FX Macro And Sentiment Analysis - Week 30 - 2013

US Dollar : Neutral.

US Dollar dropped for a third consecutive week through this past Friday as volatility leveled off and ‘Taper’ concerns eased during a lull in the economic docket. This period of calm will come to an abrupt end this week as a round of critical event risk will stoke the fires of stimulus speculation. With a combination of the first reading of Q2 GDP, July nonfarm payrolls (NFPs) and the Federal Reserve’s July rate decision; we are likely to see refining in market expectations.

U.S. economic data failed to convince investors the Federal Reserve will decide to reduce stimulus by slowing its bond-buying program during the September meeting. Worst than expected Core Durable Goods Orders, Existing Home Sales, Richmond Fed’s manufacturing index data failed to support the greenback this week and even a good Consumer Sentiment data on Friday was unable to attract dollar bulls. Wall Street Journal report by Jon Hilsenrath – considered the unofficial mouthpiece for the Fed – released a report suggesting the Federal Reserve would keep its $85 billion-per-month stimulus program untouched next week and that they would look to ‘refine’ their ‘easy-money message’. Waking the market up from its volatility lull was worth a market-wide selloff for the dollar.

Yet, the central bank’s massive purchase of Treasuries and mortgage-backed securities (MBS) will not last forever. Though we have yet to reach the Fed’s 6.5 percent target for the jobless rate, that is the level at which the discussion turns to tightening. Slowing the pace of the ballooning balance sheet (the Taper) begins before that threshold is reached. 

Net Dollar positioning in the futures market of large speculators like Hedge Fund stand at 28,162 contracts long this week, which are more reasonable long level than in April and May of this year, but still at a relatively high level subject to liquidation. 

Though there are quite a few indicators and events from the US and across the globe that can touch upon sentiment this week, the weight of the three particular catalysts (GDP, FOMC, NFP) will drown out most other developments. Conditions will reach a boil by Wednesday when the Q2 US GDP release is due. Looking through the Taper/Risk filter, it is understood that the mandates of monetary policy (full employment and stable inflation) aim to support economic activity. The primary question currently troubling investors is whether the central bank will move to first Taper at the September meeting – which approximately half of economists polled by Reuters and Bloomberg this past week believe – or if data has necessitated more time at the peak stimulus pace. The 1.0 percent annualized rate of growth established by the consensus forecast would mark a significant slowing from the previous quarter. However, a mere moderation of pace would not likely alter the Fed’s plans.

Many people believe that stimulus will simply remain – or be expanded – to help drive growth and the recovery in labor markets. Yet, it is important to recognize that there are costs related to the effort. Therefore, we have to look to the Fed rate decision later Wednesday to gauge exactly how confidence/concerned the group is about the need to build a possible bubble in order to reach a point of self-sustaining economic expansion. Few people believe this meeting will bring with it the Taper as the September event will offer updated forecasts and the Bernanke press conference (ideal for explaining difficult policy moves). Though a low probability, be wary of a possible Taper. More likely, the market will be reading the statement for clues on September. 

Given the recent pullback in the dollar and retrenchment from traditional risk assets, it is likely that the market has given more weight to a deferred Taper. That being the case, a Fed statement that is unchanged in tone and rhetoric can set the currency into a rally and sentiment into a dive. The outcome of the Fed decision is critical to deciphering how the NFPs will be interpreted Friday. If the group backs off the pressure to curb stimulus, the data will carry less influence. If, however, September is still circled on the calendar

Euro : Bullish.

Euro’s resilience has continued amid signs that the Euro-zone may be starting to emerge from the depths of the recession, with the preliminary July Euro-Zone PMI composite ticking up to 50.4, the first reading in expansion territory (>50) since January 2012 (50.4). Growth speculation will accelerate should we see two consecutive readings above 50, which hasn’t transpired since July-August 2011.

On Tuesday, the Q2 13 Spanish GDP report will be released. Spain remained in a deep recession last quarter, but the worst may be over should the report meet expectations. According to a Bloomberg News survey, the Spanish economy is forecasted to have contracted by a yearly rate of -1.8% versus -2.0% prior.

On the German docket, July inflation figures released on Tuesday shouldn’t offer any evidence for a shift in European Central Bank policy in one direction or another, while the July labor market report should see Europe’s largest economy’s labor market decisively in neutral. 

These data, combined with the July Euro-Zone CPI figures due on Wednesday (core and expectations), give reason to believe that the ECB will stand pat this week, which too could be bullish for the Euro.

Even though interest rates are to stay low for several years in the Euro-Zone, the recent improvement in secondary data gives reason to believe that a hold at the ECB’s August policy meeting on Thursday could be a vote of confidence in current policies, and thus, in the Euro.

Net Euro positioning in the futures market of large speculators stand at 29,700 contracts short this week, which put the market in a possible short squeeze environment. 

For the EURUSD to continue its recent charge higher and clear its mid-June (pre-FOMC) swing highs above 1.3400 against the US Dollar, it will require some exogenous help, although a strong Spanish GDP report and a hold by the ECB would provide the Euro will the most fertile ground for additional gains.


Yen: Neutral

The Japanese Yen has emerged as the top performer this week as further evidence that ‘Abenomics’ and the Bank of Japan’s aggressive easing strategy are starting to have their desired impact: higher inflation. 

Japan has struggled with deflation for the past two decades, and it is believed that rising prices could stoke a broader economic recovery. Accordingly, with Japanese core inflation rising at its fastest yearly rate (+0.4%) since November 2008 (+1.0%), the policies seem to be having a faster than anticipated impact; and this in turn dampens the likelihood that additional aggressive easing measures are coming.

