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USDollar Looks to Fed, US GDP, Struggling Euro and Yen to Guide It

Fundamental analysis and market themes.

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USDollar Looks to Fed, US GDP, Struggling Euro and Yen to Guide It

Fundamental Forecast for Dollar: Bullish

  • The USDollar hit five months highs, but there was little oomph to the move with the majors not clearing technicals
  • Speculation of a Fed hike this year is slowly recovering, but the market is still very skeptical at a 37% chance by December
  • See our 3Q forecasts for the US Dollar and market benchmarks on the DailyFX Trading Guides page

The USDollar has advanced for five consecutive weeks – although the pace hardly resembles the unconstrained bull trend through the first quarter of 2015. Fundamental appeal for the Greenback is thawing just as the docket looks to deliver explosive event risk like the FOMC rate decision and 2Q US GDP update. The list of ground-shaking updates – such as the aforementioned – and hearty tab of slightly more terrestrial listings presents a high probability of exceptional volatility. However, those same erratic conditions can undermine the development of consistent trends. Will the headline-crowding local event risk align to the heavy drivers from abroad to provide a trend, or will there be so much conflict that any violent activity stays contained to its 18-month range?

Heading into the new trading week, it is immediately apparent that whether we are looking for scheduled motivation from the US or abroad to engage the Dollar; it is likely to come in the second half of the week. The bulk of the heaviest-hitting data, meetings and speeches are Wednesday or later. Top listing for the global financial media is Wednesday’s FOMC rate decision – yet I do not believe it carries the greatest market-moving potential of all the items. Monetary policy as a general theme is growing in prominence once again, and speculation surrounding the Fed’s path to normalization is intensifying – though perhaps not for the same reasons that we have seen in the past.

Through previous phases of Dollar advance (such as the 9 consecutive month rally through March 2015), much of the lift came through the competitive yield view of the US in contrast to its liquid counterparts. The probability that the Fed would lift rates – even if ‘gradual’ and from an effectively zero bound – appealed to investors that were facing alternatives destined for falling or negative rates. With a firm sense of FOMO (fear of missing out) driving investors to anything that provides even a marginal yield advantage, the general luster of rate hikes in the US shown bright. That appeal has faded over the past year with the chase for tepid returns cooling and the Fed having to push back its follow up to December, but there is still some speculative juice to this speculation given the dramatic contrast to the likes of the ECB, BoJ and PBoC.

There is little chance that the Fed hikes at this upcoming meeting with even the Fed Fund futures 10 percent probability looking generous. Where there is potential to ease dovish skepticism and lift the Dollar is through rhetoric that reinforces at least one hike in 2016 as December futures only place a move at 47 percent. Yet, what appetite to front-run some negligible increase to rates will pale in comparison to the appeal that arises from the sentiment that arises from the central bank merely feeling confident in keeping with a gradual pace of removing accommodation. In contrast to major counterparts who are still tempting ever more extreme and event experimental easing efforts to avert economic and financial trouble, any hawkish view poses a vote of stability that will draw safety and speculative interests alike.

The other high-profile data point on the US docket will be the 2Q GDP update. The forecast calls for a robust acceleration in pace to 2.6 percent from the stifled 1.1 percent clip in the opening quarter. That would reinforce rate forecasts and the draw of a stable draw for global capital. It may also set the bar high and the buoyancy of optimism in this regard could be significantly undermined by a substantial miss. That being said, the important events from global counterparts’ dockets may buffer and even exaggerate the Dollar’s appeal. A weak UK 2Q GDP reading would speak to a weak foundation even before Brexit. The Eurozone 2Q GDP stats and ECB bank stress test results face growing fear over Euro-area stability. And, the BoJ is under pressure to pursue deeper accommodation to match the government.



Pressure Back on EUR/USD as Market Sees Looser ECB, Tighter Fed

News events, market reactions, and macro trends.

