US Dollar Awaits Heavier Volatility, Rate Speculation Returns
Fundamental Forecast for Dollar:Bullish
- Consumer inflation (CPI) stats will look to take control of rate forecasts led astray by Treasury demand
- Volatility measures can’t fall much further, and that imbalance offers immediate benefit to the US Dollar
- Watch the volume on dollar-based majors with the release of NFPS using the FXCM Real Volume indicator
There was a considerable commotion in the financial markets this past week with sharp declines in global equities and sizable swells in volatility measures (the short-term equity-based measure increased nearly 60 percent on Thursday). Yet, a notable contrast to this chaos was the more moderate response from FX – and particularly the calm demeanor of the US Dollar. If the greenback is considered a safe haven, why did it not rally as other capital markets felt the effects of fear? What does this mean for the currency moving forward?
Last week’s volatility originated with two startling headlines: a downed plane in the disputed territory between Russia and Ukraine, and the start of a ground offensive in the Gaza Strip. Both carry serious geopolitical ramifications and thereby generate distinct concern amongst investors that have increasingly exposed themselves to risky assets and are dependent on stability. As grave as these concerns are, we have seen comparable bouts of fear in the past whereby the market has recognized and acclimated – ultimately returning to ‘status quo’. What separates the current situation from similar circumstances in the past is the financial backdrop. Activity levels, positioning and underlying fundamental themes are shifting.
Volatility measures have, in recent weeks, hit multi-year (equity, emerging markets, commodities) and record (FX and rates) lows. A natural low is inevitable where real returns (activity adjusted) have evaporated. The absence of premia in turn dissuades short-term traders – the primary active market participant through 2014 – looking to buy dips or “sell volatility”. Anemic volumes and open interest reflect the steady withdrawal of active market participants and liquidity that is crucial to stabilize market when fear arises. We can already see this eroding conditions: in the ‘stickiness’ of this most recent spell of volatility and a growing divergence in the performance of ‘risk’-sensitive assets.
The dollar represents a safe haven with a particular appeal. Fronting the world largest and most regulated market, it is prized for liquidity. That means that temporary jumps in volatility carry far less weight here than with an equity index or even a Yen cross. Then again, the current reach for yield in thinner markets represents a perfect opportunity for the currency as a conditions normalize.
Looking at the docket ahead, there are few events that look to carry the heft of a definitive change in sentiment. Furthermore, given the market’s immunity to so many other high-level event risks – FOMC decision, employment reports, external headlines – it is more likely that optimism will cave to the reality of positioning under its own power. On the other hand, the docket offers up a listing of key event risk for the other key driver for the dollar: interest rate expectations.
There is no true level in unemployment that the Fed is necessarily forced to hike rates at. The need to tighten monetary policy is developed through inflation pressure. That means the timing on the Fed’ s first hike and subsequent pace depends on readings like Tuesday’s CPI consumer inflation figures for June. The headline figure is expected to hold at 2.1 percent and core at 2.0 percent – both conspicuously at the central bank’s target. While the group’s favored measure is the PCE – which is materially softer than this reading – the more pressure seen in this market-favorite, the more pervasive the situation and more likely a bank response.
Another consideration for interest rate speculation behind the dollar is the knowledge that there is higher profile event risk due the following week. July NFPs, 2Q GDP and a FOMC rate decision are all on the docket another week out. It is commonplace for the market to weather near-term fundamental turmoil in deference to bigger event risk on the horizon. So, while there is plenty of favorable opportunity in both risk trends and rate forecast potential moving forward, we must bear in mind its timing as a catalyst.
Euro Starts to Slip Under Weight of Falling Inflation Expectations
Fundamental Forecast for Euro: Neutral
- The daily sell signals seen in EURJPY and EURUSD on July 11 started to play out bearishly.
