US Dollar Risks Plunge as SPX Hits a Record, EURUSD Tests 1.3800
Fundamental Forecast for US Dollar: Bullish
There are multiple fronts on which the dollar will be assailed by event risk, but risk trends and NFPs will prove top catalysts
Risk trends are not as robust as the S&P 500 suggests, and there is little room for ‘disappointment’ on Taper views
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The dollar’s recovery effort fell apart this past week as a record push for the S&P 500 spawned ‘risk appetite’ headlines and the market’s Taper interests continued to fade. In turn, the EURUSD stands just below a multi-year resistance around 1.3800/3850 and the Dow Jones FXCM Dollar Index (ticker = USDollar) looks ready to collapse into another bear leg. No doubt, the imminent presence of key levels for the greenback puts it in immediate jeopardy of an unfavorable bolt of volatility. But, just as with the US equity indexes’ regular fits, there is a cavernous gap between a technical break and a committed trend.
It is important for the week ahead, that we first steel ourselves against the excitement of technical breaks and the headlines they will no doubt inspire. For the greenback itself, the USDollar Index is testing the support it has relied upon since its September 2012 reversal. The situation looks more severe / enticing for some of the major pairings. AUDUSD and NZDUSD are dangerously close to range resistance levels at 0.9080 and 0.8400 respectively. Far more extraordinary though is GBPUSD’s proximity to four-year highs above 1.6800 and the ceiling of a EURUSD wedge that has developed for the better part of the euro’s existence at 1.3800.
Under current market conditions, it isn’t difficult to trip technical barriers. A lack of conviction and momentum leads to market mechanics that set off automated orders set around key levels or draw volatility-starved speculators in for short-term drives. Yet, a breakout that doesn’t draw in greater participation to feed the move is ultimately destined to stall. Converting the disparate faithful already in the market is proving almost as difficult as luring new participants in. This is no doubt a sign of disillusionment with the potential for further traditional gains on already richly priced markets that have been inflated by a yield chase. That leads to lop-sided opportunity.
Given the S&P 500’s move to end February above the 2014 range high at 1,850, the most pressing theme to pick up on this coming week is ‘risk trends’. Yet, despite the speculative appetites the benchmark index represents, we have long ago witnessed the market’s hesitance to use the index as its banner. Stock benchmarks from other financial centers have fallen short of its highs. Yen crosses this past week were well off their own multi-year highs – failing even to find progress on near-term technical patterns. Even high yield and leveraged assets are far off pace.
The preconditions for a dedicated wave of fresh capital inflow are exceptionally high. The outlook for economic growth, yields and global financial disruptions clash with markets at record highs on the back of record leverage. Investors are overexposed as it is. Maintaining that exposure until long-term circumstances improve – that would take a considerable amount of time – is the best that can be achieved. And, it is also a fragile balance to maintain. The same circumstances that have delivered us to our current state expose us to rapid and destructive unwinding as little margin is left to cover losses. If such a situation were realized, the dollar would stand to benefit handsomely.
Despite the vulnerability to ‘risk aversion’ once it sets in, the spark to first shake complacency is proving difficult to combust. Unrest in the Ukraine, recognition of the recession of stimulus, a reversal in the dearth of risk premium, even NFPs can generate volatility. But it is that jump to the self-generating vicious cycle of deleveraging that is key. Meanwhile, monetary policy interests may elicit some movement on the dollar’s behalf. Friday’s February NFPs figures are the big-ticket item, but we should also take note of the Senate confirmation hearing for nominees Stanley Fischer, Lael Brainard and Jerome Powell. Their view can help shape policy through the rest of the Taper and into the eventual rate hike regime. Yet, the market has yet to be seriously distressed by the withdrawal of stimulus. There will be a tipping point, however. When the assumption that risk is shifting away from central bank balance sheets to individual investors, the ‘moral hazard’ premium will collapse. And, Dallas Fed Fisher is already laying the ground work by saying the Taper would continue even if capital markets were to suffer a ‘significant correction’. – JK
Euro Could Surge if Rebounding Inflation Translates into ECB Hold
Fundamental Forecast for Euro: Bullish
- The Euro’s bullish expectations have been boosted after faster than expected February Euro-Zone inflation data.
- Higher inflation diminishes the chance of new non-standard easing measures by the ECB.
