Dollar Pushed to the Edge with Risk and Yields Raising the Stakes
Fundamental Forecast for Dollar:Bullish
The USDollar’s correlation to FX-based volatility remains a link to ‘risk’, but there are limitations to further complacency
US yields have recovered as market participants attempt to set a time frame for Fed hikes
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Though its progress was restrained by the same liquidity drain that reined in risk trends, the dollar managed a broad recovery this past week. Yet, the conviction behind this move comes with a heavy dose of doubt. Like the questionable rebound for the S&P 500, the currency’s performance may have been more a reversal of the previous period’s momentum rather than a committed change in trend. With the market still working out its convictions for general risk trends and where the Fed stands in the slow shift to a global monetary policy tightening cycle, the return of liquidity will immediately engage the dollar.
Looking ahead to the new week of trading, the first thing to appreciate is the impact that the holiday trading conditions have imposed on the capital markets and the dollar. The Easter holiday took the US, European and Australian amongst other regions offline Friday; and some of those same regions will be off Monday as well. When a significant portion of the global financial system is absent – as it is now – it is exceptionally difficult to generate a market-wide trend. The gaps in the transmission of gluttonous yield chase or panicked selling quickly temper momentum. Expectations of that listlessness can also lead markets to adjust before it hits. That is likely what led equities to recovery the ground lost through the previous weeks and the dollar to do the same.
If there is a low probability of significant trend development – particularly counter-trend – traders see ideal conditions to exploit the same trading approach they have used over the past 16 months: buy short-term dips and sell jumps in volatility. However, this trading approach and the liquidity lull end quickly. That means that when markets are back up to full power, we revert back to earnest trend development. If risk measures start to slip Tuesday and further into the week, it would be a strong indication that a systemic turn is underway. For the sentiment theme to once again guide the dollar, we would need to see a serious engagement and trend.
Outside of the unrealized potential for risk-on-risk-off, dollar traders have a more effective rudder in interest rate expectations. The rebound in Treasury yields (2, 5, 10-year) may have rebound under the same liquidity pretenses as equities this past week, but the buoyancy is more likely to stick. The recent tumble in yields was suspect and likely a short-lived speculative run considering data and Fed commentary we’ve as of late firmly supports the steady Taper of QE and the forecast for a mid-2015 first hike. In fact, a strong TIPS (inflation-protected Treasury) auction this past week and rise in two-year breakeven rates (used to gauge inflation expectations) suggest those expectations are being reinforced.
For tangible catalysts to build – or undermine – US rate forecasts, the docket is pretty light. The Chicago Fed’s national activity index and Markit’s Composite PMI figure are broad measures for economic health. Housing data and durable goods will be viewed as more distant monetary policy fodder. However, this being a relative valuation scheme, we should also keep in mind the general bearing of the dollar’s market counterparts. The ECB has threatened easing to curb EURUSD’s appreciation, BoE expectations are extended, and both China and Japan may be forced to adopt new stimulus if their economic conditions worsen. So, while the Fed’s ‘mid-2015’ time frame may not change; pushing out the tightening schedule for its international peers would make it look significantly more bullish. – JK
Economic Data Holding Back Euro as ECB Pleads for Weaker FX Rates
Fundamental Forecast for Euro: Bearish
- The ECB continues to try and talk down the Euro, but there has been little if any success thus far.
- With the retail trading crowd still heavily long the US Dollar, the Euro remains in the driver’s seat.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
Despite the continued and prevalent threat of aggressive dovish policy action by the European Central Bank, the Euro remained buoyant against its major counterparts for the second straight week as volatility strikes every other major asset class around the world expect for FX. Rollercoaster tensions in Eastern Europe between Russia and Ukraine have done little if anything to dissuade traders from staying long the Euro, though the persistent disappointment in Euro-Zone economic data has rarely allowed for a substantial rally either.
The viability of the ECB’s seemingly scattered dovish monetary policy could be put to the test this week amid a light stream of economic data. The ECB’s approach to preparing the market for a round of quantitative easing – ideally coming after the November banking stress tests (AQR) so as to not confuse the market with a massive liquidity injection while the ‘health check’ is still under way – has proven less unified over the past several days.
