Euro - A Pause or a Top?

• Euro - A Pause or a Top?
• JPY - All Eyes on the BoJ
• US Data Poses No Threat to Existing FX Trends
• GBP: Hit By Weaker in Retail Sales
• Factors Behind the Breakout in USD/CAD
• AUD: No Support from Chinese Data
• NZD: CPI Declined in Q4

Euro - A Pause or a Top?

The focus of the foreign exchange market has been on the Japanese Yen all week and while that will remain the case for the most part in the coming week, we can't lose sight of some important events impacting the EUR/USD.  While the intraday volatility in the EUR/USD increased this week, the currency pair has been trapped within a tight 150 pip trading range. What is interesting about the price action is that the consolidation is happening at a 10 month high, leading investors to wonder if the EUR/USD is pausing before a stronger move higher or in the process of topping out.

Over a week ago, the EUR/USD soared after ECB President Draghi said he was satisfied with the financial market's performance, which investors interpreted to mean steady monetary policy for the rest of the year.  The rally was stalled by Eurogroup President Juncker's comment that the euro was at dangerously high levels. However his concerns may be his alone as ECB member Nowotny and Germany's economy minister both felt that the currency was not at overvalued or excessively high levels. EU Finance Ministers are meeting on Monday and a number of European officials will be speaking afterwards.  If there are additional concerns about the level of the euro, the consolidation could turn into a near term top for the currency however the comments that really matter are the ones from the ECB and more specifically central bank President Draghi.  With inflationary pressures limited, we believe that their uncle point for the EUR/USD is closer to 1.38-1.40 than 1.34.  Aside from the EU Finance Ministers meeting, a number of key economic reports are scheduled for release next week including Europe's January PMI numbers, the German ZEW and IFO reports.  Since growth is greatest risk for the euro, the near term outlook for the currency pair will hinge on next week's data releases.  Good numbers could push the pair above 1.34 while weak numbers could drive a break below 1.32.

JPY - All Eyes on the BoJ

USD/JPY climbed to a fresh 2.5 year high before ending the day right around the key 90 level. Next week is the highly anticipated Bank of Japan monetary policy meeting and the fate of USD/JPY along with all of the other Japanese Yen crosses lies in the hands of the central bank. On Monday, we'll publish a more thorough outlook for the BoJ meeting but for the time being, we fear that Shirakawa will disappoint the markets.  A shift to 2% inflation target is already discounted by the market and we fully expect the BoJ to acquiesce but what the market wants to see is an action plan and we're not sure if the BoJ Governor will go that far when there are only 3 months left in his term. Nonetheless any losses in USD/JPY should still be limited because the government is committed to easier monetary policy.  Even if the BoJ disappoints next week, Prime Minister Abe has pledged to replace Shirakawa with a central bank governor that supports aggressive easing.  Also, based on the latest comments from Japanese officials, Japan could be more comfortable with the current level of the Yen than they had let on at the beginning of the week.  Overnight, Prime Minister Abe's Economics Advisor Hamada said USD/JPY at 100 was a "good level for Japan." However don't expect much decline in USD/JPY before the Bank of Japan announcement on Monday evening in NY, or Tuesday morning in Japan.  If anything, we could see further gains in the lead up to the meeting with USD/JPY potentially setting a new 2.5 year high.

US Data Poses No Threat to Existing FX Trends

Despite a decline in U.S. bond yields and unchanged activity in the stock market, the U.S. dollar traded higher against all of the major currencies.  The rally in the greenback suggests that FX traders are nervous but this sentiment doesn't seem to be shared by equity traders.  The only economic report released today was the University of Michigan's consumer confidence index, which dropped from 72.9 to 71.3 in the month of January.  The decline in confidence was a surprise for some but given the marginal increase in IBD index and the lofty expectations of economists, the big miss was not unexpected.  Nonetheless sentiment is at its lowest level since December 2011 and if it remains there, it is not going to sit well with Federal Reserve officials. This week's U.S. economic reports were mixed. While inflationary pressures remained contained, retail sales rose slightly more than expected in December, housing starts spiked higher and jobless claims fell sharply, the main area of concern is the manufacturing sector, which is losing momentum.  Yet for the FX market, this week's U.S. economic data poses no significant risk to existing trends and we don't expect this to change in the coming week with only housing market and jobless claims data on the calendar.  The only big story we expect from the U.S. next week is the resignation of Treasury Secretary Geithner who is set to step down next Friday.

GBP: Hit By Weaker in Retail Sales

For the first time in over a month, the British pound closed below 1.60 against the U.S. dollar.  The sell-off was steep and triggered by a drop in retail sales during the month of December. Consumer spending fell 0.1% last month and if we exclude the volatile auto fuel component, sales declined by a larger 0.3%. Not only does this mean that last year's holiday shopping season was terrible, but consumer spending was abysmal in the fourth quarter. Retail sales declined 2 out of the last 3 months and were flat in November. In other words, consumers did not increase their spending at all in the fourth quarter and this is bad news for GDP, which is scheduled for release next week.  Aside from the quarterly growth figures, the minutes from the most recent Bank of England meeting and employment numbers are also due for release.  We don't expect the BoE to have anything positive to say about the outlook for the U.K. economy but with inflationary pressures pushed higher by rising energy costs, the desire to ease should also be limited. Nonetheless next week will be a busy one for the GBP and in our opinion, further losses are likely against the EUR and USD.

Factors Behind USD/CAD Breakout

All three of the commodity currencies traded lower against the greenback today with the Canadian dollar losing the most value.  What is interesting about the decline in the CAD is that there was no obvious catalyst for the move. Economic data beat expectations with manufacturing sales rising 1.7% in November, compared to a forecast for a 1.0% rise.  Oil prices declined but only slightly. The sharp drop in U.S. consumer confidence could explain the weakness because concerns about the U.S. oftentimes carry over to concerns for Canada but the rally in USD/CAD happened before the University of Michigan Consumer Confidence numbers were released. Therefore the only explanation is positioning ahead of next week's Bank of Canada monetary policy meeting.  There have been a few disappointments in Canadian data that could convince the BoC to reconsider their hawkish monetary policy stance but we doubt they will shift their tone this month. The Australian dollar also fell sharply, testing 1.05 for the second time this week.  The New Zealand dollar weakened only slightly despite a surprise decline in consumer prices.  Better than expected Chinese GDP, retail sales and industrial production numbers failed to have any lasting impact on commodity currencies.