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Pressure Back on EUR/USD as Market Sees Looser ECB, Tighter Fed

Fundamental Forecast for EUR/USD: Bearish

- July 28 stress test results could help accelerate path to Italian bank recapitalization.

- Financial market stability, steady US economic data exposes EUR/USD to downside risk.

- FX market volatility is rising ahead of the UK-EU referendum – it’s a good time to review risk management principles.

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Read our Q3'16 Euro Forecast, "Euro Awakes to Brexit Nightmare; Time for a Turn in EUR/USD?”

On balance, the Euro steadied as we passed into the second half of July, although EUR/USD lost some ground (-0.54%), putting in its lowest closing prices in the post-Brexit world. Elsewhere, one axiom of the post-Brexit world held true: the ‘Europe-centric’ versus ‘Asia-Pacific’ remained (we first noted this developing relationship two weeks back). Sure enough, there were the Australian and New Zealand Dollars and the Japanese Yen at the bottom of the pile versus the Euro last week.

There is a fundamental tug-and-pull at work for the Euro, Brexit related existential concerns aside (more on Italian banks in a minute). As evidenced in Thursday’s European Central Bank press conference, policy officials may have a dovish tilt, but they are neutral in the near-term. Financial market stability (equity markets are rallying seemingly non-stop) coupled with economic data coming in marginally better than anticipated has cultivated an environment allowing the ECB to stay put until at least September, when it next updates its staff economic projections (SEPs).

Speaking of economic data, the Citi Economic Surprise Index has improved to +8.0 on July 22 from -8.6 on June 20. Pressing its July highs, the gauge of Euro-Zone economic data momentum is close to reaching its yearly highs (obvious caveat: it’s an index of relativity, so it’s only good as its inputs – economists). Digressing, there’s not much here that’s negative; what’s driving EUR/USD must be borne elsewhere.

One place to start looking for reasons why there’s been a turn lower anew in EUR/USD is inflation expectations. The 5-year, 5-year inflation swap forwards, a market measure of inflation expectations, fell sharply over the past week, from 1.360% on July 15 to 1.314% on July 22. Accordingly, as ECB President Mario Draghi indicated as much during his press conference on Thursday, we know that the door for more action isn’t closed. With inflation expectations declining, markets continue to price new easing measures coming by year-end; EONIA rates markets are leaning towards a 5-bps rate cut by December (chart 1 below), or implicitly a 50% chance of a 10-bps move cut.

Chart 1: EONIA versus EONIA 1-month, 5-month FRAs

Pressure Back on EUR/USD as Market Sees Looser ECB, Tighter Fed

From another perspective, overnight index swaps, we can see that traders also believe that the ECB will cut its main refinancing rate or deposit rate again this year (charts 3 & 4 below).

Charts 2 & 3: ECB Implied Rate Cut Probabilities (OIS) Show Action by December

Pressure Back on EUR/USD as Market Sees Looser ECB, Tighter FedPressure Back on EUR/USD as Market Sees Looser ECB, Tighter Fed

Now that market measures of ECB rate cut expectations are being pulled forward relative to pre-Brexit, traders have started shorting the Euro. According to the CFTC’s most recent COT report, non-commercial futures traders held -99.9K net-short Euro contracts – the most since the last week of January 2016. From the week ended June 21 (the last reporting period pre-Brexit), speculators have increased shorting Euro positioning by +62.8%.

Let’s put this all together. The Euro is stable but slipping versus the US Dollar, in spite of the fact that European economic data momentum is improving. Instead, on the Euro’s side, eroding inflation expectations are boosting expectations of another ECB rate cut by the end of the year; both EONIA rates markets and overnight index swaps are essentially pricing in a coin toss’s chance of a cut by December. Add in the fact that, on the US Dollar’s side of the equation, Fed rate hike expectations are rising rapidly - pre-NFP, markets were pricing in January 2018 as the most likely period for the next hike, at the end of last week it was September 2017 – there seems to be the ideal near-term mix for further EUR/USD weakness.

