US Dollar : Neutral
To understand where the dollar will move heading forward, we have to establish the conditions under which it has arrived at its current position. The slide through this past week was extraordinary for both its consistency and intensity. Yet, the slide evolved without the burden of the benchmark currency’s primary fundamental themes. Looking for evidence of a rebound in risk appetite; the speculative-favorite S&P 500 meandered – trading on the lowest non-holiday volume since the September 2011 terrorist attack – while other measures of sentiment similarly floundered. As for Taper premiums, both speeches by Fed officials’ speeches and data on the economic docket reinforced the probability of a September move by the central bank.
Without conviction, the kind of move that we have seen this past week would more appropriately be labeled a ‘natural correction’. Though, traders know that such moves are temporary in nature without a strong shift in conviction and participation to change the underlying current. A simple look at market momentum, we find both the 100 and 200-day simple moving averages are below spot and rising steadily. So long as the systemic conditions behind the capital markets and investor sentiment don’t change, a return to trend for the greenback grows more likely with each day. Yet, the force of that transition depends on the accelerants available to facilitate it. 'Taper' talks have steadily receded and as long as the theme do not come back the greenback will not see the long awaited rally.
The first thing we have to notice, is that the economic docket does not carry the kind of event risk that we would expect to definitively wipe out risk trends nor verify the September time frame for the Fed’s first reduction in its stimulus program. It is difficult to determine what known event risk short of the next FOMC rate decision (on September 18th) can carry enough influence to upset the current equilibrium. This past week, remarkably strong numbers for US trade and service-sector activity reinforced the more dubious – but positive – 2Q GDP and employment figures from the previous week. Furthermore, the Fed speeches from the period – particularly extreme dove Charles Evans – were clearly shaped to avoid contradicting expectations of a September start for the stimulus wind down. Yet, despite this combination, confidence in stimulus-backed speculative-position held fast.
In the week ahead, we have another round of contributory data to the stimulus debate as well as central bank talks on tap; but these listings don’t seem to be any more convincing than what we have recently priced in. On Tuesday, non-voting Atlanta Fed President Dennis Lockhart (a hawk on QE) will speak on the economy, while voter St. Louis Fed President James Bullard (a QE dove) is set to speak on monetary policy on Wednesday and the economy Thursday. For data, retail sales, the consumer price index and University of Michigan consumer sentiment survey are all notable.
Japanese Yen : Neutral
The Japanese Yen surged against the US Dollar, matching its best weekly performance since its June high (USDJPY low) on an otherwise quiet week for forex markets. The Yen strengthened despite any major fundamental drivers, but it will be critical to watch how the Japanese currency reacts to the coming week’s economic growth data.
We await the key Q2 Japanese GDP Growth report, which will likely force sharp Japanese Yen moves on any surprises. Investors look to GDP figures a de facto scorecard for the effectiveness of the Bank of Japan’s hyper-aggressive Quantitative Easing measures and so-called Abenomics.
A disappointment in GDP figures would suggest the BoJ’s QE measures have been insufficient to boost economic growth and in turn fuel speculation of renewed easing measures—sending the Yen lower. The opposite also seems likely on a positive surprise: better growth could push the JPY to fresh multi-month highs. If speculation over the BoJ’s next moves is so critical to Yen forecasts, why did relative inaction last week push the domestic currency higher?
The Bank of Japan gave traders little reason to sell the Yen, and indeed it seems as though most did the opposite. Recent CFTCCommitment of Traders data showed speculative futures traders remained very heavily short the Japanese Yen (long USDJPY) into the announcement; inaction from the BoJ encouraged traders to cover those positions and sent the USDJPY lower.
It’s likewise worth noting that the Japanese Yen rally occurred on similarly significant Australian Dollar strength—unusual as the two will often head in opposite directions. What do they suddenly have in common? Both the Australian Dollar and Japanese Yen remained heavily oversold, and their outperformance serves as further evidence that shifts in positioning drove the biggest moves in forex markets.
