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A Painful Recession That May Now Be Over

A Painful Recession That May Now Be Over

Kathy Lien, Technical Strategist

Although EURUSD hasn’t rallied in response, Eurozone data has been mostly improving of late, and with GDP data forthcoming on Wednesday, the region’s lengthy recession may finally reach an official end.

Having sold off for three consecutive trading days, the EURUSD officially rejected the 1.34 level on Tuesday. The selloff was triggered by a combination of US dollar (USD) strength and mixed Eurozone economic data.

European stocks ended the day in positive territory, but traders were not impressed with the latest economic reports. Eurozone investor confidence rose to its highest level in three years, but a drop in industrial production raised concerns. We feel that worries about industrial production are overblown, however, especially since the data was for the month of June.

Wednesday's Eurozone and German GDP numbers are expected to show the region rising out of recession. After six straight quarters of contraction, economists are finally looking for a modest expansion that could lend support to the euro (EUR).

However, with German retail sales falling sharply in the second quarter, we cannot rule out a downside surprise, and perhaps some of the traders selling the euro on Tuesday were also doing so because they feel the GDP numbers could miss expectations.

German investor confidence rose to 42 from 36.3, but the big surprise was in Eurozone investor confidence. According to the ZEW Center for European Economic Research, the "First signs of an end to the recession in important Eurozone countries may have contributed to the…rise. This is also reflected by the strong increase in economic expectations for the Eurozone. Furthermore, the economic optimism is supported by the robust domestic demand in Germany."

Green shoots are appearing across the region, and investors have responded well to the news. Unfortunately, the euro failed to benefit because of ongoing skepticism about Eurozone growth that was caused in part by the recent European Central Bank (ECB) decision to lower its GDP forecasts.

BoE Minutes May Make or Break Sterling

The time has come for the biggest event risk facing the British pound (GBP) this week: the Bank of England (BoE) meeting minutes. Monetary policy is driving the direction of currencies, and in the case of GBP, we want to know how many members voted for new unemployment rate threshold, which was Boe Governor Mark Carney's first attempt to guide monetary policy lower.

See also: 2 Big Days for European Data

We will also be looking to see if policymakers Fisher and Miles voted for more quantitative easing (QE) and if any other policymakers (perhaps Carney) joined the minority. If that is the case, it would add pressure on the pound.

There is also scope for a move higher, however. Recent UK economic data has been strong, which reduces the need for extreme dovishness, and inflationary pressures have subsided, according to the latest CPI report.

Aside from the Bank of England minutes, UK employment numbers are also scheduled for release. The latest PMI numbers show improvement in the employment conditions of the service and manufacturing sector, which suggests the potential for continued upside surprises in UK data.

Fundamental Drivers for the USD/JPY Rally

A second consecutive day of recovery in USDJPY has sparked speculation of a bottom, and we believe that further gains are possible since today's rally was caused by factors that are fundamentally positive for the pair.

The initial rally in USDJPY during the Asian session was triggered by a leading newspaper in Japan, which reported that Prime Minister Shinzo Abe would balance an increase in the consumption tax with a reduction in corporate taxes. The goal would be to offset the drag on the economy and attract foreign direct investment.

Japanese stocks responded positively to the article, rising more than 2.5%, and given the positive correlation between the Nikkei and USDJPY, the rally in stocks helped to lift the currency.

The decent US retail sales report also lifted the pair, and gains were supported throughout the day by a rise in US Treasury yields. The real test, however, is whether the rise in yields can be sustained. If US Treasury yields continue to press higher, USDJPY could find the momentum to break above 98.75, a key resistance level.

See related: Retail Sales Decrease, but Taper Talk Doesn’t

While complementing an increase in the consumption tax with a reduction in corporate taxes could be a smart tactic, a decision won't be made until October, which means it is nothing but speculation at this point.

For the time being, Japan is still in the midst of recovery. Industrial production was revised higher for the month of June, while machine orders dropped less than expected. The Bank of Japan (BoJ) also released the minutes from the July monetary policy meeting where the Bank upgraded its assessment of the economy.

By Kathy Lien of BK Asset Management

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