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The Euro capped off a strong week by hitting fresh yearly highs against the US Dollar on Friday, seeing its highest exchange rate above $1.3800 for the first time since the week beginning December 22, 2013. It was not a pretty week for the Euro, though; the EURUSD nearly having clear 1.3600 to the downside on Thursday before staging its impressive near-200-pip comeback.
With the only true weight on the Euro right now speculation that the European Central Bank will enact further easing measures to fight purported deflation, the Euro looks well-positioned heading into next week given the February Euro-Zone inflation figures.
True, the Euro-Zone Consumer Price Index Estimate was still low at +0.8% y/y; but the EZ CPI Core reading perked up to +1.0% y/y – the first time it was at or above +1.0% since September. Rebounding inflation right now fits neatly in with ECB policy. Policy rate changes typically take around six-months to fully cycle through developed economies, and the ECB cut its main rate to 0.25% in November.
The recent bout of inflation data may have been the best shot at weakening the Euro’s resiliency. Instead, the Euro’s bull run from last summer may be gearing up as ECB policymakers find little reason otherwise to enact aggressive easing policies. A look at EONIA rates (interbank lending rates) shows that the cost of capital is falling and the Asset Quality Review (AQR - stress tests) may have been the reason for higher rates at the beginning of the year. EONIA rates remain below the ECB’s main rate, settling at 0.162% on Friday, and the 20-day average was 0.155% - lending conditions are stable.
An expanded view of credit conditions on the sovereign level see peripheral yields holding at or near multi-month and multi-year lows; financial conditions wholly do not scream the necessity for more easing right now. The ECB wants inflation, true; but it wants organic inflation – the result of accelerating economic activity resulting in excess demand over supply.
The ECB isn’t simply going to fork over more capital to banks carte blanche during the stress tests and when crisis conditions aren’t present – this could result in only asset inflation rather than translating into credit growth for small- and medium-sized enterprises (SMEs).
In light of these stabilizing conditions, we maintain that a BoE-styled Funding for Lending Scheme (FLS) has become more appealing for the ECB as it could address credit concerns without putting the Euro at risk of a massive ECB balance sheet expansion that another LTRO or a Fed-styled QE would bring. (To this end: outright QE looks less likely after the German Constitutional Court ruling.)
At most, a small, 0.15% cut to the main rate could be made to help support the recent rebound in inflation pressures – but even that wouldn’t pin down the Euro for long as the ECB’s surprise November rate cut proved.–CV
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Yen Crosses May Revive Equities Correlation On a Collapse
Fundamental Forecast for Japanese Yen: Bullish
Yen crosses correlation to S&P 500 collapse – which is the better bellwether for sentiment
Last week’s data allows for the BoJ to maintain a wait-and-see, but time is running out
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The Japanese yen put in for a mixed performance this past week versus its major counterparts. Yet, such a performance is much more disconcerting than the benign picture it seems to put on. While USDJPY, EURJPY and other key crosses were developing ranges, the speculative benchmark S&P 500 has forged new record highs. Is this a sign that yen’s steady depreciation (crosses advance) has hit a ceiling or is this a reflection on the quality of risk trends? It is likely a mixture of both, and that doesn’t bode well for bulls.
Over a longer period of time (60 trading days or 3 months), USDJPY has fostered an exceptionally strong 0.72 correlation to one of the market’s favored – or at least bombastic – measures of risk appetite trends: the S&P 500. Intuitively, that makes sense. In the traditional portfolio, equities represent the higher return asset that investors overweight in ‘good’ times. And, over years of playing the role of a funding currency for the carry trade (the currency we borrow in), the yen has played a similar role in FX where pairs like AUDJPY advance when the market is seeking greater exposure and yield.
Yet, the yen crosses relationship to risk is now proving a source of discord. Turning down the time frame, we find the two-week (10-day) correlation between USDJPY and the S&P 500 has dropped from over 0.90 (exceptionally strong) in the first half of month to -0.28 through Friday. Is this a reflection of the Bank of Japan and Japanese government losing their control over the steady depreciation of their currency? In recent months, we have seen data improve and officials back off of their verbal threats of more stimulus. While that might be encouraging for domestic investment, it curbs speculators’ appetite for the yen crosses. If the BoJ is not committing itself to a depreciation of the local currency, the argument for a long position has to be made on either a strong risk appetite or expectations for growing yield differentials – both factors of the carry trade.
