US Dollar : Neutral
It was supposed to be a massive week for the Greenback with a Fed interest rate decision, Q2 GDP Growth data, and US Nonfarm Payrolls results for July. The US dollar managed to end the busy week a bit stronger, but the NFP took some of the wind out of its sails.
The week ahead promises relatively little in the way of US economic event risk, and indeed volatility prices have tumbled in anticipation of fairly uneventful price action. Yet if there’s one thing that’s clear it’s that the next big market-moving event isn’t necessarily scripted.
US economic event risk will be limited to ISM Services data due Monday and weekly Initial Jobless Claims on Thursday. Performance of the USD will be data dependent again in anticipation of the September FOMC meeting.
IMM specs keep whittling down USD net longs, down 4.3 bln to 24.489 bln.
Euro : Bullish
The euro managed to gain ground against all but one of its major counterparts this past week: the US Dollar. Given the absence of overriding themes like ‘risk trends’ and speculation surrounding the Federal Reserve’s stimulus withdrawal (the Taper), euro-based fundamentals can carry more influence. That will be particularly interesting for pairs like EURUSD or EURJPY prone to breakouts as top tier event risk like the Italian 2Q GDP release cross the wires.
Over the past few weeks, the periphery members of the Eurozone were in focus as potential catalysts for euro-based volatility. The IMF and European Union approving Greece’s latest tranche of aid, Portugal avoiding an early election and thereby deviation from its austerity course, and Cyprus receiving the ‘okay’ from its Due Diligence assessment averted the revival of systemic crisis concerns. Of course, over the past months, there have been a number of events that have not fallen in favor of progress or even status quo. And despite the negative implications, the euro has held steadfast. This may suggest that investor confidence has built up an immunity to regional problems that are not critical.
Notable releases to keep an eye on includes the regional service sector activity indicator, German trade, the Sentix Eurozone investor confidence survey, the ECB monthly report and Greek unemployment rate. With a significant enough ‘surprise’, these updates can generate volatility. However, we shouldn’t expect trends from these headlines unless there is a more convincing theme at play and the releases complements an existing lean.
Yen: Neutral
The Japanese Yen finished in the middle of the pack last week, but dropped by less than one percent against the top performers as a late-Friday surged helped boost the Yen crosses. With it looking less likely that the Federal Reserve will begin to taper QE3 at its September meeting, the Yen’s fundamental footing next to the US Dollar has improved relatively speaking.
Certainly, if the Fed is less likely to taper QE3 within the next two months, then bond markets across the globe will need to readjust if only slightly: sovereign bond yields shot up in the wake of the Fed’s June policy meeting. But new speculation about the Fed doesn’t stand to just benefit the Japanese Yen; higher yielding currencies that have weakened dramatically in recent weeks could gain too as the promise of more stimulus lingers.
The Yen, however, does have the potential to be a top performer now that the Fed has sown the seeds for softer US yields. The Bank of Japan policy meeting on Thursday, the first since the Japanese diet elections two weeks ago, is possibly the most important event on the calendar for the coming week.
The Japanese elections were expected to clarify the path towards more stimulus for Prime Minister Shinzo Abe and BoJ Governor Haruhiko Kuroda. Instead, with no supermajority, neither the fiscal nor the monetary authorities have spoken with the conviction of those that felt like whatever policies they wanted to push through, they could with ease. While I originally (and wrongly) suspected that the Yen would weaken after the elections, it has not for two key reasons, one of which will be highly debated this week at the BoJ’s policy meeting.
On the fiscal side, recent chatter has been that the government will no longer pursue its long-discussed sales tax hike. So far, this has been a bullish catalyst for the Yen, and should it become set in stone, it could even more so. If there is no sales tax hike, consumers have more disposable income than they would have had otherwise. Accordingly, in line with recent trends, they would consume more. Therefore, prices would be supported by bolstered aggregate demand, keeping inflation pointed higher. Thus, growth is stronger, inflation is higher, and the BoJ wouldn’t have to act further to weaken the Yen.
