Dollar: A Thunderous Collapse or Slow Revival
Fundamental Forecast for Dollar:Bullish
The worst S&P 500 and US equity drop in nearly two years has yet to resurrect the greenback’s safe haven status
A tempered forecast for the Fed’s first rate hike has driven the dollar lower, particularly against its core counterparts
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The dollar has suffered. A 1.1 percent tumble through the past week marks the currency’s worst performance since October 18 – notably, when the greenback bottomed out a three-month slide. On the verge of a stark trend change on a individual basis (the Dow Jones FXCM Dollar Index is standing just above a mulit-year trendline and 12-month range low around 10,400) and its important pairings (EURUSD close to 1.4000, GBPUSD at four-year highs and USDJPY looking heavy above 100), the potential for a crippling collapse or dramatic recovery is tangible. Bears will point to the recent slide in Treasury yields and rate expectations as their cue for the next leg. Bulls see the tumble in capital markets last week as the currency’s salvation. What we find is likely something in the middle…and perhaps still bullish.
While FX markets carved hefty moves and tested serious levels, the top financial headline of this past week was the drop in equities. In particular, the S&P 500’s 2.6 percent slide through the period was the benchmark’s worst since the period ending June 1, 2012. In this move, there is the potential for dollar’s salvation – though it isn’t especially high. This benchmark for risk appetite is down 4 percent from the record high set last Friday. For many, such an abrupt move translates into substantial ‘risk aversion’. If there is enough ‘fear’ in this correction such that it infects the broader financial system, the dollar could regain its traction amid a scramble for liquidity.
The difficulty in turning this recent volatility swell into a lever for the dollar is the balance of conviction. To tap the currency’s unique safe haven status, we need the level of speculative unwind that redirects investors from higher yields in the Eurozone, China and the UK to the deep markets and regulations of the US. That is easier said than done. There have been plenty of temporary corrections during the past 5-year dominant bull trend that have petered out and inevitably acted as a spring board for opportunistic speculators. Such consistency has led to an extraordinary sense of complacency and certainty.
Whether we are looking at the bigger picture from a technical view (record high stocks), a fundamental view (high valuations) or structural view (excessive leverage); the potential for a ‘cleansing fire’ is high. The risk that it happens over the coming weeks or months is higher now than it has been in the past years, but it will be particularly difficult to generate the kind of panic that revives the dollar’s safe haven status this week. For one, there are few events that tout the kind of influence necessary to single-handedly redefine sentiment. Perhaps more a burden is that the trading ranks will be severely thinned out by a market holiday for much of the western world on Friday.
It is important to maintain a healthy sense of skepticism for scenarios that are low probability – especially those that we desire for more favorable trading conditions – but it is just as important to have a plan in place should they be realized. If we do manage to see sentiment ignite in flames, the dollar would do more than bounce – it would surge.
A more engaged fundamental theme for FX traders to keep track of this week is the development in interest rate forecasts. The greenback’s tumble these past three months – and particularly the past week – have been heavily influenced by a substantial corrosion in rate forecasts. From a time frame as competitive as early as 1Q 2015, the market is conforming to the mid-2015 by the Fed. This has led to a drop in Treasury yields and market rates – and the dollar in turn. Yet, while the USDollar stands on the cusp of a major trendline break, it is important to differentiate a loss of premium from an actual dovish turn for US forecasts. The latter could sink the greenback, but that is not the circumstances we are working with. The question is how far the premium retreat goes. Does it end this week with March CPI and Fed Chair Yellen speeches or does it continue to weigh? Be ready. – JK
Euro Elevation versus Dollar Isolated as ECB QE Threat Remains
Fundamental Forecast for Euro: Bearish
- The ECB hinted at QE, but the Euro failed to lose ground versus the US Dollar after the weaker March NFPs.
- The Euro was weaker elsewhere, and faces perhaps its most serious threat in the Japanese Yen if equity markets dive further.
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The Euro’s weakness in the wake of the European Central Bank’s most recent bout of intensifying its dovish forward guidance was hardly apparent last week, as the Euro paced as the third strongest major currency versus the US Dollar (EURUSD +1.30%). With the US Dollar reeling from a sustained streak of weak economic data amid the Federal Reserve tapering QE3, the focus this week was on the unwind of USD-based risk positions.