We’d be remiss if we didn’t mention Italian banks in this piece. (For a primer, read our piece from last Sunday, “Brexit’s True Impact on Euro Will be Felt via the Italian Banking System.”) There is a potential major milestone coming up this week, with the European Banking Authority and ECB stress test results due out on July 28. Evidence that the Italian banking system is rife with failing institutions could provide the spark necessary to begin the recapitalization process. For a country whose banks have some €360 billion of non-performing loans (NPLs) on their balance sheets, a bailout/bail-in is all but guaranteed. –CV

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Read our Q3'16 Euro Forecast, "Euro Awakes to Brexit Nightmare; Time for a Turn in EUR/USD?”



USD/JPY July Recovery at Risk on Wait-and-See FOMC/BoJ Policy

Central bank policy, economic indicators, and market events.

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USD/JPY July Recovery at Risk on Wait-and-See FOMC/BoJ Policy

Fundamental Forecast for JPY: Neutral

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The diverging paths between the Federal Open Market Committee (FOMC) and the Bank of Japan (BoJ) may encourage market participants to adopt a long-term bullish bias for USD/JPY, but the fresh batch of central bank rhetoric may heavily impact the near-term outlook should the policy statements show a greater willingness to retain the status quo.

Even though the advance 2Q U.S. Gross Domestic Product (GDP) report is anticipated to show a meaningful pickup in economic activity, forecasts for a slowdown in the core Personal Consumption Expenditure (PCE), the Fed’s preferred gauge for price growth, may push the committee to buy more time as officials argue market-based measures of inflation compensation weak, while ‘most survey-based measures of longer-term inflation expectations are little changed.’ In turn, another unanimous vote to retain the current policy may produce headwinds for the greenback, with the dollar-yen at risk of giving back the advance from earlier this month as market participants continue to push out bets for the next Fed rate-hike.

At the same time, the BoJ may stick to the sidelines as Prime Minister Shinzo Abe pledges to unveil a ‘bold’ fiscal stimulus package to encourage a stronger recovery, and Governor Haruhiko Kuroda may continue to defy market expectations as the central bank head appears to be ruling out the possibility for ‘helicopter money.’ With that said, the BoJ may keep the door open to further embark on its easing cycle, but more of the same from the central bank may derail speculation for more non-standard measures as the board continues to monitor the impact of the negative-interest rate policy (NIRP). Moreover, the weakening outlook for the global economy may spur greater demand for the Yen as Japan’s Balance of Payments (BoP) report is anticipated to show the Trade Balance returning to a surplus in June, and USD/JPY may largely conform to the downward trend from earlier this year as the region turns to its historical role as a net-lender to the rest of the world.

USD/JPY July Recovery at Risk on Wait-and-See FOMC/BoJ Policy

Even though the Relative Strength Index (RSI) on USD/JPY threatens the bearish formation carried over from June 2015, the rebound from the July low (99.98) appears to be losing steam amid the failed attempts to close above the Fibonacci overlap around 106.60 (61.8% retracement) to 107.00 (61.8% expansion). With that said, more of the same from both the Fed and the BoJ may open up the downside targets for dollar-yen, with the first hurdle coming in around 104.20 (61.8% retracement) followed by the former resistance zone around 103.20 (38.2% retracement) to 103.60 (38.2% retracement).



British Pound Trade Seems too Good to be True – Watch Key Risk

Quantitative analysis, algorithmic trading, and retail trader sentiment.

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British Pound Trade Seems too Good to be True – Watch Key Risk

British Pound Trade Seems too Good to be True – Watch Key Risk

Fundamental Forecast for GBP: Bearish

The British Pound finished the week almost exactly unchanged against the Dollar despite clear disappointments in UK economic data. A busy economic calendar in the days ahead could nonetheless have a lasting impact on trader sentiment, and the stakes are high heading into a critical Bank of England interest rate decision in two weeks’ time.

