- The GBP could get Pounded on Thursday
- Will ECB Draghi Express Concerns about Euro?
- USD: Stocks Consolidating, Jobless Claims Next
- NZD: Unemployment Rate Drops but so Does Participation Rate
- AUD: Retail Sales will Subtract from Q4 GDP
- CAD: Shrugs Off Sharp Rise in IVEY
- Is USD/JPY Vulnerable to Further Profit Taking?
Why GBP Could Get Pounded on Thursday
The British pound was one of the few currencies that did not lose value against the U.S. dollar today but it remains near 5 month lows ahead of Thursday's monetary policy announcement. While the European Central Bank meeting will be the main focus of trading tomorrow, the prospects for U.K. monetary policy should not be ignored. However it won't be the Bank of England meeting that triggers volatility in sterling. Instead, current Bank of Canada Governor and incoming BoE head will be testifying before the U.K.'s Treasury Select Committee at 4:45am ET / 9:45 GMT or 2 hours before the BoE meeting. Carney will be asked some very specific questions about monetary policy tools and whether the existing framework is the right one for the U.K. after barely any economic growth in the past 5 years. If Carney even suggests that he is in favor of easier monetary policy, the hammer could slam down even harder on the British pound. With economic data taking a turn for the worse, the U.K. economy desperately needs additional stimulus but concerns about inflation have prevented the central bank from pulling the trigger. The question now is whether Carney will kick off his term as BoE Governor in July with a powerful dose of stimulus to jumpstart the economy, and we think its likely since he's being brought in to engineer a stronger recovery. The BoE meeting should be a nonevent for sterling since no monetary policy changes are expected, all eyes will be on Carney's hearing. In Davos, Carney suggested that he is ok with delaying the process of bringing inflation back to its target level if economic activity is weak. He also previously suggested that a GDP target could be helpful if stimulus options are exhausted. If any of these views are repeated, sterling traders could interpret it to mean more stimulus this year and even though Carney won't become BoE Governor until July, they will punish the GBP/USD immediately. However if Carney's responses to the questioning by U.K. lawmakers are vague, the lack of commitment to do more could actually help the currency. Aside from the BoE meeting, industrial production and the trade balance are also scheduled for release. Given the drop in the manufacturing PMI index, our bias is for weaker data.
Will ECB Draghi Express Concerns about Euro?
Euro traders are taking profit ahead of the European Central Bank's monetary policy meeting. As we had warned previously, concerns about Mario Draghi's comments on the currency could lead to unwinding of long euro trades ahead of Thursday's meeting. Many politicians in Europe have voiced frustration with the recent rally in the EUR/USD because over the past 2 months, the euro appreciated more than 7% against the dollar from a low of 1.2660 to a high of 1.3710. As an export dependent region, a strong currency crimps exports and growth. For many countries, especially the ones that have sought bailouts, any ounce of growth needs to be protected vigorously. However despite complaints from the head of the Eurogroup to French President Hollande, the euro continued to rally because investors understand that the ECB is the one agency with the power to stop the currency's uptrend. The ECB controls monetary policy and decides if and when currency intervention is necessary. If they are worried about the level of the euro, investors should be as well but if they express no concerns, it would be a green light for further gains in the currency. When the ECB last met in January, Mario Draghi said, "so far, both the real and the effective exchange rate of the euro are at their long-term average." At the time the EUR/USD was trading at 1.31 and is now trading around 1.35. This morning the German government said the currency is not overvalued at its current level and the appreciation actually shows confidence in the euro area. We expect the ECB to have a similarly nonchalant attitude about the currency as long as it remains below 1.38. Since the last monetary policy meeting in January, we have seen stronger service and manufacturing activity in the region. The problem however is that Germany is once again carrying the Eurozone on her shoulders. Most of the improvements in economic activity have been in the Eurozone's largest economy. France, the second biggest economy in the region endured a deeper contraction in service and manufacturing activity during the month of January along with stagnant consumer spending. While stronger German growth can mask weakness in other parts of the Eurozone and provide peace of mind for the ECB, we wonder how much longer the central bank can ignore weakness in smaller more vulnerable countries. Interest rates are expected to remain unchanged and Mario Draghi will most likely remind us that monetary policy remains firmly on hold. For the most part, with the tail risks removed and funding conditions returning to normal levels, Draghi will remain satisfied with the stability in the financial markets. We don't expect any major changes to his overall view on the economy. While the ECB is done with easing monetary policy, they also have no plans to exit immediately. Draghi has thrown the ball back into the court of European governments, saying that reducing unemployment is their responsibility. In other words, the ECB is no longer in crisis fighting mode because the battle with the financial markets have been won. The markets have stabilized and the worst is over but monetary policy needs to remain accommodative because growth is weak. We expect the EUR/USD to recover after the ECB meeting but gains to be capped below 1.40.