Evidently, the ECB wants to have its cake and eat it too: it is threatening action but doesn’t want to ever have to pull the trigger; it expects market participants to comply with its demands for a weaker currency just as the market did for a stronger currency when it lifted the Euro up from the depths of the Euro-Zone financial crisis on the back of ECB President Mario Draghi’s “whatever it takes” to save the Euro promise in July 2012.
There’s little reason for traders, at present time, to comply with the ECB’s demands. As we’ve previously mentioned in this weekly note, Euro bears have simply been on the losing side of the trade even after the ECB cut its main deposit rate to 0.25% in November 2013. Since November 7, EURAUD is up by +4.11%; EURJPY has gained +6.97%; and EURUSD has appreciated by +2.85%. The best performer versus the Euro over the same time period, the British Pound, has only gained +1.35%. Simply put, even the ECB’s conventional policy tool (interest rate changes) has failed to dissuade Euro appreciation. More is needed than further jawboning.
Fortunately for the ECB, the economic data backdrop has been disappointing enough so as to prevent a further push by EURUSD through $1.4000, apparently a threshold of pain for the ECB given the recent rise in dovish rhetoric on approach to the big round figure. As a proxy for momentum of economic data (better or worse than expectations), the Citi Economic Surprise Index has fallen to -10.6 by this week’s end, a yearly low for 2014.
With the incoming economic data slate set to show a slight deterioration in the Euro-Zone’s growth prospects in both the core economies – Germany and France – the ECB’s pleas for weaker FX rates might be heard a little more clearly this week. The Markit PMI surveys across the board are set to show slight deteriorations in the rate of growth (positive but at a slower pace), which should help keep the Euro in its state of indecision, having stayed within +/-0.50% of six of the major currencies thus far through April. –CV
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Bullish USD/JPY Outlook at Risk as Japanese Inflation Picks Up
Fundamental Forecast for Japanese Yen: Neutral
A further pickup in market sentiment should continue to fuel the near-term rally in the USD/JPY, but the fundamental developments coming out next week may keep the dollar-yen contained within the wedge/triangle formation as the Bank of Japan (BoJ) remains upbeat on the economy.
The recent rise in risk appetite may gather pace as the U.S. earnings season boosts trader confidence, and the ongoing themes in the financial markets may continue to heavily influence the USD/JPY as it remains highly correlated to equity prices.
Nevertheless, it seems as though the BoJ is in no rush to further expand its asset-purchase program as Governor Haruhiko Kuroda remains confident in achieving the 2% target for inflation and another uptick in the region’s Consumer Price Index (CPI) may continue to alter the policy outlook as market participants scale back bets of seeing a larger quantitative-easing (QE) program. With that said, we may see a growing number of BoJ official show a greater willingness to carry the current policy into the second-half of 2014, and the USDJPY may continue to congest ahead of the next central bank meeting on April 30 as Fed Chair Janet Yellen remains reluctant to move away from the zero-interest rate policy (ZIRP).
As a result, the USDJPY may continue to face narrowing ranges as it consolidates within the wedge/triangle formation from earlier this year, and it appears as though we’re going to need a key fundamental catalyst for a major move in the pair as market participants mull the outlook for monetary policy. - DS
British Pound at Clear Risk as Positions Stretched and Gains Slowing
Fundamental Forecast for Pound:Neutral
The British Pound was the only major currency to strengthen against the US Dollar in a holiday-shortened week of trading, but can it continue higher? The high-flying Sterling will need support from the Bank of England to hold near multi-year peaks in the week ahead.
A strong wave of domestic economic data drove the lion’s share of British Pound gains, and indeed Sterling strength coincided with a big improvement in UK bond yields. The spread between the UK and US 2-year government bond yields stands at its largest in three years.
It’s with that in mind that we look for any surprises out of upcoming Bank of England Minutes as a potential catalyst for big GBP moves. The BoE released no details in the policy announcement following its April 10 meeting, and we can only speculate as to whether it remained a unanimous decision to keep rates and Quantitative Easing levels unchanged. And though officials would not have final UK unemployment figures released six days later, it will be interesting to hear whether labor market improvements could force the bank to tighten policy ahead of expectations.
The risks to the British Pound are clear: it has thus far set a fairly ominous daily reversal at multi-year highs. CFTC Commitment of Traders data likewise shows speculators are their most long GBP in over three years when it set a significant top near $1.65. And though important price and positioning extremes are only clear in hindsight, the fact that leveraged trades are stretched warns that gains may at least slow.