With the Euro-Zone, thanks to its largest economy, Germany, running a current account surplus, there is a natural inclination for market forces to push the exchange rate higher as a corrective mechanism. Accordingly, when the US Dollar undergoes a series of mishaps as it has the past few months – poor consumption data, weak trade data, disappointing jobs data, and mixed signals from the Fed – the Euro instantly generates positive attention. Central banks have taken notice: in Q1’14, the Euro gained about +0.35% of the total share in global forex reserves (top among major currencies), while the US Dollar’s presence dissipated by about -0.55% (International Monetary Fund).
Euro-Zone economic data has been poor in its own right (which is why the discussion of QE by the ECB is back on the table). The Citi Economic Surprise Index fell to -9.9 on April 11, its lowest level of 2014 and lowest since June 21, 2013. There’s been little evidence to suggest that market participants have stayed in the Euro for optimistic speculative reasons.
Therefore, what we may be witnessing is that, as global central banks diversify away from the US Dollar, and as the Euro-Zone continues to progress from the depths of its financial crisis, the Euro engenders the role of an alternative safe haven. Price action among the forex majors this week supports this assertion. With US equity markets plunging in the second half of the week, all of the Euro’s losses versus the Australian and New Zealand Dollars were wiped out; the Euro was the third best performer overall behind the Swiss Franc and the Japanese Yen.
Even in the face of global risk aversion, the Euro was only able to squeeze out minor gains of +0.18% and +0.27% against the Australian and New Zealand Dollars, which have proved surprisingly resilient to concerns over emerging market growth thanks to significant outperformance by their respective domestic economies. The desire for traders to shift from the higher yielding currencies to the lower yielding currencies was exceptionally muted.
If the economic data environment improves for the Euro, then the conversation can shift back to the Euro gaining ground amid growth speculation. This week, the Euro was more or less the “anti-US Dollar.” The Euro’s financial underpinning, beyond the weak economic data environment, is soft as well. Interbank lending rates continued to push higher in recent weeks: in April, the EONIA rate has averaged 0.212%; in March, it was 0.192% (excluding the March 31 spike to 0.688%, the March average would have otherwise been even lower at 0.167%). In light of these facts, there is little evidence that the ECB’s threat of QE will disappear anytime soon, leaving the Euro vulnerable should economic data improve elsewhere around the world. –CV
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Whats the Risk of a Much Larger Japanese Yen Breakout?
Fundamental Forecast for Japanese Yen: Bullish
The Japanese Yen surged against major forex counterparts as the S&P 500 and Japanese Nikkei 225 tumbled. A rush to safety favored the JPY, and the fact that it trades at critical resistance (USDJPY support) suggests the week ahead could bring further volatility.
Japanese equities bore the brunt of the global shift towards safe-haven assets as the Nikkei posted its single-largest weekly decline in three years. The highly-correlated Dollar/Yen exchange rate looks especially at risk if the Nikkei falls to further lows.
Sharp domestic equity underperformance can partly be blamed on a disappointing Bank of Japan monetary policy announcement. Central bankers left the current pace of Quantitative Easing purchases unchanged, and surprisingly hawkish rhetoric from BoJ Governor Kuroda sunk hopes that they would ease policy further. To that end it will be important to monitor commentary from the BoJ chief this week; we suspect that Nikkei weakness and JPY surges would likely soften the bank’s stance on further QE.
Similarly surprising commentary from the US Federal Reserve put further pressure on the US Dollar/Yen exchange rate in particular. Minutes from the recent Federal Open Market Committee meeting showed that several members believed interest rates would rise more gradually than staff projections predicted. The effect on US interest rate futures was clear: implied yields for the December, 2015 interest rate futures fell to their lowest since the USD traded to ¥101.20 just one month ago.
There’s certainly risk that this may be the start of a larger USDJPY breakdown and Japanese Yen break higher. Yet it’s important to note that FX options show volatility prices remain near multi-year lows. In plain words: traders aren’t necessarily betting on/hedging against much larger USD moves.
Until we see a more significant shift in FX market conditions it’s difficult to argue for a much larger JPY break higher (USDJPY breakdown). Yet it would be foolish to ignore the clear risk that the Nikkei 225 could fall further, and clear pressure on US interest rates could likewise keep the Dollar under pressure through the days and weeks ahead. - DR
GBP/USD Remains Poised for Higher High on Stronger U.K. Recovery
Fundamental Forecast for Pound:Bullish
The British Pound struggled to hold above the 1.6800 handle after failing to clear the February high (1.6821), but the fundamental developments coming out next week may generate fresh highs in the GBP/USD as the economic recovery in the U.K. gathers pace.