- EURUSD faces significant trendline support from the July 2012 and July 2013 lows.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
The Euro’s price movement this past week by no means screams ‘the period of low volatility has ended!’ but there are definitely signs of markets coming unstuck. The 18-member currency was broadly under pressure over the past five days, losing ground to all of the majors but for the CHF (+0.08%) and NZD (+0.78%); against the five other majors, the Euro’s losses ranged from -0.46% (GBP) to -0.63% (CAD). Still, there hasn’t been one definitive event to kick off the latest round of Euro weakness.
The outside pressures that may be dragging down the Euro by proxy – vis-à-vis the Euro’s pairings with the British Pound and the US Dollar – are still the most prevalent influences on the EUR-complex. The Bank of England’s low interest rate policy may start to come under more pressure now that inflation readings have started to pick back up, while the Federal Reserve may be closing in on the end of QE3 sooner than market participants have priced in.
The influence of the Euro’s own central bank is very much in flux. One perspective dictates that the European Central Bank has opened up the floodgates for monetary easing, by lowering the interest rate corridor into negative territory and promising targeted liquidity measures (TLTROs) to ease credit conditions for small- and medium-sized enterprises. Another perspective says that the ECB has already reached the end of its easing capabilities so long as debt crisis fears stay capped during the banking system stress test period (through the end of October).
While we feel that any chance of a full-blown, Fed-styled QE program is unlikely in the near-term (hence the only limited downside in the EUR-complex after the ECB’s June and July meetings), we must be acutely in tune with the inflation environment. The ECB has made it clear, through its official policy transmissions and various policy speeches from Governing Council members, that only further erosion in the region’s price environment would warrant additional easing action over the coming months.
Given recent developments along the inflation expectation front, a softened outlook for price pressures may be setting in, which in turn could be providing the fuel for the Euro’s recent move to the downside. Indeed, a look at inflation expectations for the Euro-Zone’s largest economy, Germany, are revealing. The 2014 CPI forecast fell to +1.00% the week ended July 18 from +1.30% three-months earlier; the 2015 CPI forecast fell to +1.65% the week ended July 18 from +1.80% three-months earlier; and the 2016 CPI forecast fell to +1.90% the week ended July 18 from +2.00% three-months earlier.
Now that inflation expectations are falling, additional evidence of slowed growth can compound the issues facing the Euro in the near-term. This coming week, preliminary July PMI surveys out of France, Germany, Italy, and the broader Euro-Zone are expected to show a slowed pace of growth from the prior month, perhaps supporting the developing trend seen in German inflation expectations for 2014, 2015, and 2016. While we anticipate exogenous influences maintaining their clout with respect to the Euro, we shouldn’t be dazed by the low volatility state persisting in spot FX markets, as more local influences are starting to exert themselves on the Euro once again. –CV
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Japanese Yen Losses Remain Likely, but What Could Change?
Fundamental Forecast for Pound:Bearish
The Japanese Yen finished the week marginally higher versus the US Dollar, but the fact that it trades near critical resistance (USDJPY at support) leaves it at risk. We’ll watch the coming week’s Bank of Japan interest rate decision with special interest.
We expect little change from the BoJ and indeed the Dollar/Yen exchange rate seems likely to stick to its year-to-date trading range. It’s with that in mind that we believe the US Dollar looks like a buy versus its Japanese counterpart. But what are the risks to that trade?
Markets have long waited for BoJ Governor Kuroda to signal further monetary policy easing is likely, and continued disappointments have kept the Yen from falling further versus the Dollar. Kuroda recently reiterated that the BoJ expects the domestic economy will continue recovering at a moderate pace and inflation will continue to rise.
The lack of urgency for further policy action will likely keep the JPY contained, but any hawkish surprises could force a significant USDJPY decline.
FX derivatives show that 1-week volatility prices on the Dollar/Yen continue to trade near record lows; if traders fear a hawkish shift from the Bank of Japan they’re certainly not showing it. There may be only so long the Japanese Yen can continue to stay below key highs, and the recent breakdown in the EUR/JPY acts as warning that miniscule price ranges can only last so long.
