The Dollar's Biggest Event Risk This Week
The US dollar (USD) and stocks are currently at a crossroads. The S&P 500 dropped 1.4% on Friday and the Dow Jones Industrial Average experienced its largest one-day slide in five weeks. While one day of weakness does not make a trend, if this week's US event risks surprise to the downside, the selloff in stocks could mark a near-term top for equities, which would also impact the performance of currencies.
The greenback extended its losses against the Japanese yen (JPY) but appreciated against other major currencies.
FX traders are trying to figure out whether to buy or sell the dollar when stocks fall. For most of last week, lower stocks meant a lower dollar as investors reduced exposure. However, that dynamic changed on Friday when the dollar rose against high-beta currencies such as the euro (EUR), British pound (GBP), and the Australian (AUD) and New Zealand dollars (NZD).
The question of what becomes the broader driver of dollar flows also lies in this week's reports. The primary reason why investors loaded up on US dollars was because of the belief that the Federal Reserve will dial back asset purchases sooner rather than later.
Friday’s economic reports kept the Fed on track to taper asset purchases later this year, and the next test will come in the form of this week's non-farm payrolls (NFP) report. If job growth continues to increase, then the dollar could become the beneficiary of safe-haven flows. However, if payrolls growth suddenly contracts, then both the US dollar and US stocks could fall in unison.
See also: 2 Standout Data Points the Fed Will Love
ECB Set to Meet This Week
The euro (EUR) ended Friday lower against the US dollar ahead of this week’s European Central Bank (ECB) meeting. Based on the deterioration in the German retail sales report and the latest German unemployment numbers, the ECB will maintain a bias to ease. Whether they follow through remains to be seen, but for the time being, these reports should harden the central bank's commitment to additional stimulus.
See also: The EUR/USD’s “Turbulent Tumble”
We feel that the ECB is far more willing to signal their intention to lower rates than to actually follow through with it. The bar is high for negative deposit rates, and the Bank would want to see PMIs decline again before pulling the trigger.
Last Week’s Biggest Currency Loser
The New Zealand dollar (NZD) was Friday's biggest mover and the worst-performing currency. NZD dropped over 1.5% against the US dollar, nearly 2% against the Japanese yen, and 1% against the euro. Given the losses, you wouldn't be able to tell that the economic data was actually good.
Instead, NZD extended its slide after the Reserve Bank of New Zealand (RBNZ) threatened to intervene in the currency this week. We wouldn’t be surprised if they were already in the markets buying the currency, but since the bulk of the Friday move happened between 6 pm and 8 pm in Auckland, the Bank may not have been responsible.
Meanwhile, the Canadian dollar (CAD) and Aussie also extended lower despite better-than-expected data. Canadian GDP grew at an annual rate of 2.5%, the fastest in six quarters, but despite the stronger data, the loonie declined against the US dollar as oil prices dropped 2%.
This strong first-quarter growth gives the Bank of Canada (BoC) projection for 2.1% growth in 2013 a sturdy start. No major economic reports were released from Australia, but that will change this week when the country's PMI numbers and the Reserve Bank of Australia (RBA) monetary policy announcement both upcoming.
Bank of England (BoE) Likely to Stay the Course
The reversal in US stocks caused the British pound (GBP) to give up its gains against the dollar, but the currency still managed to edge higher against the euro on Friday. UK economic reports did not add to the improvements seen in house prices, and for that reason, the Bank of England (BoE) is widely expected to postpone any major policy decisions, even if we get a big surprise in this week's PMI numbers.
Japan to Weigh New Bond Buying
The selloff in US and European equities drove the Japanese yen (JPY) lower against all major currencies on Friday, but not before some exaggerated intraday volatility. USDJPY initially hit a three-week low after softer personal income and personal spending numbers, but rebounded to 101.30 after the stronger Chicago PMI data and the U of M consumer confidence survey.
Unfortunately, USDJPY failed to hold on to its gains as the selling of US stocks gained momentum. Japanese economic reports also indicated that the country's recovery did not lose momentum in the month of April, as earlier reports suggested.
There has also been an interesting report that the government's pension investment fund is planning to re-examine its portfolio strategy, although the overall mix of the portfolio may not change. This suggests that the fund may choose not to boost its holdings of foreign bonds despite the central bank's concerted effort to drive down yields. No verification has been made, but this story is not positive for USDJPY.
By Kathy Lien of BK Asset Management
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.