Even though the International Monetary Fund (IMF) lowered its global growth forecast for 2014, the group sees the U.K. outpacing the other advanced economies as the region is now expected to grow an annualized 2.9% this year, and the Bank of England (BoE) may come under increased pressure to normalize monetary policy sooner rather than later as U.K. Jobless Claims are projected to contract another 30.0K in March, while wage growth is anticipated to pick-up for the third consecutive month in February.
With that said, the U.K. Core Consumer Price Index may continue to highlight sticky inflation in the U.K. amid the ongoing pickup in economic activity, and Governor Mark Carney may do little to halt the ongoing appreciation in the British Pound as it helps the Monetary Policy Committee (MPC) to achieve the 2% target for price growth.
In turn, the BoE Minutes due out on April 23 may sound more hawkish this time around, and a further shift in the policy outlook may heighten the bullish sentiment surrounding the sterling as the central bank moves away from its easing cycle. As a result, we will continue to look for opportunities to ‘buy dips’ in the British Pound, and the GBP/USD may continue to carve a series of higher highs & higher lows this year as it retains the bullish trend carried over from 2013. The next topside objective for the GBP/USD comes in around 1.6850-60, the 78.6% Fibonacci expansion from the October advance, and we will continue look for a higher high as it carves a higher low earlier this month. –DS
Gold at Major Inflection Point Ahead of Fed Beige Book- $1327 Key
Fundamental Forecast for Gold:Bearish
Gold is up 1.1% on the week with the precious metal trading at $1318 ahead of the New York Close on Friday. The rally comes on the back of a substantial sell-off in broader risk assets with US stock indices off by 2-3% across the board. Gold prices have found support on risk-aversion flows and Fed rhetoric after coming off seven week lows at $1277. The advances are likely to remain limited however as the technical picture keeps the broader focus weighted to the downside.
The release of the minutes from the March FOMC policy meeting noted that several Fed officials said ‘forecasts overstated the rate rise pace,’ suggesting that the central bank does in fact expect to keep rates anchored well after the cessation of QE. Remarks by Philadelphia President Charles Plosser, a voting member this year, further reinforced the central bank’s stance, saying that the ‘dot forecasts are not the FOMC consensus.’
Interest rate expectations were subsequently pushed out, offering support for bullion as the greenback came under tremendous pressure. The Dow Jones FXCM Dollar Index (Ticker: USDOLLAR) fell to levels not seen since October with a decline of more than 1.2% heading into the close of the week. However, with the US docket picking up next week, the greenback may find some support, limiting the fuel needed to sustain the gold rally.
Traders will be closely eyeing key US data prints next week including retail sales, the consumer price index (CPI), housing data and the release of the Fed’s Beige Book. Inflation data on Tuesday is expected to show a n increase in the pace of year on year price growth to 1.4% from 1.1% with core and m/m inflation expected to hold steady at 1.6% and 0.1% respectively. The updated assessment of the Fed’s twelve districts on Wednesday will likely highlight the week’s docket as investors look for signs that the recovery remains on firm footing.
From a technical standpoint, gold remains at risk below the March opening range low at $1327, with only a move surpassing $1348 shifting our focus back to the topside. This level represents the 61.8% retracement of the decline off the March highs and would require a breach back above the 2012 trendline resistance we broke last month. Bottom line: we’ll be looking for short triggers next week to offer favorable entries targeting objectives into $1270 with only a breach/close above $1327 invalidating our medium-term bias. Such a scenario eyes a break above $1348 to put resistance objectives at $1366, $1383 and $1408 in view. –MB
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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Australian Dollar Rally at Risk as Soft Chinese Data Looms Ahead
Fundamental Forecast for Australian Dollar: Neutral
Australian Dollar Hits Five Month High on Firming RBA Policy Bets
Soft Chinese Economic Data May Undermine Aussie in the Week Ahead
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The Australian Dollar continued to recover last week, finishing Friday’s session with the highest close in five months against its US counterpart. The move tracked a pickup in RBA interest rate hike expectations, with a Credit Suisse gauge tracking the priced-in outlook now at levels unseen since November and pointing to an interest rate hike within 12 months.