Traders have thus far seemed willing to push the British Pound to fresh highs, but it may take something special to keep the high-flying currency near these significant peaks. –DR
Gold Carves Lower High in April- Bearish Below $1327
Fundamental Forecast for Gold:Neutral
Gold is off sharply this week with the precious metal shedding 1.7% to trade at $1298 heading into the weekend. The sell-off comes on the back of the strong performance in US equity markets with all three major stock indices closing higher by 1-1.7% on the week. We will take a more neutral tone heading into next week on the heels of this decline while noting a broader bearish bias below key resistance which was tested this week.
Looking ahead, traders will be closely eying the US economic docket and the ongoing geopolitical tensions in between Ukraine and Russia. Existing/new home sales, durable goods orders and the final April read of the University of Michigan confidence survey will be on tap next week. With the recent Fed rhetoric suggesting that the markets continue to overstate the timing of Fed normalization, look for weaker than expected data to support gold at the expense of the greenback. The gold vs USD correlation continues to press deeper into inverse territory, posting its lowest levels since march 24th and we’ll look for a reaction off key support at 10,400 in the Dow Jones FXCM USDOLLAR Index (Ticker: USDOLLAR) for further conviction on our directional bias.
From a technical standpoint, gold reversed off a key inflection point we highlighted in last week’s outlook at $1327. This level is defined by the March opening range low, the 23.6% Fibonacci extension taken from the advance off the December 31st low and a longer-dated trendline resistance dating back to the 2012 high. The resulting move saw the daily RSI signature turnover ahead of the 60-theshold, keeping our broader focus on the short-side of gold. Look for support at the monthly open at $1283 with a break below shifting our focus to a massive support range at 1260/70. This region has triggered substantial inflections in gold prices dating back to June of last year with multiple longer-term and medium-term fib ratios once again highlighting the technical significance of this range.
Bottom line: Key interim resistance remains at $1327 and we continue to favor selling rallies with only a breach/close above this threshold invalidating the broader downside bias. The biggest risk to our outlook remains a broader risk sell-off which could trigger haven flows into the perceived safety of bullion. Look for a break above 1891 in the S&P to signal the end of the correction off the April high.
Canadian Dollar To Consolidate Ahead of GDP Report
Canadian Dollar To Consolidate Ahead of GDP Report
Fundamental Forecast for Canadian Dollar: Neutral
The Canadian dollar strengthened this week against its U.S. counterpart on an improved economic outlook in the U.K. and U.S. Britain managed to avoid a triple-dip recession, recording a positive growth rate in the first quarter. Meanwhile, the U.S. jobless claims report came out better than expected as first-quarter GDP grew at a moderate rate, further helping to push the loonie higher. Also, Crude oil, Canada’s biggest export, rebounded, and hit its highest level in two weeks. Looking forward, we may see the Canadian dollar consolidate and build a short-term base before making another major move to the upside.
Canada’s February Gross Domestic Product highlights the biggest event risk for the week ahead. According to a Bloomberg News survey, economists have called for a consensus estimate of 0.2 percent growth in GDP, the same pace as in the previous month. In his last testimony before parliament, Bank of Canada Governor Mark Carney said that “Canada’s economy is strong but still faces risks.” Furthermore, signs of improvement in the domestic economy have materialized recently, with positive data in the manufacturing and sales sectors. At the same time, the latest unemployment rate report indicates that the recovery in the labor market remains slow. As a result, uncertainties in Canadian fundamentals could lead to a disappointing GDP report, potentially dragging down the loonie
Inflation within Canada has remained low in recent months, but is expected to gradually rise to the target level of 2 percent by mid-2015, when the economy is expected to return to full capacity. Although the Bank of Canada chose to hold its benchmark interest rate at 1.0 percent, the continual threat of record-rising household indebtedness could cause the central bank to hike interest rates in order to make borrowing more difficult and expensive. However, Governor Carney softened his tone on such a rate increase after growth unexpectedly stalled. The central bank cut its 2013 growth forecast to 1.5 percent from 2.0 percent. In addition, the IMF’s latest report suggested that Canada should refrain from tightening its monetary policy until its economy improves. In order to get a clue on the timing of interest rate move, investors will want to keep a close eye on three factors: economic growth, personal debt, and aspects of the housing market. With rates currently as low as they are, the Canadian dollar has less upward support.-RM
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Australian Dollar Facing Conflicting Domestic, External Catalysts
Fundamental Forecast for Australian Dollar: Neutral
Australian Dollar Looking to Upbeat CPI Data to Rekindle Up Move
Firming US News-Flow May Hurt AUD/USD on Narrowing Policy Gap
Help Time Turning Points for the Australian Dollar with DailyFX SSI
The Australian Dollar’s month-long winning streak ran into resistance last week as the build-up in RBA policy expectations stumbled. A Credit Suisse measure of investors’ priced-in policy bets over the coming 12 months declined for the first time in three weeks. A potentially conflicting set of fundamental event risk in the week ahead promises to keep driving policy outlook speculation and keep volatility elevated.
