to a close, but several factors, including economic data, central bank policy, and political risks, made Q1 a forgettable quarter for many world currencies.
With US markets closed for Good Friday, the first quarter of 2013 has officially drawn to a close. The past three months have certainly been a tumultuous time in the forex markets, but for equity traders, there's hasn't been a better time to be in the markets!
In fact, the S&P 500 and the Dow Jones Industrial Average closed at record highs on Thursday. It may be hard for some investors to believe how stocks could be doing so well given the current state of the global economy, but it is not a stretch to understand why investors are buying equities and selling currencies.
While US data has improved, the performance of the US economy has been less than outstanding, and there are plenty of reasons why central banks still view the recovery with skepticism. But, it is this same level of skepticism that has helped equities perform so well because this improvement in market sentiment is exactly what central banks have been trying to achieve, which makes this a central-bank-driven rally.
The Federal Reserve and its counterparts around the world are still engaged in aggressive monetary easing, and in doing so, they are pushing the return in bond investments lower and driving investors into riskier assets like equities. Combine that with the initial evidence of a stronger US recovery and problems in Europe and we can understand why investors are buying stocks so aggressively.
See also: 4 Catalysts for Renewed Risk Aversion
However, it is this same monetary stimulus that has driven investors out of currencies because quantitative easing (QE) is negative for a country's currency. The Fed is in no rush to taper asset purchases, and the European CentralBank (ECB) is keeping the spigots open and could ease again if growth deteriorates. Furthermore, the Bank of England (BoE) is trying to balance higher inflationary pressures with weak growth, and the Bank of Japan (BoJ) is gearing up to ease aggressively. Simultaneous easing has prevented any major rallies in currencies.
Traditionally, the EURUSD has a strong and positive correlation with the S&P 500, but this correlation broke down completely over the past two months with the S&P 500 rising and the euro falling. While we expect this correlation to resume eventually, we don't see it happening before Europe finally rids itself of tail risk caused by uncertainties such as like the Italian election and Cyprus.
See related: The New Epicenter for Eurozone Problems
Watch for Upbeat US Economic Data
Meanwhile, there were a handful of US economic reports released on Thursday. Fourth-quarter GDP growth in the US was revised higher to 0.4% from 0.1%. Economists were looking for a slightly stronger print, but personal consumption was revised lower.
Jobless claims also rose to 357K from an upwardly revised 341K. While this was the largest miss in claims in four months, it is still a relatively low number that won't raise too many eyebrows inside the Fed. Over the past few weeks, claims have been abnormally low, and 350K is more consistent with the overall state of the labor market.
The Chicago PMI index, on the other hand, dropped to 52.4 from 56.8, a sign of slower activity in the manufacturing sector.
Personal income and spending numbers are due for release on Friday, and given the rise in retail sales and the increase in average hourly earnings, we look forward to stronger numbers that should be positive for the dollar, equities, and overall risk appetite.
Good News and (Very) Bad News from Germany
The euro traded higher against the US dollar on the back of better-than-expected German retail sales data and the lack of panic on the first day that Cyprus banks have reopened. Both those events eased concerns in the financial markets and stabilized the euro.
The strict capital controls put in place have gone a long way toward preventing bank runs . As we said in yesterday's note, whether EURUSD trades at 1.29 or 1.26 will largely hinge on German economic data, and these reports weren't all that bad.
After a handful of softer economic reports, the increase in spending eased some concerns about slower German growth in the first half of 2013. Economists were looking for retail sales to decline, but instead, they rose by 0.4%. This was the second straight month of stronger spending, and that bodes well for the outlook for the German economy.
Unfortunately, one piece of data won't be enough to turn us optimistic on Germany, particularly since unemployment increased for the first time since October. A total of 13k workers lost their jobs this month versus a 2k decline in February.
My colleague Boris Schlossberg put it best when he wrote:
"Overall labor conditions in Germany are markedly better than in the rest of the region, especially the periphery economies of southern Europe. However, today's data was the first uptick in joblessness in more than five months, and taken together with the sharp declines in flash PMI readings, it suggests that the economic slowdown may be spreading to Germany as well.”