Does that make a difference for our Japanese Yen forecasts? If recent Yen strength is indeed a function of traders closing positions, it gives us reason to believe that the JPY downtrend (USDJPY uptrend) remains intact. The next question is obvious: when can we buy? The ¥95 level looks of particular interest.
British Pound : Bullish
The British Pound surged higher following the Bank of England (BoE) inflation report, with the exchange rate climbing to a monthly high of 1.5573, and the upward trending channel in the GBPUSD may continue to take shape next week as the economic docket is expected to highlight an improved outlook for growth. Indeed, a ninth consecutive decline in U.K. Jobless Claims along with a 0.6% rise in Retail Sales should raise the scope for a faster recovery in the second-half of the year, but the Consumer Price report raises the risk of seeing a near-term pullback in the pound-dollar as the headline reading for inflation is expected to narrow to an annualized 2.8% from 2.9% in June.
Although the BoE adopted a 7.0% threshold for unemployment, the central bank added the inflation ‘knock out,’ which sparked speculation that the Monetary Policy Committee may have to start normalizing monetary policy ahead of schedule, and the shift in the policy outlook may continue to prop up the sterling as the board has failed to achieve the 2% target for price growth since late 2009. Given the MPC’s track record, the risk of seeing inflation expectations being unanchored may become a growing concern for the committee, and a stronger-than-expected U.K. CPI print may spark another short-term rally in the British Pound as it dampens the BoE’s scope to retain its highly accommodative policy stance.
With the inflation report out of the way, the BoE Minutes due out on August 14 may have a limited impact on the sterling, but the policy statement should show another unanimous vote, with the central bank turning increasingly upbeat towards the economy as the economic recovery gradually gathers pace. Former BoE board member Charles Goodhart argued that the ‘British recovery is probably somewhat underestimated’ and said that the MPC may ultimately deliver a rate-cut ahead of the third-quarter of 2016 as the economy gets on a more sustainable path.
Australian Dollar: Neutral
The Australian Dollar outperformed last week, adding a hefty 3.4 percent against its US namesake to produce the strongest 5-day rally in 20 months. The move is all the more impressive considering it was produced against the backdrop of an interest rate cut from the RBA and a disappointing set of Employment figures that showed the economy shed 10,200 jobs in July, yielding the worst result in four months.
While traders’ response to further easing was to be expected (buy the rumor, sell the news), resilience following the jobs data is of interest considering the details of the report were not much more encouraging than the headline figure. Full-time and part-time hiring both declined and a slight drop in the unemployment rate seems to have owed to a drop in the participation rate rather than a robust labor market. Furthermore, June’s figures were revised broadly lower.
Such counter-intuitive performance seems to reflect a deceleration in capital flows feeding the Aussie-short trade. Put simply, those market participants that intended to be short at current levels are already there, meaning the down trend is running dry on fuel needed to perpetuate itself. This makes me believe that this week movement was a short squeeze.
Furthermore, the breakdown in the Aussie over recent months has closely tracked the deterioration in the relative monetary policy outlook, which in turn appears to have emerged as the markets aggressively slashed their outlook for Chinese economic growth. With this in mind, it’s noteworthy that Chinese economic news-flow appears to be stabilizing relative to expectations. If this helps halt the slide in Chinese growth bets, it may likewise scatter calls for further RBA easing in the near term and set the stage for Aussie gains.
Indeed, this dynamic was on full display in price action last week after China released encouraging trade, inflation and industrial production figures.Imports rose by 10.9 percent, marking the largest year-on-year increase in three months and hinting demand from Australia’s top trading partner may be far more resilient than expected. Meanwhile, soft CPI and PPI readings signaled greater room for Beijing to introduce stimulus and Industrial Production posted a 9.7 year-on-year increase, marking the strongest gain in five months. The week ahead seems to offer a relatively clear path for an Aussie recovery to continue.
The Australian economic docket features second-tier event risk and the Chinese calendar is effectively blank. US news-flow is worthy of consideration in the event that speculation about the Fed’s intention to “taper” QE asset purchases produces a strong response from sentiment trends that spills over into AUD price action. CPI, Retail Sales and the University of Michigan Consumer Confidence gauge are all due to cross the wires.
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