USD: Stocks Consolidating, Jobless Claims Next
The U.S. dollar ended the North American trading session unchanged or slightly higher against all of the major currencies with the exception of the Japanese Yen. No U.S. economic reports were released today but the rally in safe currencies suggests that investors are starting to get nervous. The S&P 500 failed to make a new high today and for the past 4 trading days, it consolidated below the 1,515 level. This means that either stocks are primed for a major upside breakout or beginning to top out. Figuring whether stocks are headed higher is not our forte but with the VIX trending lower which is good for equities. The dollar could get some play after this weekend's G20 meeting. If policymakers start to get combative about currency rates, we could see some interesting trading on Monday. Jobless claims are due for release tomorrow. Economists are not looking for any major change. Overall, we expect the level of jobless claims to be consistent with a gradual recovery in the U.S. economy.
NZD: Unemployment Rate Drops but so Does Participation Rate
The New Zealand and Australian dollars traded lower against the greenback on the heels of weaker economic data. In New Zealand, the unemployment rate dropped to 6.9% from 7.3%, which got traders initially excited but when everyone saw employment change drop by 1.0%, they turned around and sold kiwis. The main reason why the unemployment rate declined is because the participation rate fell and that is bad news for New Zealand because it means that less people are working. The only silver lining is that this is Q4 data and hopefully the RBNZ's optimism is directed at the period going forward. However the big story overnight was the "surprising" decline in Australian retail sales. While the weak number caught the market off guard, our readers shouldn't be surprised considering that we said last night that the decline in the sales component of service sector PMI and the decline in job growth means that consumer spending weakened in the month of December. Nonetheless the disappointing 0.2% decline drove the AUD/USD to 2-month lows against the U.S. dollar because it reinforces the need for additional stimulus from the Reserve Bank. Retail sales will subtract from GDP growth in the fourth quarter because spending declined every month between October and December. Australia's employment report is due for release this evening along with construction sector PMI. Economists are looking for a rebound in job growth in January after the previous month's decline. This is a tough call because the service sector experienced stronger job growth but the manufacturing sector experienced more job losses. The Canadian dollar on the other hand failed to benefit from the sharp increase in the IVEY PMI index, which rose for the second month in a row to 58.9 from 52.8. This improvement is very encouraging for Canada but CAD traders are worried because it didn't stop the Bank of Canada from growing less hawkish. Canada's new housing price index and building permits are due for release tomorrow.
Is USD/JPY Vulnerable to Further Profit Taking?
After climbing to a fresh 2.5 year high during the Asian trading session, USD/JPY ended the New York session near its lows. There was no U.S. economic data on the calendar today but the slide in U.S. Treasury yields weighed on the currency. The 3.8% rally in the Nikkei should have been extremely positive for USD/JPY, especially since it was the strongest one-day move in 23 months. However after such an extensive and relentless rally that has driven the currency pair up 20% over the past 4 months, USD/JPY is reaching a level of exhaustion. It has taken out 80, 85, 90 and today 94. We believe that 95 will prove to be a significant level of resistance for the currency pair. The uptrend in USD/JPY should remain intact but we would not be surprised if the currency pair comes under additional profit taking and pulled back to approximately 92.25. According to one of the most popular Japanese newspapers, Prime Minister Abe is poised to select the next BoJ governor after his visit to the U.S. later this month. All 3 candidates that he is considering are doves and going into as well as on the heels of the nomination, we expect Abe and the new candidate for BoJ Governor to reinforce the central bank's dovish message.