In terms of yields and yield growth, the outlook looks rather bleak. Benchmark lending rates across the developed world are still at record lows while aggregate market-based yields (from their 10-year government bonds) are still extremely depressed – far below mere cyclical lows. This means that there is little carry to be had historically speaking…and yet, the yen crosses are still 20-40 percent off of their record lows. That makes for fundamentally ‘expensive’ positions without an active participation by the central bank to maintain the momentum behind moral hazard and speculative front-running.
Six months ago, the prevailing forecast was for the central bank to upgrade its open stimulus program around one of the April meetings to coincide with the fiscal year end and the implementation of the sales tax hike. Yet shaky growth-based data, rising inflation (CPI) figures and tepid wage growth measures have given policymakers reason to rethink their QE efforts and traders to doubt their reliance.
The best way to reengage the yen crosses is through risk trends. However, we are not currently experiencing the ‘risk on’ sentiment that the S&P 500 seems to point to. Global equity indexes are trailing this move with the Nikkei 225 notably struggling with 15,000. Meanwhile, the emerging markets, high yield assets and other naturally sensitive asset classes are breaking stride with the US equity market. Of course, if conviction were to solidify in appetite for yield, the yen crosses could be urged to rally. Yet, the level of exposure, leverage, fundamental balance and now doubt says the more volatile scenario would be one where the yen crosses collapse alongside risk. - JK
GBP to Target 1.6850-60 on Hawkish Bank of England (BoE) Testimony
Fundamental Forecast for the British Pound: Bullish
The GBPUSD pulled back from a fresh monthly high of 1.6784 following the better-than-expected U.S. Non-Farm Payrolls report, but the British Pound may continue to coil up for a move higher as the Bank of England (BoE) moves away from its easing cycle.
Indeed, the Monetary Policy Committee (MPC) refrained from releasing a policy statement after retaining its current policy in March, but it seems as though the central bank will do little to halt the appreciation in the sterling as it helps to achieve the 2% target for inflation.
Beyond the U.K. data prints on tap for the week ahead, Governor Mark Carney, Paul Fisher, David Miles and Martin Weale are scheduled to testify in front of Parliament’s Treasury Committee on March 11, and the fresh batch of central bank rhetoric may spur a bullish reaction in the GBPUSD should we see a growing number of BoE officials show a greater willingness to normalize monetary policy sooner rather than later.
With that said, we will retain a bullish outlook for the GBPUSD as it appears to be carving a higher low above the 1.6600 handle, and will continue to look for a move into the 1.6850-60 region, the 78.6% Fibonacci expansion from the October advance, as the Relative Strength Index (RSI) preserves the bullish trend carried over from the previous year. - DS
Post NFP Break Below $1330 May Signal Gold Top in Place
Fundamental Forecast for Gold:Bearish
Gold is firmer at the close of trade this week with the precious metal up by nearly 1% to trade at $1335 ahead of the New York close on Friday. Tensions regarding the ongoing geopolitical dispute in Ukraine propped up gold prices early in the week with spot turning just ahead of technical resistance at $1357. Gold has since traded within the March 3rd range with major US economic data on Friday offering little support for the 2014 rally.
The US employment report on Friday was the highlight of the week with non-farm payrolls adding 175K jobs last month, toping expectations for a print of just 149K. The unemployment rate unexpectedly rose to 6.7% from 6.6% and while this would typically be seen as a negative, the move was accompanied by a broadening in the civilian labor force- a factor that will inherently elevate the headline rate. Gold immediately came under pressure on the release as concerns over the widely debated impact weather had on jobs abated. That’s said, it’s likely the Fed will continue tapering QE purchases as expected and the bid for gold (at least from an inflation standpoint) is likely to be limited barring any additional geopolitical risk.
Looking ahead to next week, investors will be closely eying retail sales data and the preliminary March University of Michigan confidence numbers. Gold prices are likely to take direction from broader market sentiment with our attention shifting on the USDOLLAR’s recent rebound at key Fibonacci support on Friday at 10,508. Should this rebound materialize into a more substantial advance, look for gold prices to remain under pressure.
