What FX Traders are Focusing on this Week

• What FX Traders are Focusing on this Week
• EUR - Limits to the Breakout
• USD/JPY - First Stop 100
• GBP - Time to Reload GBP Shorts
• NZD: Worst Drought in 30 Yrs to Shave 0.7% off GDP
• AUD: Shrugs Off Deeper Contraction in Construction
• CAD: Extends Losses Following Weak Employment

What FX Traders are Focusing on this Week

The lack of U.S. economic data today did not stop USD/JPY from powering higher.  The currency pair climbed to a fresh 4 year high of 99.04, extending a move that has taken USD/JPY up more than 6.5% since the Bank of Japan announcement on Thursday.  While USD/JPY and a possible run to 100 remains a central focus for forex traders this week, an abundance of Chinese economic data and the beginning of earnings season will also affect currency flows.  The dollar's mixed performance today is an example of what investors should expect in the second quarter as relative performance plays a bigger role in FX movements than risk on risk off.  The greenback traded higher against the Japanese Yen, British pound and Canadian dollar but lost value against the euro, Swiss Franc, Australian and New Zealand dollars. We expect the dollar to outperform the EUR, JPY and GBP this quarter but underperform the AUD, NZD and CAD.  For more on our Outlook for the USD this quarter, see our Top FX Trades for Q2.

Meanwhile the earnings season kicks off with Alcoa today followed by some financial names on Friday.  U.S. stocks may have a difficult time extending last week's record breaking moves after the latest non-farm payrolls report. The minutes from the March FOMC meeting are scheduled for release later this week and the Fed minutes will most likely sound optimistic since policymakers did not have the payrolls report on hand before the meeting.  Traders should therefore take any talk of tapering asset purchases with a grain of salt because the views of many Fed officials probably changed as a result.  No major U.S. economic reports are scheduled for release tomorrow but Bernanke will speaking this evening at 7:15pm ET / 23:15 GMT and could be asked about his outlook on the economy post payrolls in the Q&A session.

Tonight's Chinese consumer and producer price reports are expected to show slower inflationary pressures and in that case, the People Bank of China could retain their modest easing bias, which in the short term would be negative for the Australian dollar but in the long term more flexibility in monetary policy should be positive for China, Australia and the global economy. While the CPI numbers are important, the primary focus this week will be Tuesday night's trade balance report. 

EUR - Limits to the Breakout

The euro traded higher against the U.S. dollar for the fourth consecutive trading day on the back of stronger German industrial production.  After dropping 0.6% in January, industrial production rose 0.5% in February.  This recovery follows a similar rebound seen in German factory orders and bodes well for tomorrow's trade balance report.   However there is still potential weakness in Tuesday's release because manufacturing activity declined according to the latest PMI manufacturing report.  Today's upside surprise does not remove the risk of weaker growth in the Eurozone's largest economy.  We believe that the extension of the EUR/USD breakout from last week will be limited to 1.3135 - 1.32. The primary reason for the EUR's breakout last week was the ECB who failed to lay the foundation for a rate cut and suggested their toolbox is empty.  These are hardly the words of an optimistic central bank particularly since Mario Draghi also stressed the downside risks to their outlook.  A rate cut is still on the table and without a Single Supervisory Mechanism, other countries could fall victim to the same problems as Cyprus.  In addition, we expect growth to remain weak as austerity measures limit economic activity in the region. 

USD/JPY - First Stop 100

The biggest movers in the FX market continued to be the Japanese Yen crosses, which soared to fresh multi year highs. Better than expected economic data did not provide any support to the Yen as investors look at the improvements as validation for the positive effects of the central bank's easy monetary policy. Thanks to the depreciation in the currency, Japan turned a current account surplus in February and reported a 50% improvement in the trade deficit.  The Eco Watchers survey which measures the sentiment of barbers, taxi drivers and restaurant workers (the true "man on the street") also soared.  These positive reports give the BoJ stronger reason to push forward with their monetary policy plans. Despite the approximate 29% rally in USD/JPY over the past few months, the currency pair has not gotten too expensive. Its 10 year average is 100 and at minimum a full 30% move from the low would take USD/JPY to 103 if not higher.  When it comes to USD/JPY it is important to realize that trends in the pair can last for a very long time and extend further than what most would imagine. 100 should only be the first stop for USD/JPY and before the end of the second quarter, we expect 105 to be tested.

GBP - Time to Reload GBP Shorts

Next to the Japanese Yen, the British pound performed the worst against the U.S. dollar today.  Sterling fell sharply against the USD and EUR on the back of weaker economic data.  Employment confidence declined further in the month of March according to a survey by Lloyds.  Shorting GBP is one of our Favorite FX Trades for Q2.  For most of the first quarter, sterling had been in a very strong downtrend but the currency bottomed in the beginning of March after the Bank of England minutes revealed renewed concern about inflation.  Prior to that, investors had widely believed that the BoE would ease again but the focus on price pressures and the impact of a falling currency shut the door on this possibility.  However we believe that this reluctance to ease is only temporary.  BoE Governor King is stepping down at the end of June and barring any major financial crisis, a chance of significant changes in monetary policy is slim.  However the game changes completely when Mark Carney takes office with a mandate to transform monetary policy.  While he doesn't join the BoE until June, expectations on his level of aggressiveness can start to affect sterling as early as May.  U.K. economic data has been mixed with improvements at the beginning of March starting to fade.  The central bank's focus on inflation is very "data dependent" and could change if fiscal consolidation or slower global growth starts to weigh on the economy again.  Aside from the BoE's concerns about inflation, sterling also rallied at the end of the first quarter because the problems in Cyprus drove European investors back into the safety of the GBP.  If contagion from Cyprus is limited and the euro starts to recover from here, then the quasi-safe haven status of GBP becomes less attractive to regional investors.   Industrial production and trade numbers are due for release tomorrow - any downside surprises could exacerbate sterling weakness.

NZD: Worst Drought in 30 Yrs to Shave 0.7% off GDP

The Australian and New Zealand dollars traded lower against the greenback despite weaker economic data and cautionary comments from government officials.  Starting with the AUD, construction sector activity contracted sharply in the month of March as the PCI index dropped to 39.0 from 45.6. While this was not the weakest reading seen in recent months, it is an indication that the housing market has peaked.  The Chinese government called on Australia's Prime Minister to reduce restrictions on foreign investment and any pullback in housing market activity could encourage her to do so.  Yet the report did not hurt the AUD, which is being pushed higher by demand for AUD/JPY.  Business confidence numbers are due for release this evening and we do not anticipate any major changes since slightly weaker manufacturing activity was offset by stronger services.  The New Zealand dollar also ignored warnings from the Treasury and the RBNZ.  New Zealand is currently enduring its worst drought in 30 years and the Treasury estimates that the drought could shave a minimum of 0.7% off 2013 GDP growth.  The RBNZ on the other hand had separate concerns - they are worried about the high level of household debt and the impact mortgage credit risk poses on the financial sector.  The Canadian dollar on the other hand continued to weaken despite an uptick in Business Outlook as investors adjust their positions following last week's decline in jobs.