A "Slip of the Tongue" That Shook the FX Market
The euro (EUR) was hit from all sides on Tuesday despite the lack of Eurozone data. The shared currency fell to a three-month low against the US dollar (USD) after European Central Bank (ECB) board member Jorg Asmussen said officials need to prepare for potential capital shortfalls.
Speaking at a conference in London, Asmussen talked about the possibility of a new long-term refinancing operation (LTRO) and said the central bank's guidance for an extended period of easy monetary policy goes beyond 12 months.
This caused quite a stir in the markets, and the ECB was quick to respond by clarifying that Asmussen did not intend to provide an exact length of time as guidance.
The comment citing “12 months” was the problem, because while it may be realistic to expect no major reduction in stimulus from the ECB over the next year, the Bank is not ready to provide specific timing. Still, Asmussen's slip of the tongue was enough to give investors a frame a reference.
His comment about capital shortfalls has to do with the stress tests the ECB wants to impose on banks, although the methodology for those tests has yet to be determined.
Euro losses were exacerbated after Standard & Poor’s downgraded Italy's sovereign debt rating to BBB from BBB+ due to growth-related concerns. This leaves Italy's debt rated only two levels above “junk” status, and with a negative outlook, the country is vulnerable to another downgrade either this year or next.
Growth is one of the region's biggest problems, and according to German chancellor Angela Merkel, who sees her country growing by only 0.3% in 2013, sustainable global growth is still a challenge and the motivation for low rates in the Eurozone. Monday's weaker German industrial production and trade numbers confirm that the outlook for the region is grim, which is one of the main reasons why the ECB is talking down the euro.
With inflationary pressures relatively muted, the central bank has the luxury of keeping monetary policy ultra-easy and driving the euro lower.
The April low of 1.2746 is support for the EURUSD, but below there, it should be clear sailing down to 1.25. A break of the year-to-date low may only require modestly hawkish Federal Open Market Committee (FOMC) meeting minutes on Wednesday.
See also: The Critical EUR/USD Factor to Watch
British Pound Hits Multi-Year Lows
The British pound (GBP) fell to a three-year low against the US dollar on the back of weaker economic data. Industrial production stagnated in the month of May, while manufacturing production fell 0.8%. Economists had been looking for production to increase on both fronts, but both readings instead fell short of expectations with broad-based declines in all 14 sub-sectors.
Aside from the miss in production, the UK’s trade deficit also widened in the month of May, and retail sales growth slowed, according to the British Retail Consortium (BRC). This pullback could be only temporary because the business surveys are for the month of June, while today's reports were for May. Nonetheless, these disappointments validate Bank of England (BoE) Governor Mark Carney's dovish monetary policy stance.
Aussie Benefits from the “China Effect”
Unlike European currencies, the improvement in risk appetite and rise in US stocks continued to drive the Australian (AUD), New Zealand (NZD), and Canadian dollar (CAD) all higher. Economic data from the three commodity-producing countries was better than expected and the rallies were also supported by a rise in commodity prices.
Chinese inflation reports were also released, and the data showed hotter consumer price pressures. Despite the rise in CPI, inflation in China should remain below 3%, and Tuesday night, the focus will remain on China as the latest trade balance is scheduled for release.
Economists are looking for stronger trade activity and a nice increase in both exports and imports. If the data meets or beats expectations, the recent AUDUSD bounce could turn into a stronger recovery for the currency pair.
However, if export growth slows, or worse, declines, which we feel is more likely, the AUD could head towards 90 cents.
See related: 3 Main Focal Points for AUD/USD
Traders Australia also has consumer confidence numbers due for release, but no data is expected Wednesday from either Canada or New Zealand.
Signs of Fading Japanese Yen Strength
It was another mixed day for the Japanese yen (JPY), which strengthened against European currencies but weakened against the US dollar and all three commodity dollars.
No major economic reports were released from Japan, where the only noteworthy data was machine tool orders, which fell 12.4% in June. The positive impact of Japanese stimulus is beginning to fade, and in order to extend the recovery, the Bank of Japan (BoJ) may need to provide the economy with another jolt of stimulus.
The outlook for USDJPY hinges less on Japanese data and more on monetary policy. An extension in the currency pair will depend initially upon the outcome of Wednesday’s FOMC minutes, Fed Chairman Ben Bernanke's speech, and then on the Bank of Japan announcement that’s due out later.
By Kathy Lien of BK Asset Management
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.