The upcoming release of UK Q2 Gross Domestic Product growth numbers will give investors a close look at the economy’s relative strength heading into the UK Referendum. And though we will have to wait some time before we see the ultimate impact of the so-called “Brexit” on GDP, any signs the economy was faltering before the vote would almost certainly worsen outlook after the fact. Recent industry surveys suggested the UK economy contracted at its steepest pace since the Global Financial Crisis through July. The disappointing figures forced an immediately sell-off in the GBP, and interest rate traders now predict a near 90 percent chance that the Bank of England will cut interest rates at their August 4 meeting.

Suffice it to say economic sentiment remains gloomy for the world’s sixth-largest economy. And yet by the same token the weight of expectations on future economic data is so low that even a small positive surprise could force an important British Pound relief rally. Recent CFTC Commitment of Traders data shows large speculators are now at their most net-short GBP/USD since the week of June 3, 2013.

Clearly the GBP remains in a strong downtrend, and yet it is demonstrably true that extremely one-sided short positioning raises the risk of sharp short-covering rallies. We need only look to the British Pound’s fast rally on July 20 following unexpected comments out of Bank of England voting member Kristin Forbes. Forbes stood in sharp contrast to BoE Governor Mark Carney as she suggested the central bank’s Monetary Policy Committee should not cut interest rates until there is more evidence of a post-Brexit economic slowdown. It is certainly newsworthy that a voting member would so candidly break rank and speak out against rate cuts. Yet her words alone do little to change broader outlook for the future of Bank of England policy, and the yield-sensitive British Pound now trades almost exactly where it stood before she made such remarks.

Traders should thus brace for British Pound volatility as any surprises out of GDP figures, and ultimately the focus remains on whether the Bank of England will move to cut interest rates and ease policy at their August meeting. The broad trend favors further British Pound weakness and the macroeconomic backdrop supports calls for GBP declines. Yet the risk is clear—extremely one-sided positions raise the risk of sharp relief rallies. Caution is advised in trading the Sterling given the clear uncertainty ahead. - DR



Gold Prices Vulnerable Ahead of FOMC / July Close

Short term trading and intraday technical levels

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Gold Prices Vulnerable Ahead of FOMC / July Close

Fundamental Forecast for Gold:Bearish

Gold prices are weaker for a second consecutive week with the precious metal off by more than 1% ahead of the New York close on Friday. The losses come alongside a quiet week off economic data with equity markets on a slow grind higher into the close of the week. The outlook for gold remains broadly unchanged and heading into next week, a near-term recovery may offer another opportunity to take prices lower.

All eyes will once again fall on the FOMC next week with the central bank interest rate decision slated for Wednesday. Fed Fund Futures are showing the first material expectation (>50%) for a rate hike to be in March 2017 and although no change is anticipated tomorrow, traders will be looking for any changes to the policy statement / vote count that could suggest the committee may look to hike rates at the next quarterly monetary policy meeting on September 21st. Expectations for higher interest rates will tend to weigh on gold which does not pay a dividend, and with markets more-or-less on a steady footing, the near-term outlook for bullion prices remains vulnerable.

In addition to FOMC, the advanced read on U.S. 2Q GDP on Friday may spur added volatility in gold prices. Consensus estimates are calling for an annualized print of 2.6% q/q, up from just 1.1% q/q with personal consumption expected come in at 4.1%, up from 1.5%. We’ll want to keep a close eye on the core personal consumption expenditure (PCE) -which is the Fed’s preferred gauge on inflation- with estimates calling for a 0.3% decline to 1.7% q/q. With inflation continuing to be the laggard of the Fed’s dual mandate, a weaker-than-expected read could put a near-term floor under gold prices as interest rate expectations are pushed out further.

Gold Daily

Gold Prices Vulnerable Ahead of FOMC / July Close

From a technical standpoint, our outlook for gold remains unchanged from last week. Key near-term confluence support extends into 1303/08 with the immediate short-bias at risk heading into this zone. With that said, the region could prompt a near-term recovery- look for initial resistance at 1337 backed by our bearish invalidation level at 1359 (both areas of interest for possible exhaustion / short-entries).