From a technical standpoint, gold remains at risk below key resistance at $1357/61 with a clean monthly opening range highlighting support into $1330. Look for a decisive break of this range mid-next week to offer clarity on a medium-term bias heading into March with our immediate focus against the $1357/61 resistance range. A daily RSI support trigger looks to have been broken on Friday’s decline and a move below the March opening range puts support targets into view at $1320 and $1300/06 where more substantial demand is expected. Only a break below the $1268/70 support level would put the broader decline off the 2012 high back into play while noting that a break above the $1361 threshold suggests that a much more significant low was put in place last December. Such a scenario would eye topside objectives towards the August highs at $1433.
---Written by Michael Boutros, Currency Strategist with DailyFX
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Canadian Dollar To Consolidate Ahead of GDP Report
Canadian Dollar To Consolidate Ahead of GDP Report
Fundamental Forecast for Canadian Dollar: Neutral
The Canadian dollar strengthened this week against its U.S. counterpart on an improved economic outlook in the U.K. and U.S. Britain managed to avoid a triple-dip recession, recording a positive growth rate in the first quarter. Meanwhile, the U.S. jobless claims report came out better than expected as first-quarter GDP grew at a moderate rate, further helping to push the loonie higher. Also, Crude oil, Canada’s biggest export, rebounded, and hit its highest level in two weeks. Looking forward, we may see the Canadian dollar consolidate and build a short-term base before making another major move to the upside.
Canada’s February Gross Domestic Product highlights the biggest event risk for the week ahead. According to a Bloomberg News survey, economists have called for a consensus estimate of 0.2 percent growth in GDP, the same pace as in the previous month. In his last testimony before parliament, Bank of Canada Governor Mark Carney said that “Canada’s economy is strong but still faces risks.” Furthermore, signs of improvement in the domestic economy have materialized recently, with positive data in the manufacturing and sales sectors. At the same time, the latest unemployment rate report indicates that the recovery in the labor market remains slow. As a result, uncertainties in Canadian fundamentals could lead to a disappointing GDP report, potentially dragging down the loonie
Inflation within Canada has remained low in recent months, but is expected to gradually rise to the target level of 2 percent by mid-2015, when the economy is expected to return to full capacity. Although the Bank of Canada chose to hold its benchmark interest rate at 1.0 percent, the continual threat of record-rising household indebtedness could cause the central bank to hike interest rates in order to make borrowing more difficult and expensive. However, Governor Carney softened his tone on such a rate increase after growth unexpectedly stalled. The central bank cut its 2013 growth forecast to 1.5 percent from 2.0 percent. In addition, the IMF’s latest report suggested that Canada should refrain from tightening its monetary policy until its economy improves. In order to get a clue on the timing of interest rate move, investors will want to keep a close eye on three factors: economic growth, personal debt, and aspects of the housing market. With rates currently as low as they are, the Canadian dollar has less upward support.-RM
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Forex: Australian Dollar Facing Conflicting Domestic, External Forces
Fundamental Forecast for Australian Dollar: Neutral
Upbeat Jobs Data May Reinforce Positive Shift in the RBA Policy Outlook
Fading Doubts About Fed “Taper” Continuity May Undermine the Aussie
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The Australian Dollar launched a brisk recovery last week, pushing to the highest level in three months against its US counterpart. While the RBA monetary policy announcement repeated the now-familiar status quo, a round of supportive economic data proved to be a potent catalyst. The central bank once again argued in favor of a sustained period of stability in monetary policy. That has re-framed speculation to focus on which direction rates are likely to go once that period runs its course, and last week’s news-flow seemed to argue for tightening.
The fourth-quarter GDP report topped economists’ forecasts, showing the year-on-year growth rate accelerated to 2.8 percent and marked the highest reading since the three months through December 2012. Meanwhile, retail sales unexpectedly jumped 1.2 percent in January to yield the largest increase in 11 months. Investors’ RBA policy expectations notably shifted following these upbeat outcomes, with a Credit Suisse gauge of the priced-in outlook jumping to a three week high. While an outright interest rate hike is still not being telegraphed over the coming 12 months, a meaningful hawkish shift in the underlying bias for what the RBA’s next move will be is clearly perceptible.