On the domestic news-flow front, the spotlight will be on first-quarter CPIdata. Expectations suggest the headline year-on-year inflation rate will rise to 3.2 percent from 2.7 percent recorded in the three months through December 2013, marking the highest level in over two years.
Data from Citigroup shows Australian economic news-flow has increasingly outperformed relative to consensus forecasts since mid-February, suggesting economists are underestimating Australia’s place in the business cycle. That opens the door for an upside surprise. Such a result may go a long way toward rebuilding support on from the RBA policy outlook and driving the Aussie higher.
Externally, a busy docket of US activity data will help inform bets on the continuity of the Fed’s effort to “taper” QE asset purchases. Home Sales, Durable Goods Orders and Consumer Confidence figures are in the spotlight. Economic data outcomes from the world’s largest economy showed a notable improvement relative to expectations over the past two weeks. If that trend continues, ebbing doubt about the continued withdrawal of Fed stimulus. That may highlight the immediacy of the Fed’s move to narrow the policy gap compared with the RBA’s apparent preference for inaction in the near term, weighing on AUD/USD.
New Zealand Dollar: Lots of Room to Disappoint in RBNZ
Fundamental Forecast for the New Zealand Dollar: Neutral
The market seems pretty certain that the New Zealand central bank will usher in the strongest wave of monetary policy – and thereby carry increase – of the majors. Yet, if the outlook is so certain and hawkish; why is the performance for the New Zealand dollar not more bullish? The Kiwi reminds us that markets move to price in fundamental considerations as soon as they are deemed probable enough to be acted on; and fundamental impact – as with currency performance – is relative.
On Wednesday at 21:00 GMT, the Reserve Bank of New Zealand (RBNZ) is set to deliberate on the country’s monetary policy. According to the 15 economists polled by Bloomberg, the meeting will end with a 25 basis point (bp) hike to 3.00 percent. The market is equally as convinced that the policy authority will raise rates at back-to-back meetings. Overnight swaps are pricing in a 97 percent probability of another quarter-percent hike.
That certainty inadvertently diminishes the potential for bullish market response to this event while simultaneously leverages the potential and impact of a ‘disappointment’. If the market is certain of an impending hike, carry traders and speculative frontrunners should theoretically already positioned for such an outcome. As such, realizing the move would generated limited reaction for a stronger bullish swell as there would be few that haven’t already accounted for it. Consider, since the March 12 rate hike – the first – the New Zealand dollar has maxed out its bullish move with a 2 percent climb versus the euro. Its performance versus others is materially weaker – and even negative versus the Australian dollar.
And, what happens if the RBNZ decides not to move forward so aggressively with its policy course? If the bulk of the market is positioned for a hike, its absence could lead to a material unwinding of long exposure to account for a more moderate course of tightening. In other words, the market is already pricing perfection; and now RBNZ Governor Wheeler needs to keep pace.
In probability terms, a rate hike is the more likely outcome; but there will still be speculation surrounding subsequent moves. According to Wheeler’s own forecasts, he expected another 200 bps of tightening through the first quarter of 2016. That would mean that there are inevitably gaps between hikes. If that first wait-and-see moment is for the next meeting in June, the kiwi could fall back. The market will look to assess this in the central banker’s usually blunt commentary.
Another factor to keep in mind with this high profile event is that risk appetite dictates the influence that monetary policy changes have. In other words, if there is a market-wide ‘risk aversion’ drive; a 25bp increase in New Zealand’s still-historically low yield will likely do to quell the capital flight. And given the market’s pricing in perfection for the kiwi and New Zealand monetary policy, the risk is again amplified should risk aversion touch off. - JK