We remain ready for anything, but at this stage the USD/JPY seems likely to trade above key year-to-date lows at ¥100.70 through the foreseeable future.
GBP/USD Needs Hawkish BoE Minutes, Upbeat 2Q GDP for Fresh Highs
Fundamental Forecast for Pound:Bullish
The Bank of England (BoE) Minutes and the U.K.’s 2Q Gross Domestic Product (GDP) report is likely spark increased volatility in the GBP/USD as market participants continue weigh the outlook for monetary policy.
The BoE policy statement may prop up the British Pound as a growing number of central bank officials show a greater willingness to normalize monetary policy sooner rather later, but we would need to see a greater dissent within the Monetary Policy Committee (MPC) to see fresh yearly highs in the GBP/USD as the pair retains the range-bound price action from earlier this month. With that said, a more hawkish statement along with a greater rift within the MPC may drive the British Pound higher ahead of the next quarterly inflation report due out on August 13, and the going shift in the policy outlook may continue to heighten the bullish sentiment surrounding the sterling as it boosts interest rate expectations.
However, the 2Q GDP print may undermine the bullish outlook for the British Pound as the economy is expected to retain a 0.8% rate of growth in the second-quarter, and we would need to see a more meaningful pickup in private sector activity to see a bullish reaction in the sterling as the BoE continues to mull the margin of spare capacity in the U.K.
With that said, we would need to see a series of positive fundamental developments to see a higher-low being carved ahead of the 1.7000 handle, but the GBP/USD may face a larger correction over the remainder of the month should the U.K. event risks drag on interest rate expectations.
Gold Posts 2% Weekly Loss- $1324 Key Resistance ahead of US CPI
Fundamental Forecast for Gold:Neutral
Gold prices are considerably lower on the week with the precious metal down more than 2.3% to trade at $1307 ahead of the New York close on Friday. The losses come amid a tumultuous week for markets with geopolitical tensions continuing to build both in Ukraine and Israel. A downed civilian airliner in Ukraine and an Israeli ground invasion of Gaza fueled a substantial rally in gold on Thursday as broader equity markets turned over. The subsequent gold rally halted at a key resistance range and while the technical picture here is a little murky, our baseline scenario is for further weakness in gold while sub $1324.
Looking ahead to next week, investors will be closely eyeing the release of the US Consumer Price Index (CPI) with consensus estimates calling for the headline reading to hold at an annualized rate of 2.1%. In light of the recent commentary from Janet Yellen in this week’s Humphrey Hawkins testimony, the central bank chair continued to suggest that the inflation outlook remains “noisy” due to temporary factors. However, a strong inflation print may undermine the Fed’s dovish tone as a growing number of central bank officials show a greater willingness to normalize monetary policy sooner rather than later. As a result we would need to see a significant deviation from market expectations for the data to spur a material shift in the Fed’s policy outlook. Should the inflation data come in stronger than expected, look for gold to trade heavy as interest rate expectations fuel strength in the greenback.
From a technical standpoint the outlook for gold remains clouded with a mid-week rally taking prices back above the initial July opening range low. That said, it’s important to note that our topside bearish invalidation level remains at the zone between the 38.2% extension off the 2013 low and the 61.8% retracement from this month’s high at $1322/24.This week’s rally met strong resistance at this threshold and near-term focus will favor the short-side of the trade while below this threshold. Interim support rests at $1305 and is backed by the confluence of the monthly low, the 50% retracement of the June rally, the 50-day moving average and trendline support off the June low at $1292. A break below this level further validates our broader directional bias with such a scenario eyeing subsequent targets into more significant support at $1270. A topside breach/close above $1324 invalidates our near-term approach with subsequent resistance levels seen higher at $1335 the monthly high at $1345 and the 78.6% retracement of the decline off the March highs around $$1360. We will maintain a neutral bias heading into next week’s CPI data while noting a greater inclination to sell while below $1324.