Looking ahead, speculation will be further informed by February’s employment figures. The economy is expected to have added 15,000 jobs, which would amount to the largest gain since November. Data from the Australian Industry Group showed hiring in the service sector, which employs close to three quarters of the labor force, expanded for the first time in three months in February. This increases the probability of an upbeat outcome, bolstering bets on a rate hike cycle to be initiated after the current standstill. A strong-enough result may even hasten the timeline for its expected commencement in the minds of investors. Needless to say, such a scenario would bode well for Aussie.
External factors remain an important consideration however and may undermine the Australian unit’s prospects. The US economic calendar is expected to yield a pickup in retail sales and an improvement in consumer confidence. On the “fed-speak” docket, the spotlight will be on Senate confirmation hearings for Stanley Fischer, Lael Brainard and Jerome Powell. The former is nominated for Fed Vice Chair while the latter two are to be Governors.
Comments from Mr Fischer – until recently the Governor of the Bank of Israel and formerly a high-ranking official at both the IMF and the World Bank – will be in focus. He has vocally supported US monetary policy normalization in recent months, suggesting he will add to the chorus of pro-“taper” rhetoric from other Fed officials. Taken together, the arrival of these catalysts on the heels of Friday’s upbeat US payrolls data has scope to significantly reduce speculation about a possible deceleration of the QE cutback cycle. That may undermine risk appetite, weighing on the Aussie in the process. -IS
New Zealand Dollar to Hold Range Ahead of RBNZ
New Zealand Dollar to Hold Range Ahead of RBNZ
Fundamental Forecast for New Zealand Dollar: Neutral
The New Zealand Dollar ended the week nearly 2.0 percent lower, a dramatic turnaround from previous weeks. After disappointing Chinese data showed slower than expected growth in New Zealand’s biggest business partner, investors were forced to reconsider their positions in the kiwi. In addition, weak US data and a collapse in the prices of precious metals dragged down risk-linked currencies like the New Zealand Dollar. On the other hand, New Zealand’s first-quarter Consumer Price Index met economists’ forecasts and has grown at a steady pace. Looking forward, given this positive and negative momentum, we may see the kiwi rebound within range.
The main event risk for the New Zealand Dollar next week comes in the form of the central bank rate decision scheduled for Tuesday. Currently, the country’s overall inflation pressures remain subdued, growing at a pace below the Reserve Bank‘s bottom target range for the third consecutive quarter. Recently, the currency’s high exchange rate has placed downward pressure on the price of traded goods such as imported household items. According to the RBNZ there are some growing concerns over the “current escalation of house prices”, which continue to climb, particularly in the country’s two largest cities, Auckland and Christchurch. However, the increase in rents and construction costs are not as significant as expected and there is little sign of a spillover in rebuild-related inflation in other regions of New Zealand outside of Canterbury. Domestic inflation is expected to rise gradually with the economic recovery, but is likely to remain in the bottom half of the central bank's target zone throughout the rest of this year. Consequently, the RBNZ’s inflationary concerns are minimal and the RBNZ may hold interest rates at record lows in order to boost jobs and help exporters who are hampered by a strong kiwi.
On the Chinese data front, the April Manufacturing PMI and Business Sentiment Indicator reports will be the top drivers for the New Zealand Dollar. New Zealand’s small market size limits its global competitiveness and the nation’s economy has become closely correlated with that of China, similar in nature to the relationship between Canada and US. Despite China’s first-quarter GDP shortcomings, the nation’s recovery continues to be lead by improving domestic demand. As we discussed last week, signals continue to suggest that China is moving away from export-led growth to import-led growth. During this transition period, we may see some volatility and a subsequent economic slowdown in the short term. In the long term, however, China’s enormous population (1.3 billion) has the potential for significant consumption should individual savings be reduced from their current levels of 50% of income. This long term perspective adds positively to the outlook of New Zealand and its currency.
The pace of the kiwi's weekly decline slowed following a Bloomberg News report concerning a G-20 draft statement, which affirmed a commitment, among the 20 nations, to avoid purposely weakening their currencies in order to gain a trade advantage. Previous gains in the Kiwi were largely driven by the increasing demand among investors who were looking for positive returns outside of Japan. As a result, traders should focus on the G-20 meeting over the weekend, as markets will look for any comments about Japanese currency intervention.
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