NZD: Expect a Big Reaction to RBNZ

• NZD: Expect a Big Reaction to RBNZ
• AUD Soars on Hotter CPI
• CAD: Mixed Retail Sales Report
• Euro Hangs Tight Ahead of PMIs
• GBP/USD - Break of 1.70 Hinges on UK Retail Sales
• NZD: Gold and Oil Retreat
• USD/JPY Extends Gains Despite Pressure on Treasury Yields

NZD: Expect a Big Reaction to RBNZ

The Reserve Bank of New Zealand's monetary policy announcement is the most highly anticipated event risk this week because the RBNZ is the only major central bank raising interest rates and tonight they are expected to lift rates by another 25bp.  Normally a rate hike is positive for a currency but New Zealand is at a critical juncture in their monetary policy cycle.  Having raised interest rates at each of the last 3 meetings, their next rate hike would bring total tightening to 100bp from the beginning of the year.  As recently as June, we began to see evidence of slower growth and when combined with the steep decline in dairy prices, investors expect the central bank to slow their pace of tightening after today's move.  If the RBNZ decides that it is time to take a break and let the economy absorb their latest rate hikes, NZD/USD could extend its losses below 0.86.  However last month, investors were also looking for the RBNZ to signal plans to pause but instead they made their intention to hike in July abundantly clear. Earlier this year the RBNZ said they plan to bring rates to 4.25% by mid 2014 and after the June meeting, RBNZ Assistant Governor McDermott said he sees another 50bp of tightening before the end of the year. With only 3 more meetings to go before year-end, the central bank could surprise the market by remaining committed to tightening which would be extremely positive for NZD.  While dairy prices have been falling, inflationary pressures in general have been firm so we cannot rule out this possibility.   Either way the central bank's guidance will determine the New Zealand dollar's short and medium term reaction.  Meanwhile the best performing currency pair today was the Australian dollar, which benefitted from hotter than expected consumer prices.  The Canadian dollar on the other hand ended the day unchanged on the back of mixed retail sales data. Consumer spending growth beat expectations in May but fell short excluding auto sales.

Euro Hangs Tight Ahead of PMIs

While the euro dropped to a fresh 8 month low against the U.S. dollar today, it ended the North American trading session unchanged.  Softer economic data and a steeper slide in Eurozone versus Treasury yields put downside pressure on the currency but with speculators already holding significant euro shorts, the downside has been limited.  Eurozone consumer confidence weakened in the month of July, which is not surprising given the slow recovery and geopolitical uncertainties.  The big test for the euro will come from Thursday's PMI reports.  Based on the decline in industrial production, factory orders and the ZEW survey, investors are bracing for a weak report. If activity in the Eurozone continues to slow, the sell-off in the EUR/USD could extend to 1.34. We are still looking for the currency pair to only spend a brief time below 1.35 but with market moving data scheduled for release over the next 48 hours, EUR/USD is vulnerable to additional weakness.

GBP/USD - Break of 1.70 Hinges on UK Retail Sales

The Bank of England minutes failed to provide the hawkishness that was needed to drive GBP/USD back above 1.71 and instead drove the currency pair closer to 1.70.  Thursday's retail sales report will decide whether this key level is broken. Consumer spending is expected to rebound after falling in May but according to the British Retail Consortium, shop prices declined and retail sales fell further in June.  However with consumer confidence improving, claimant count falling and the World Cup providing a boost to spending, a recovery would not be out of the question.  Based on the price action of sterling today, speculators are still holding out hope that stronger data will push the Bank of England to raise rates this year. While we agree that most likely, the BoE will be the next major central bank to start tightening, they can afford to wait. According to the BoE minutes, U.K. policymakers voted 9-0 to keep interest rates and the size their Quantitative Easing program unchanged this month.  While the central bank felt that the "sustained economic momentum was generally looking more assured," they expressed concerns about anemic wage growth, the downside risk to inflation, slower output and housing growth.  Along the same lines, the MPC expected the economy to grow 0.9% in Q2 before slowing modestly in the second half of the year.  Given the extreme level of speculative long positions in sterling, traders needed a clear sign that rates could be increased this year for the GBP to resume its rise.  Unfortunately not only did the central bank failed to deliver but BoE Governor Carney said he doesn't know when rate rises will begin.  The problem is the slack in the labor market and wage growth - unless wages start to rise, posing a threat to inflation, the BoE will refrain from raising interest rates prematurely. 

Dollar Unlikely to See Much Action from Thursday Data

There was very little consistency in the performance of the dollar today, which is not surprising considering the lack of U.S. data.  The greenback held steady against the euro, Japanese Yen, Swiss Franc and Canadian dollar, strengthened versus the British pound and weakened against the Australian and New Zealand dollars.  New highs in the S&P 500 and decline in the VIX kept risk appetite steady. The performance across asset classes is consistent with the overall belief that the Federal Reserve will leave interest rates on hold for an extended period of time after Quantitative Easing ends. A number of U.S. economic reports are scheduled for release on Thursday including jobless claims, manufacturing PMI and new home sales.  Of these reports, the manufacturing PMI index will be the most important - over the past year Markit Economics' US manufacturing PMI index has received more following especially after ISM's debacle in June when back-to-back revisions caused a tremendous amount of confusion.  We expect these reports to show an uneven but steady recovery in the U.S. economy.  However with this in mind, the dollar is unlikely to see much action from Thursday's second tier economic reports.

USD/JPY Extends Gains Despite Pressure on Treasury Yields

The Japanese Yen traded lower against the U.S. dollar for the fourth consecutive trading day but the gains have been extremely modest.  Since hitting a low of 101.09 on Friday, the highest level that USD/JPY traded at this week was 101.60.  Considering that Treasury yields have trended lower since Friday, the resilience of USD/JPY should be noted.  While many investors have lost faith in the idea of Treasuries selling off this year, they also don't see much in the way of downside for USD/JPY with yields not expected to fall much further. This lack of volatility in USD/JPY allowed the base currency to drive the price action of the Yen crosses. In other words, the only reason why AUD/JPY performed as well as it had today is because of the rally in the Australian dollar.  At the same time, sterling weakness made GBP/JPY the worst performing Yen pair. No major Japanese economic reports were released overnight but this evening we look forward to Japan's trade balance and manufacturing PMI index.  Stronger numbers are expected all around as Japan continues to recover from the sales tax increase.