A break below confluence support targets subsequent downside targets at 1287 & confluence support into 12665/70. We would be looking for long-triggers on a move into this region. Ahead of next week’s Bank of Japan (BOJ) interest rate decision, it’s worth noting that the Yen (inverse of USD/JPY) vs. gold correlation is at its strongest 20-day rolling correlation since 2008 at 0.82. With that in mind, keep an eye out for USDJPY support around 104.16/59.Continue to track this trade throughout the week on SB Trade Desk.

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---Written by Michael Boutros, Currency Strategist with DailyFX

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USD/CAD to Eye Downside Targets on Sticky Canada Inflation

Central bank policy, economic indicators, and market events.

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USD/CAD to Eye Downside Targets on Sticky Canada Inflation

Fundamental Forecast for CAD: Bullish

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USD/CAD may continue to give back the advance carried over from the previous month as the Bank of Canada (BoC) softens its dovish outlook for monetary policy, but the fresh data prints coming out of the region may dampen the appeal of the loonie as the central bank warns ‘the output gap will close somewhat later than estimated in April, towards the end of 2017.’

Even though the BoC sees ‘above-potential growth from the second half of 2016, lifted by rising US demand and supported by accommodative monetary and financial conditions,’ a slowdown in Canada Retail Sales accompanied by a downtick in the Core Consumer Price Index (CPI) may produce near-term headwinds for the Canadian dollar as it puts pressure on the central bank to further support the real economy. The ongoing adjustment to the oil-price shock accompanied by the weakening outlook for global growth may push BoC Governor Stephen Poloz to preserve a cautious tone at the next interest-rate decision on September 7, but the central bank may have little choice but to gradually move away from its easing cycle should price growth continue to exceed expectations.

Indeed, the BoC argued ‘inflation has recently been a little higher than anticipated, largely due to higher consumer energy prices,’ and a stronger-than-expected CPI report may spur a further shift in the monetary policy outlook especially as the central bank anticipates a ‘pickup in growth over the projection horizon.’ With that said, Governor Poloz may adopt a hawkish tone over the coming months should the key data prints coming out of the Canadian economy boost the outlook for growth and inflation.

USD/CAD to Eye Downside Targets on Sticky Canada Inflation

As a result, USD/CAD may threaten the July low (1.2830) as the pair continues to find resistance around 1.3130 (38.2% retracement), and a break of the monthly opening range may open up the downside targets, with support coming in around 1.2620 (50% retracement) to 1.2650 (50% retracement). - DS



Aussie Drops on RBA Minutes, Inflation to Provide Directional Cues

Price Action, Swing & Short Term Trade Setups

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Fundamental Forecast for the Australian Dollar: Bearish

AUD/USD Bullish RSI Formation Falters Despite Wait-and-See RBA

AUD/USD Quietly Coils Together Two Bearish Patterns in a Row

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Are FXCM traders buying or selling AUD/USD? Find out here.

The Australian Dollar has put in a sizeable reversal of the prior bullish trend this week, falling by as much as 234 pips or 3% against the US Dollar from last Friday’s high. There was one primary motivator throughout this week driving price action in AUD, and that was the release of the meeting minutes from last month’s RBA rate decision which indicated that the bank was in a ‘wait-and-see-approach’ regarding future rate policy. This seemingly opens the door to future rate cuts in the effort of stoking growth and inflationary pressure.

The RBA did reiterate their data dependency pertaining to future rate moves at that most recent meeting; saying that further data on inflation and jobs would become available in the coming months and that the bank would update forecasts ahead of their August meeting. And despite these pledges to look towards future data prints for rate cues, the bank also noted that inflation remains a concern as it remains well-below targets; and this deductively highlights the importance of next week’s Australian Q2 CPI print for gauging probabilities of a cut in the coming months.