On the monetary side, inflation recently hit its highest level since November 2008, above analysts’ and policymakers’ forecasts alike; it has arrived sooner than expected. Likewise, growth too has been stronger than expected. There is little reason to believe that with energy prices approaching their highest level in a year, the BoJ would want to see a much weaker Yen at the expense of destroying its trade balance (Japan has to import nearly all of its energy and therefore is very exposed to higher and volatile energy costs).
With a fairly light calendar otherwise on tap, it is crucial that the BoJ is optimistic on recent economic progress so as to ensure that its policy remains on hold. If so, the Yen’s gains could easily extend as the global growth picture comes into question, which might promote Yen-positive “risk off” sentiment. On the flipside, not all economic data has been rosy, and the BoJ won’t want to say anything that might upset momentum behind inflation.
Pound : Neutral
The British Pound struggled to hold its ground even as the Bank of England (BoE) retained its current policy in August, and the sterling may face additional headwinds in the week ahead amid growing speculation that the central bank will adopt forward-guidance for monetary policy. Nevertheless, it seems as though there was another unanimous vote within the Monetary Policy Committee (MPC) as the central bank refrained from releasing a policy statement, but the quarterly inflation report may dampen the appeal of the British Pound as the MPC pledges to implement a ‘mixed strategy’ for the U.K. economy.
Indeed, there are growing bets that the BoE will implement a ‘qualitative’ approach for monetary policy, which could include a potential threshold for unemployment and inflation, and a shift in the policy outlook may force the British Pound to give back the rebound from 1.4812 as it raises the scope of seeing the MPC retain its highly accommodative policy for an extended period of time. However, the majority of the MPC may continue to favor a wait-and-see approach as they anticipate a faster recovery in the second-half of the year, and there’s limited scope of seeing the BoE move away from its inflation-targeting framework as the U.K. is expected to face above-target price growth over the policy horizon.
At the same time, the updated forecast from the BoE may reflect an improved outlook for growth as the fundamental developments coming out of the U.K. exceeds market expectations, and we may see the BoE slowly move away from its easing cycle as the Funding for Lending Scheme (FLS) continues to work its way through the real economy. In turn, we may see BoE Governor Mark Carney rely on central bank rhetoric to address the downside risks surrounding the region, and the sterling may continue to recoup the losses from earlier this year as market participants scale back bets of seeing additional monetary support.
As the GBPUSD appears to have found interim support around the 1.5100 handle, positive developments coming out of the U.K. may prop up the British Pound ahead of the BoE inflation report, but the near-term outlook will be largely dependent on the BoE’s language as market participants weigh the outlook for monetary policy.
Australian Dollar: Bearish
The Australian Dollar recorded the largest 5-day decline in close to two years last week, closing near the lowest level since September 2010 against its US namesake. Looking ahead, another volatile outing looks likely as the economic calendar fills out with an ample supply of high-profile event risk.
Needless to say, the spotlight is on the monetary policy announcement from the Reserve Bank of Australia. Economists’ forecasts point to a 25bps cut in the benchmark lending rate and markets appear to agree, with traders pricing in a 91 percent probability of such an outcome. This suggests the cut itself may not prove market-moving, with markets more interested in the guidance offered for the months ahead.
Meanwhile, the latest COT report from the CFTC shows that net speculative positioning continues to stabilize having hit a record high. This hints at a deceleration in capital flows feeding the AUD-short trade and suggests the market may be increasingly likely to reverse.
Against this backdrop, an RBA statement that does not explicitly point to the likelihood of another prolonged easing cycle may prompt the markets to default to profit-taking on bets against the Aussie, driving the currency higher.
Rhetoric that leaves a sense of ambiguity surrounding the near-term outlook may make a data-sensitive environment however, suggesting any corrective gains could be capped by a soft July jobs report. The economy is forecast to add 6K jobs, down from 10.3K in the prior month, and the unemployment rate is expected to tick higher to 5.8 percent.
External developments remain of note as well. Last week’s notable response to HSBC’s disappointing Chinese Manufacturing PMI print suggests markets may be watching upcoming official news-flow with significant interest. Chinese Trade Balance, CPI, Industrial Production and Retail Sales figures are all set to cross the wires, with any signs pointing to a deepening slowdown in Australia’s largest export market threatening to weigh on AUD.
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