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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AUD Braces For Jawboning From Stevens And Quarterly Inflation Data
Fundamental Forecast for Australian Dollar: Neutral
AUD/USD finishes flat despite a bumpy week on RBA minutes, China data, and geopolitical shocks
CPI figures and Stevens’ speech unlikely to shift expectations for a “period of stability” for rates
If geopolitical tensions fail to intensify, traders could return to the Aussie for its yield appeal
The Australian Dollar’s consolidation continued over the most recent week with AUD/USD remaining within its narrow range between 0.9210 and 0.9440. A status-quo set of Minutes from the RBA and positive Chinese second quarter growth figures failed to inspire the Aussie bulls. While a sell-off on heightened geopolitical tensions proved to be short-lived, with the currency bouncing back during Friday’s trading. Over the week ahead, two key themes are likely to continue to offer the Aussie guidance; policy expectations and risk appetite.
On the risk-appetite front; geopolitical turmoil carries the potential to put pressure on the risk-sensitive currencies like the Aussie. There is considerable uncertainty over whether the flare-up between Israel and Hamas, as well as tensions in Eastern Europe could escalate, which could leave traders hesitant to move back to the Aussie. Investors’ reactions to the latest developments suggests that the market is highly sensitive to outside shocks at present. If either situation were to intensify, it could lead to an unwinding of AUD carry trade positions built up over recent months.
However, we have witnessed several of these geopolitical shocks this year, which have ultimately failed to leave a lasting impact on sentiment. When the dust settles from the latest flare-up traders could again be tempted to return to the Aussie for its yield appeal.
Next week’s domestic CPI data and speeches by RBA officials could feed the policy expectations theme. A surprise second quarter inflation reading may see a knee-jerk reaction from the currency, however given a shift in the rate outlook remains unlikely at this stage, follow-through could prove limited.
Similarly, another attempt at jawboning the Aussie lower from Stevens may fail to leave a lasting impact on the unit. In recent addresses the RBA Governor has simply been delivering the central bank’s view that the currency is overvalued, and at this stage remains unwilling to take action such as intervention to put pressure on the AUD. For views on the US Dollar side of the AUD/USD equation, refer to the US Dollar outlook available here.
Written by David de Ferranti, Currency Analyst, DailyFX
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NZD/USD Risks Fresh Record-Highs Ahead of RBNZ on Faster Inflation
Fundamental Forecast for Pound:Bullish
The NZD/USD remains at risk of marking fresh record-highs ahead of the next Reserve Bank of New Zealand (RBNZ) policy meeting on July 23 as the economic docket is expected to show heightening price pressures across the region.
Indeed, the headline reading for New Zealand inflation is expected to increase an annualized 1.8% in the second-quarter, which would mark the fastest pace of growth since the last three-months of 2011, and heightening price pressures may generate a further advance in the exchange rate as it fuels interest rate expectations. According to Credit Suisse overnight index swaps, market participants are pricing a 90% chance for another 25bp rate hike in July, but we may see the RBNZ take a more aggressive approach in normalizing monetary policy as the stronger recovery raises the risk for inflation.
RBNZ Assistant Governor John McDermott warned that the central bank will aim for ‘low and stable inflation’ as the central bank raises its outlook for growth, and the stronger recovery should continue to heighten the appeal of the New Zealand dollar, especially as Fitch Ratings raising its credit rating outlook for the region. With that said, the positive developments coming out of the region may continue to limit the downside risk for the NZD/USD, and we may see the RBNZ do little to halt the advance in the local currency as it helps the central bank to achieve price stability.
As a result, we will retain a bullish outlook for the NZD/USD as it approaches the 2011 high (0.8841), and we will continue to look for opportunities to ‘buy dips’ ahead of the RBNZ interest rate decision should the inflation report further boost interest rate expectations.