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2 More Reasons Fed Tapering Is on Track

2 More Reasons Fed Tapering Is on Track

Kathy Lien, Technical Strategist

No major revelations from Fed Chairman Bernanke’s Congressional testimony and the latest uptick in US manufacturing activity have boosted the dollar by reinforcing the Fed’s plans to ease stimulus this year.

The US dollar (USD) ended Thursday’s North American trading session higher against all major currencies. This rebound in the greenback should not be surprising considering that the US economy is still in recovery mode, and the Federal Reserve plans to taper asset purchases this year.

No new revelations were made on day two of Ben Bernanke's Congressional testimony, which means that the main takeaway from the Fed Chairman's time with Congress is that Bernanke and company are in no rush to raise rates, and while reducing asset purchases is the intention, there is no pre-set course for how that ultimately will happen.

See also: Unspoken Fed Policies That Matter Most

On balance, this leaves Fed policy less dovish than that of many other central banks around the world, including the European Central Bank (ECB), which just today eased collateral rules. This dynamic explains why investors are once again snapping up US dollars.

The optimism in yesterday's Beige Book report was further reinforced by today's US economic releases. The Fed indicated that hiring is steady or increasing at a measured pace in most districts, which is reinforced by the decline in jobless claims.

For the week that ended July 13, jobless claims dropped to a two-month low as the effects of auto plant shutdowns begin to ease. However, continuing claims rose to 3.114 million, up from 3.023 million, to reach the highest level in five months. Nonetheless, we are still seeing gradual improvements in the US labor market, which supports the case for a reduction in asset purchases.

The Philadelphia Fed survey also surged from 12.5 to 19.8, its strongest reading since March 2011. The significant improvements in New York and Philadelphia manufacturing conditions are also consistent with the Beige Book report. The only disappointing data was leading indicators, which was flat in June, although we don't expect that to impact the Fed's bias to ease.

Looking ahead, there is no US data on the economic calendar for Friday, and while we expect the dollar to continue to rise, the greenback is nearing key resistance levels against many of the major currencies, including 1.30 in EURUSD, the July high of 101.55 in USDJPY, and .9000 in AUDUSD. As a result, it will be interesting to see if there is enough momentum to push the dollar higher.

ECB Eases Collateral Requirements

The euro (EUR) traded slightly lower against the US dollar Thursday on the back of weaker economic data and the relaxation of collateral rules by the ECB.

The Eurozone's current account surplus shrank from EUR23.8 billion to EUR19.6 billion in the month of May. This deterioration is not surprising considering that Germany reported a smaller surplus and France reported a larger deficit for the same month.

It has been a quiet week for Eurozone data, and as such, EURUSD has remained trapped between 1.30 and 1.32. The biggest news out of Europe on Thursday was the ECB's decision to ease collateral rules. The Bank cut the minimum rating for acceptable asset-backed securities to 2 A ratings from 2 AAA ratings and reduced the haircut for these assets to 10% from 16%, and 22% from 26%.

In doing so, the ECB is leaving more liquidity in the financial markets in hopes that banks will lend. Unfortunately, many are skeptical whether this will be effective because the freeze-up in lending is not because of the amount of cash on hand at banks, but the deterioration in credit quality and increase in non-performing loans.

Modest UK Data Gives BoE a Dilemma

The British pound (GBP) extended its gains against the euro and Japanese yen (JPY) on Thursday, but ended the North American session unchanged against the US dollar. UK retail sales grew 0.2%, which was less than expected for the month of June, but on annualized basis, spending growth accelerated to 2.2% from 2.1%.

While retail sales growth slowed dramatically in the month of June, the modest rise follows strong spending in May. Discounting by retailers continues to lure in customers, keeping overall retail sales growth in Q2 steady as compared to Q1.

Recent UK reports have not been terrible, and it will now be interesting to see how the Bank of England (BoE) feels about the outlook for the economy when the quarterly inflation report is released next month.

In the meantime, there is quite a bit of technical resistance for GBPUSD at 1.53. Public sector finances are scheduled for release on Friday, and a small deterioration in the data is expected.

AUD Selling Resumes on Back of Weaker Data

The Australian dollar (AUD) traded sharply lower against the greenback on Thursday, resuming a downtrend that has AUDUSD poised for another test of the .9000 level.

The latest round of Aussie weakness was sparked by a decline in second-quarter business confidence and leading indicators. According to the National Australia Bank, business confidence turned negative last quarter, and this survey measures a broader base of companies than the monthly report.

This data confirms that slower growth in China and Australia has negatively affected business conditions and business sentiment.

The New Zealand dollar (NZD) also declined against the USD on Thursday, but not nearly as much as the Australian dollar. Due in part to concerns about Australian growth, consumer confidence in New Zealand dropped 3.3% in the month of July, down from a three-year high.

The Canadian dollar (CAD), on the other hand, ended virtually unchanged thanks in part to a 2.3% surge in wholesale sales. While this is not a closely followed report, we feel that it is a good leading indicator for retail sales growth, which is due for release next week.

On Friday, New Zealand credit card spending and Canadian consumer prices are scheduled for release.

Political Change Coming Soon in Japan

The Japanese yen traded lower against all major currencies on Thursday except for the Australian dollar, which continues to come under heavy selling pressure due to concerns about domestic and global growth.

Last night's Japanese economic reports were strong, with nationwide and Tokyo department store sales rising at the fastest pace since March 2012. Considering that wage growth in Japan has slowed, the 7.2% growth in nationwide sales and 9.4% growth in spending in Tokyo signals significant improvement in consumer appetite, which should have contributed positively to second-quarter GDP growth.

However, the yen did not receive any lift from the data and instead weakened because the polls show a Liberal Democratic Party (LDP) win in Sunday's upper house elections. If Prime Minister Shinzo Abe's party is successful in securing a victory, it suggests they would attempt to push through structural reforms including an expansion of the massive stimulus program later this year.

See related: Growth Potential Japan Has Waited Years for

The Ministry of Finance (MoF) will be releasing its weekly portfolio flow data, and we will be watching closely to see if the Japanese were net buyers of foreign bonds for the second week in a row, a trend that would be extremely supportive of USDJPY appreciation.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.