Though it must not be forgotten that Abenomics second arrow, namely expansionary fiscal reforms, has yet to get launch and are seen as negative for the yen by traders. So get alert to any comments from Japan's politicians on that front as the market will turn increasingly sensible to this subject.

It’s shaping up to be a make-or-break week for the Yen as we look forward to a critical US Federal Reserve (FOMC) interest rate decision, US Q2 GDP growth figures, highly-anticipated US Nonfarm Payrolls data, and a scheduled speech from Bank of Japan Governor Kuroda.

BoJ Governor Kuroda starts the week with a scheduled speech on Sunday night/Monday morning when he could hint on further guidance on monetary policy. Kuroda’s aggressive Quantitative Easing measures got a vote of confidence as recent Japanese CPI data showed inflation for the first time in over a year. Yet Kuroda will almost certainly worry that a recent jump in global bond yields and particularly those in Japan may limit the effectiveness of policy easing. Given that short-term interest rates are already at zero, there’s speculation that the BoJ governor could state that policy will remain extremely easy for “an extended period of time.” If he says this, expect JPY weakness (USDJPY strength). If he doesn’t, the opposite may occur and the USDJPY may fall further off of recent peaks.

The biggest Yen and broader FX volatility may nonetheless come on a highly-anticipated US Federal Open Market Committee interest rate decision due Wednesday—likely to force substantial moves across all USD pairs. see USD comments


Pound : Bullish.

The British Pound continued to pare the decline from earlier this year, with the GBPUSD pushing to a fresh monthly high of 1.5433, and the sterling looks poised to appreciate further next week as the Bank of England (BoE) appears to be slowly moving away from its easing cycle. Indeed, the BoE interest rate decision on August 1 highlights the biggest event risk for the following week, but the sterling may track higher ahead of the policy meeting as U.K. Mortgage Approvals are expected to pick up in June, while consumer sentiment is projected to improve for the third consecutive month in July.

Although the BoE pledged to implement a ‘mixed strategy’ for monetary policy, the central bank is widely expected to maintain its current policy next week, and the board may turn increasingly upbeat towards the economy as they anticipate a faster recovery in the second-half of the year. Should the BoE refrain from releasing a policy statement, the move would highlight another unanimous vote in the Monetary Policy Committee, and we may see Governor Mark Carney rely on central bank rhetoric to address the risks surrounding the region as the group remains poised to retain its inflation-targeting framework. Despite speculation of seeing the MPC adopt a growth target, there’s a greater likelihood of seeing the committee adopt forward-guidance for monetary policy as the region continues to face above-target inflation, and the BoE Minutes due out on August 14 may further dampen speculation for more quantitative easing as the U.K. economy gets on a more sustainable path. In turn, the fundamental developments on tap for the following week may spark a more meaningful rally in the GBPUSD, and we may see the sterling continue to retrace the selloff from back in June amid the shift in the policy outlook.

With large speculators at 49 653 contracts short on the futures market and adding to those short all the way up in the past 3 weeks, a short squeeze looks very probable.

Indeed, the near-term rally in the GBPUSD appeared to be tapering off as the pair failed to maintain the upward trend channel from earlier this month, but the next level to watch is the 38.2% Fibonacci retracement of the 2009 range coming in at 1.5680-90 as it clears the 50.0% retracement around 1.5270. However, the persistent wait-and-see approach at the BoE may keep the GBPUSD within a broad range over the near to medium-term, and we would need to see a more detailed exit strategy coming out of the central bank to see a move back towards the 2013 highs as market participants weigh the prospects for future policy.


Australian Dollar: Bearish

The Aussie has now completed the first set of back-to-back weekly gains since mid-March, adding a cumulative 2.2 percent against its US namesake. Looking ahead, the situation is relatively unchanged on the domestic front. The latest set of COT figures shows net speculative shorts remain near record highs but the pace of weekly growth has withered dramatically, reinforcing the idea that the selloff is running dry on capital inflows needed to perpetuate it. The priced-in probability of an RBA interest rate cut at next month’s policy meeting remains elevated at 72 percent. China’s official Manufacturing PMI print headlines the economic calendar, with a drop back below the 50 “boom/bust” threshold expected, but the sting of such an outcome may prove limited having been telegraphed by last week’s disappointment from an analogous release from HSBC. 

The coast is far from clear however as a packed US economic calendar threatens to overshadow Aussie-specific considerations and pull the currency into the “taper on/off” debate surrounding the direction of Federal Reserve policy. Investors have been scrambling to handicap the timing and size of the central bank’s move to reduce its monthly asset purchases (currently at $85 billion) since the June FOMC meeting, sparking aggressive volatility across the spectrum of financial markets. The week ahead brings a perfect storm of fundamental event risk to inform the debate. 

The Fed meeting clearly speaks most directly to monetary policy speculation.Markets will be watching for any changes in the central bank’s forward guidance (like setting a lower bound on inflation to match the upper one or a lowering of the jobless rate threshold) that highlight policymakers’ intent to remain accommodative, underscoring the message that "tapering" and "tightening" are not the same thing. Such a scenario is likely to be perceived as relatively dovish, boosting risk appetite and helping the Aussie Dollar higher. The absence of at least a rhetorical dovish shift in the Fed’s policy statement and/or a strong showing on the US data front may boost bets on a near-term cutback in QE however, undermining sentiment and likely sinking the Australian unit.