A hefty helping of top-tier Chinese economic data may undermine Aussie strength in the week ahead however. The first quarter GDP report takes top billing, with expectations pointing to a slowdown to 7.3 percent on the year-on-year growth rate. That would mark the weakest pace of expansion since the Great Recession trough recorded in March 2009. Softening retail sales and industrial production readings are likewise on tap.
Data from Citigroup shows Chinese economic news-flow has increasingly underperformed relative to consensus forecasts since mid-February. Indeed, the gap between expectations and realized outcomes is now at its most dramatic in five years. That suggests analysts continue to underestimate the extent of the slowdown in the world’s second-largest economy, opening the door for disappointing outcomes.
China is Australia’s largest trading partner. That means that a slowdown in the East Asian giant may spill over into Australia via ebbing cross-border demand, undermining the case for RBA tightening. Needless to say, that bodes ill for the Aussie Dollar. The release of minutes from April’s monetary policy meeting where Governor Glenn Stevens and company once again argued in favor of a period of stability in baseline rates may further temper hawkish bets.
On the external front, a busy docket of scheduled commentary from Federal Reserve officials including Chair Yellen as well as the release of the central bank’s Beige Book survey of regional economic conditions may prove market-moving. AUD/USD has moved closely in line with the Australia-US front-end bond yield spread. If last week’s disappointment in minutes from March’s FOMC minutes is softened by supportive outcomes on these fronts, a pro-taper shift in policy bets may likewise put pressure on the Aussie.
Chinese Yuan Risks Drop to 12-Month Lows On Heavy Data
Fundamental Forecast for the Renminbi: Neutral
A rebound for the Yuan faltered quickly this past week and put the currency back at 12-month lows versus the dollar
Risk trends are a key aspect for this currency, but it isn’t as sensitive as other emerging market counterparts
1Q GDP will be this week’s top scheduled event risk, but financial measures should be paid an equal mind
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The Chinese Yuan (also called the Renminbi) attempted a recovery in its opening move of this past week, but the currency would ultimately end back up on the cusp of 12-month lows against its US counterpart. No doubt risk trends played a significant role in this failed attempt at liftoff. With global equities on the lam, the frequent financial headlines lamenting China’s slowing growth, impending wave of defaults and asset bubbles are taken more seriously. Will the international market’s scrutiny increase this week as speculators come under pressure? Will heavy economic docket alter the Yuan’s position on the global scale? These are the question we should ask to determine whether USDCNH will mark its break above 6.2500 or below 6.1750.
Historically speaking, USDCNH maintains a strong negative correlation to the S&P 500. In other words, the Chinese currency has risen consistently alongside the ‘risk trends’. Fundamentally, this makes sense. Investors seeking higher return on their capital put their money to work in China where relative returns mirrors the country’s astounding growth rate. Naturally, when the tide goes back out on sentiment, funds are repatriated to seek stability. However, the situation is a little more unique with China.
First and foremost, there is an issue with the scale of risk aversion. While we have seen genuine stumbles in exuberance these past years, we haven’t seen anything on the scale that would shake highly leveraged positions nor the less liquid investments in China. To turn the Yuan into a more sensitive emerging market currency (like the South African Rand, Brazilian Real or Indonesian Rupiah), we need to see a greater sense of conviction.
Another unusual aspect that has kept this pair from deviating from its long-term depreciation (Yuan gain) are the external controls – and the speculative distortion that has. The PBoC sets the USDCNY reference every day and doesn’t allow fluctuation greater than 2 percent around its band. Under the assumption that Chinese authorities will continue to loosen the exchange rate as it approaches ‘fair value’, investors feel particularly confident about investing in the country expecting stability. That has led to what many call the ‘China Carry Trade’. Yet, debt defaults, asset bubbles and curbs on capital outflow can quickly work against those same investors.
A more traditional route to volatility – event risk – may be tempted in the week ahead. China’s calendar is dotted with foreign reserves, lending, foreign direct investment (all without specific days for release) as well as precisely timed business activity, fixed assets, retail sales and industrial production figures for March. However, the big ticket item will certainly be the first quarter (1Q) GDP report. The consensus is for the country’s pace of growth to slow from 7.7 percent in the final months of 2013 to 7.3 percent. The Premier and Central Bank Governor have both said that would be within the tolerable band, but will investors be so confident as defaults mount and officials deny fresh rounds of stimulus? - JK