Major currencies will be on the move this week following a range of important economic data and upcoming rate decisions from the Fed and European Central Bank (ECB).
Strap on your seatbelts, we have an action-packed week ahead in the forex market! Key economic reports are expected from the US, Eurozone, China, UK, and Australia. With so much data on the economic calendar, it will be difficult to tell which ones will have the largest impact on currencies.
In the US, we have a Federal Reserve monetary policy meeting along with ISM numbers and the non-farm payrolls (NFP) report. Considering that the Fed has no reason to act, we don't expect much from the Federal Open Market Committee (FOMC) statement.
Instead, non-farm payrolls will be the number to watch, but given that the report is due at the very end of the week, country-specific factors—rather than risk-on/risk-off sentiment—should drive currency flows for most of the week.
In other words, the performance of the US dollar (USD) could be mixed in the coming days depending on how Chinese, UK, and Australian data fare and whether the European Central Bank (ECB) cuts interest rates.
We fear that the PMI numbers from these countries will show a slower pace of growth in the month of April, which could compound concerns about the sustainability of the global recovery. If we are right about that, the stall that we are seeing in some of the major currencies, and maybe even equities, could turn into a more significant reversal.
The four key events for the week ahead will be Chinese manufacturing PMI on Tuesday evening, the FOMC rate decision on Wednesday, ECB rate announcement on Thursday, and Friday's US non-farm payrolls report.
Despite last month's abysmal non-farm payrolls number and decline in consumer spending, the Federal Reserve is not expected to alter its stance on monetary policy. Based upon the most recent Beige Book, there is evidence that the pullback in March did not extend into April, and some policymakers share this view.
The answer will lie in Friday's non-farm payrolls report. Economists are looking for job growth to rebound from 88K in March to 150K in April. Anything less than 100K will drive the dollar lower, particularly against the Japanese yen (JPY). Job growth between 100K and 175K will be a relief for the Fed, but probably won't inspire much optimism in the market. We need to see job growth in excess of 200K for the rally in USDJPY to resume.
EUR/USD’s Magnetic Attraction to 1.30
There's something to be said about the magnetic attraction of the 1.30 level in the EURUSD. Despite extremely disappointing economic data this past week and discussions about the possibility of a rate cut by ECB policymakers, the euro refuses to fall. Each time the currency pair dropped below 1.30, it was quickly magnetized back above this key level.
While 1.30 may be an important psychological support level for the currency pair, given that the EURUSD dropped to 1.2955 this past week, 1.2950 could be the more significant level. We think there's a tremendous amount of stop orders and option barriers below 1.2950, which is keeping EURUSD propped above this level. As a result, a very big catalyst is needed for the EURUSD to see a sustained break below 1.30, and more specifically, 1.2950.
EURUSD popped at the start of this week's trade on the back of enthusiasm regarding the formation of a new government in Italy, but the rally stalled near 1.3100 after fresh economic data revealed that consumer confidence and spending in the region remained near yearly lows.
Enrico Letta was sworn in on Sunday as Italy's new Prime Minister. Mr. Letta is a center-left politician who will share some of his power with PDL secretary Angelino Alfano, who is a staunch supporter of Silvio Berlusconi. The government will, therefore, be relatively well balanced.
The market voiced its approval not only through FX, but also in fixed income, as the latest Italian bond auction went off well, with five- and ten-year yields hitting their lowest levels since October 2010. Italy sold EUR 3 billion in five-year notes at 2.84% and EUR 3 billion in ten-year notes at 3.94%.
However, the latest economic data from the region tempered some of the early enthusiasm. Eurozone retail PMI came in at 44.2, which was a bit better than the 43.7 reading the month prior, but still deep below the 50 boom/bust line. Consumer confidence remained at -22, while the business and consumer survey inched lower to 88.6 from 90.1 the period prior.
Overall, the data from Eurozone continues to show an economy in a deep funk and one that is in sore need of some stimulus. This week's ECB meeting will be eagerly awaited, with many analysts calling on the central bank to lower rates. If so, 1.2950 will break easily, and even if the Bank just sets the stage for a rate cut in June, the EURUSD could also move significantly lower. If the central bank sounds non-committal about the need for a rate cut, expect the EURUSD to hold 1.30 and power higher.
Meanwhile, the EURUSD continues to hold the 1.3000 level, and if investors shrug of the latest economic data in the North American session, the pair could clear 1.3100 as the day progresses.
A Risky Replacement for the Stalled USD/JPY Trade
The USDJPY remains under pressure, and for the time being, this should be a near-term top in the pair. We have seen zero evidence of Japanese investors raising their foreign bond exposure, and until all of the investment plans by Japanese lifers to diversify are put into action—which will happen eventually—there's no reason for FX traders to jump back into the short yen trade.
Hopefully, this won't lead to a resurgence of the long gold trade, where everyone buys on the expectation that quantitative easing (QE) would drive up inflation, only to be stopped out brutally. We wouldn’t be surprised if it did, however.
There is some hope for USDJPY this week, however. If US yields rise on optimism from the Fed or stronger non-farm payrolls numbers, it could reverse the slide, but unless we have a blowout NFP number (250K or more), USDJPY may not be able to break 100.
GBP/USD Hits Two-Month High
The British pound (GBP) was on a tear last week, and the GBPUSD currency pair climbed to its highest level in two months thanks to the stronger UK GDP report and sharp rise in the services index. While the data was for the month of February, the services industry expanded at its fastest pace in six months.
This week's economic reports will shed light on whether the outperformance of the UK economy continued. Aside from consumer confidence, manufacturing, construction, and services PMI numbers are scheduled for release. Currently, economists are looking for very minor improvements. If the data is good, the rally in the GBPUSD could extend to 1.56. If they surprise to the downside—and the chance is high given the sharp drop in the CBI index—the rally could fizzle quickly.
Remember, the chance of additional QE is not off the table, and this week's economic reports only soften the case, while pushing the decision to Mark Carney, who becomes Bank of England (BoE) governor in July.
By Kathy Lien of BK Asset Management