The brutal reaction in the Australian Dollar after the release of these meeting minutes highlights the growing expectation for a cut at the bank’s next meeting in August. As inflation in Australia has continued to lag, the RBA’s apparent reticence to cut rates had kept AUD/USD rather strong. Now with this new information that the bank may be open to cuts should data continue highlighting weakness, expect more emphasis to be placed on individual data points out of Australia. Next week brings us but two relevant data points on the calendar with Wednesday’s CPI release being the highlight (Tuesday night in the U.S.). In the first quarter inflation had contracted from the prior quarter, with a CPI read of 108.2 from the prior quarter’s read of 108.4.

Should CPI contract yet again, expect the Australian Dollar to trade lower under the anticipation of a cut coming in August: And even if that inflation print comes-in in-line with last quarter’s read, markets will likely continue to expect dovishness out of the RBA until some element of strength is seen in the Australian economy. Should CPI show above the prior high set in Q4 2015 of 108.4, we’ll likely see rate-cut bets price-out of the market with an extremely strong Aussie; but this appears to be a distant possibility from where we sit now given the global drag on growth that’s been seen in most developed economies of recent.

The forecast on the Australian Dollar will be set to bearish for the week ahead.



New Zealand’s 7-Wk Win Streak Backed By 2.25% 10-Yr Yield

Position Trading based on technical set ups, Risk Management & Trader Psychology.

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New Zealand’s 7-Wk Win Streak Backed By 2.25% 10-Yr Yield

Fundamental Forecast for the New Zealand Dollar: Bullish

The New Zealand Dollar surprised a lot of G10 currencies last week as the seven-week uptrend continued. One reason that the New Zealand Dollar held firm was that doubts are creeping in as to whether the Reserve Bank of New Zealand will be able to cut rates as the housing prices surge.

For a majority of the year, New Zealand Economic Announcement have surpassed economists’ expectations. Such positive surprises have allowed NZD also to gain against many of its commodity currencies brethren. While the calendar was light this week, traders turned focus to an impressive BusinessNZ Manufacturing Reading of 57.1 (Above 50 shows economic expansion,) and a strong rebound in Food Prices from -0.5% MoM to +0.4% MoM. Per REINZ, House Sales YoY did slow, but price appreciation of homes sold continues to rise.

Despite the stable data and continued resilience of the commodity sector, there is still an expectation of a rate cut. However, we saw last week the Bank of England (who was widely expected to cut post-Brexit,) and the Bank of Canada hold as the economic situation did not yet warrant such aggressive actions. The next RBNZ meeting where there is a priced-in probability of cutting 25bps to take the rate from 2.25% to 2.00% is August 11. Currently, the Future Implied Discount Rate isn’t pricing in more than one cut over the next year and a half, and a rate rise is not expected over the next year and a half by over 95% of market participants.

The big print next week that could shift the scales of a priced-in move by the RBNZ is 2Q CPI QoQ. The prior read of 0.2% is expected to get a boost thanks to migration, which has influenced housing toward 0.5% QoQ. A beat, which has been the trend, would align with the NZD/USD spot price showing a likely continuation of the 7-week uptrend. Possible price support can be anticipated around the 34-DMA (where we’ve traded above since early June) at 0.7085. Below there, traders should keep an eye on 0.6897, which is the 100- DMA.

In addition to the upcoming CPI print, the recent China GDP could align with a further flight of global capital into New-Zealand’s Bond Market. While the correlation is messy, NZ 10-Yr Bonds have seen their yield fall (Yields trade inversely to price) over the last 3-months from 2.89% down to 2.21 % this week. That is a fall of ~25% in yields as the hunt for yield may have found a friend in the New Zealand Bond Market. Ironically, this may put further pressure on the RBNZ to hold or even discuss raising rates if the property price appreciation gets too far out of hand, as many argue it already has.

NZDUSD Sentiment Puts The NZD Bears To the Test



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