“The slowdown in German activity is far more important and potentially more damaging to the health of the euro than the series of financial crises that have erupted in periphery economies. Germany is the bellwether of Europe and its primary driver of growth. If it suddenly sees a slowdown in demand, the impact on EURUSD is likely to be negative, potentially driving the pair to fresh lows over the next several weeks.”
British Pound (GBP) Rally Is Revived
The British pound (GBP) strengthened against the greenback, Japanese yen (JPY), and all three commodity dollars. Today's survey released by GfK showed that consumer confidence remained unchanged this month with the confidence index holding steady at -26. This was actually good news because the market had anticipated a decline.
GfK said in a statement, "The ongoing recession in the Eurozone and the danger of a renewed eruption of the debt crisis have thus far not been damping the economic mood." Amidst the turmoil in Cyprus, "The stable labor market, rising income, and moderate prices all suggest consumer sentiment will remain stable in the coming weeks."
Nationwide housing prices were little changed for the month of March. Nationwide Building Society said, "The outlook for the housing market is unusually uncertain at present, in part because the prospects for the wider economy are unclear, but also as the impact of a number of policy initiatives is hard to gauge."
No UK economic reports are due for release on Friday, but the lack of data may not stop the GBP from edging higher now that it has cleared Wednesday's high.
The Weakest of All Commodity Currencies
The Canadian (CAD) and New Zealand (NZD) dollars held steady against the greenback while the Australian dollar (AUD) extended its losses on Thursday. While the rallies in the CAD and NZD remain intact, the AUD is quickly losing momentum.
Overnight data from Australia was mixed with job vacancies falling more than 10%, inflationary pressures increasing slightly, according to the TD Securities index, and private sector credit maintaining the same pace of growth as the previous month.
New Zealand building permits rebounded in February, but the 1.9% rise fell short of the market's 3% forecast.
Meanwhile, the Canadian economy grew by 0.2% in the month of January. On an annualized basis, this translates into GDP growth of 1.0% versus 0.7% the previous month. While the data was strong enough to help the CAD hold onto its gains, a larger upside surprise was needed to increase the momentum of the downtrend in USDCAD. The 1.4% increase in industrial product prices and 2.2% increase in raw material prices, however, verify the increase in inflationary pressures last month.
For the Bank of Canada (BoC), slightly stronger GDP growth and hotter inflation pressures will leave the hawkish monetary policy stance intact. With no economic reports scheduled for release from the three commodity-producing countries on Friday, the commodity dollars should take their cues from equities, but as we saw Thursday, that may not always be the case.
A Proven USD/JPY Correlation at Work
The Japanese yen continued to trade higher against the US dollar and most major currencies despite the new highs in US equities. Weaker-than-expected consumer spending failed to hurt the yen but managed to drive the Nikkei down more than 1.25%.
USDJPY has a very strong positive correlation with the Nikkei, and the drop in Japanese stocks is one of the main reasons why the currency pair is under pressure. Bank of Japan (BOJ) Governor HaruhikoKuroda spoke on Wednesday, and he vowed to continue easing monetary policy until the Bank’s 2% inflation target is reached. While this is an affirmation of the central bank's commitment to additional asset purchases, it was clearly not enough to rally the yen. Investors want action, not talk, and unfortunately, we won't get any of that until April 4, at the earliest.
A number of Japanese economic reports are scheduled for release, however, and we could see the yen react to this data. These reports include PMI manufacturing, household spending, the jobless rate, consumer prices, and industrial production.
All of these releases are important, but Prime Minister Shinzo Abe has been saying that he is watching inflation, and therefore, our eyes will be on CPI. If inflationary pressures increase significantly, the BoJ may opt for more moderate stimulus, whereas steady inflationary pressures would give the Bank flexibility to do more.
By Kathy Lien of BK Asset Management