FX: US Data vs. Russia's Empty Threat to Sell Dollars

• FX: US Data vs. Russia's Empty Threat to Sell Dollars 
• CAD: What to Expect from the Bank of Canada
• AUD: Q4 GDP on Tap
• NZD: Oil and Gas Prices Retreat
• EUR: Failing Again at 1.38?
• GBP: No More Support from M&A
• Shift in Risk Appetite Drives USD/JPY Back Above 102

FX: US Data vs. Russia's Empty Threat to Sell Dollars 

There was not much consistency in the dollar's performance today but even with a quick glance it is clear that there is a general sense of risk appetite in the financial markets.  Currencies and equities traded sharply higher on the hope that tensions between Ukraine and Russia are easing. However Russia's vow to retaliate with its own sanctions if the U.S. were to pose economic restrictions indicates that the crisis is far from over.  One of their latest threats involves abandoning the U.S. dollar as a reserve currency by reducing its reliance as a payment for international transactions.  At face value, this threat is a significant one because Russia has the fourth largest stockpile of currency reserves but in reality, any diversification out of dollars would be a gradual process because dollars represent a large share of their currency basket.  With more than $225 billion in dollar reserves, there are few markets capable of absorbing this demand and even fewer if we exclude the countries that support tough action against Russia.   In addition, Russia has already been selling U.S. dollars to defend the Ruble and the greenback has taken it in stride. Of course, in the very unlikely scenario where they follow through with this threat, selling dollars would involve selling Treasuries, which would drive U.S. yields sharply higher.  Based on the price action of the market today, investors see this as nothing more than an empty threat and we completely agree that there will be no follow through.

As long as the situation does not worsen in the Ukraine over the next 24 hours, investors will start to shift their focus to the outlook for the U.S. labor market. Non-farm payrolls are scheduled for release on Friday and tomorrow the ADP and non-manufacturing ISM reports are scheduled for release - 2 very important leading indicators for NFPs that will help set expectations for the key report. The Federal Reserve will also release the Beige Book, which provides a written insight into labor market and general economic conditions across the nation.   This report along with this week's economic releases are extremely important inputs for the Federal Reserve who is preparing to make significant changes to forward guidance later this month. USD/JPY rose back above 102 today but its ability to sustain these gains going into Friday's release will hinge in large part on the non-manufacturing ISM number because the U.S. is a services based economy.

CAD: What to Expect from the Bank of Canada

Despite the improvement in risk appetite, the Canadian dollar traded lower against the greenback today. Part of the weakness was caused by the sell-off in oil prices. The price of oil climbed to a 5 month high on the back of the Ukraine crisis and any let up in tension will take the pressure off crude.  The Canadian dollar also sold off ahead of the Bank of Canada rate decision.  Some investors are concerned that the BoC will grow more dovish because of the recent contraction in retail sales.  However taking a look at the table below, there has been as much improvement as deterioration since the January meeting.  Although retail sales fell sharply, job growth rebounded and consumer prices edged higher.  These improvements should give the BoC the confidence it needs to keep its monetary policy outlook steady.  Meanwhile last night's RBA announcement contained no major surprises.  The central bank reaffirmed its neutral monetary policy stance and reiterated their concerns about the strong currency.  Economic data was relatively positive with the current account balance narrowing in the fourth quarter and building approvals rising strongly.  Tonight, Q4 GDP and the PMI services report are scheduled for release. Growth is expected to have picked up slightly towards the end of the year. 

EUR: Failing Again at 1.38?

Over the past 4 months, 1.38 has been a very important level of resistance for EUR/USD.  Every attempt to break through this level during this period fizzled with last week being the most recent attempt.  Unlike many of the major currencies, EUR/USD failed to benefit from the turn in risk appetite. While Russia's decision to return their troops conducting military exercises near the Ukraine border back to their barracks, the standoff between Russia and the Ukraine and Russia vs. the rest of the world remains in place.  The situation is highly volatile and could deteriorate quickly if Russia makes another move.  With Europe's economic reliance on Russia, leaders in the region are divided on how to respond to Putin. Some are joining the U.S. and calling for an aggressive stance with sanctions while others like Germany who counts the country as their fourth largest trading partner simply want to condemn Russia for their actions.  Sanctions on Russia will mean weaker economic activity, which could lead to slower growth for some of the country's key trading partners. Lower inflation also added pressure on the EUR/USD.  Producer prices dropped a more than expected 0.3% in the month of January.  Final Eurozone PMI services and retail sales figures are scheduled for release on Wednesday.  If the European Central Bank expresses any additional concern about the recent geopolitical risks and inflation, the recent sell-off could turn into a more meaningful reversal, making the retracement off of 1.38 an official top.

GBP: No More Support from M&A

The British pound ended the day unchanged against the U.S. dollar and euro.  Softer economic data played a role in the underperformance but the currency is also no longer supported by M&A flow. Verizon settled the $23.9 billion cash payment to Vodafone shareholders today, removing a primary source of support for the currency over the past month.  If tomorrow's U.K. PMI services index drops more than expected, GBP/USD could slip down to 1.66.  Based on the data released so far for the month of February, we have seen improvements in manufacturing activity and the housing market.  However heavy rains and floods last month dampened construction activity, driving the PMI Construction index down to 62.6 from a 6.5 year high of 64.6. Yet like the manufacturing sector, the construction sector also experienced strong job growth with the employment component of the report rising to its highest level in 3 months. The index remains at a high level that is indicative of strong expansionary conditions.  According to Markit Economics, six construction companies forecasted higher activity over the next year for every one anticipating a reduction.  Tomorrow's service activity sector activity report is key.  Economists are looking for a small decline and with consumer confidence holding steady it is difficult to tell how much momentum there was in the sector last month. 

Shift in Risk Appetite Drives USD/JPY Back Above 102

The price action in USD/JPY today is an example of how quickly sentiment can change in the foreign exchange market.  On Monday, USD/JPY was hit from all sides by risk aversion, lower yields and the sell-off in equities. Today however, stocks are up strongly, yields increased and risk appetite improved and this shift in sentiment drove all of the Yen pairs higher.  Having fallen to a 3 week low yesterday, USD/JPY is now trading back above 102.  Labor cash earnings was the only piece of Japanese data released overnight and the surprise 0.2% decline in January limited the rally in the Nikkei. Economists had been looking for earnings growth to slow to 0.3% from 0.8% but not only did it fall but earnings in December were also revised lower. Wage growth is important for every economy but especially Japan who needs to make sure that wages need to rise enough to match or exceed the increase in the inflation rate.  Right now, real wage growth is still negative.  There are no Japanese economic reports scheduled for release this evening.