What Could Trigger a EURO Rally?

• Potential Triggers for EUR/USD Rally
• Retail Sales Should Extend the Dollar's Gains
• USD/CAD is the Day's Biggest Winner
• AUD Falls Sharply Despite Record Job Growth
• NZD: Extends Losses after RBNZ Keeps Rates Unchanged
• Sterling Extends Recovery as Concerns about Scottish Independence Ease
• JPY: BoJ is Comfortable with Yen Weakness

Potential Triggers for EUR/USD Rally

Unlike some other major currencies that experienced big moves this week EUR/USD remained confined within a 100-pip range.  Since the ECB's decision to ease last Thursday, we have actually seen very little follow through in the currency, which is surprising because of the significance of the central bank's move.  However it is important to understand that the EUR/USD is deeply oversold, short positions are at 2-year highs and this month's actions will most likely mark the last of the central bank's moves this year. The details of the ABS program still need to be unveiled and based on this morning's comments from Eurozone policymakers, Quantitative Easing remains on the table so EUR/USD is not out of the woods.  If the program is large enough and we think it will be, the euro could drop to fresh lows but the details are not expected until October and between now and then there is a FOMC meeting and the ECB's TLTRO rollout.  If the Fed downplays the recent improvements in U.S. data and refrains from fanning speculation about tightening, the dollar could give up part of its gains. There is also upside risk for the EUR/USD if the uptake for the TLTRO program next week is strong.  So while we are still looking for further losses in the EUR/USD over the next 3 months, in the near term, a bounce would not be unusual and even expected in the coming week if the Fed meeting and ECB TLTRO go as we described.

Retail Sales Should Extend the Dollar's Gains

We are finally beginning to see some divergence in the performance of the U.S. dollar.  The greenback extended its gains versus the Japanese Yen and commodity currencies but continued to correct against the euro, British pound and Swiss Franc.  This indicates that investors are no longer buying dollars blindly against all major currencies. The larger decline in U.S. rates is part of the problem but ultimately certainly currencies have become deeply oversold versus the greenback and profit taking ahead of the only piece of market moving U.S. data this week is not unusual.  In fact if you took a look at how 10 year Treasury yields performed today versus yields of the same tenure for other countries, they coincide perfectly with the moves in currencies.  For example, 10-year Canadian bond yields are down more significantly than U.S. yields, making USD/CAD the day's best performing currency.  In contrast, U.K. Gilt yields are down less than Treasury yields, providing support to the GBP/USD. We believe that Friday's retail sales report will show an uptick in demand because according to the International Council of Shopping Centers and Johnson Redbook consumer spending accelerated last month. This should ease some concerns created by the non-farm payrolls report and extend the gains for the dollar.  

USD/CAD is the Day's Biggest Winner

All 3 of the commodity currencies traded lower against the U.S. dollar today but the big surprise was the nosedive in the Canadian dollar.  House prices stagnated in the month of July but this report is not significant enough to explain the nearly 1% rally in USD/CAD. No comments were made by policymakers and the increase in oil prices should have been positive and not negative for the CAD. The only possible explanations for today's move are the market's appetite for U.S. dollars, stops being triggered above 1.10 and a catch-up to the other commodity currencies.  While our view that the BoC will lag behind the Fed in raising rates, a move like the one we saw today is generally driven by a specific catalyst. Of course, the rally in USD/CAD is not the only "bizarre" move in the FX markets today. The Australian dollar traded sharply lower despite record job growth in the month of August. Although nearly all of the jobs created were part time, the sheer magnitude of the increase along with the decline in the jobless rate and rise in the participation rate should have been extremely positive for the Australian dollar.  AUD spiked higher immediately after the report but recent changes to the survey group contributed 47k to the surge in part-time employment.  Even with this distortion, the data is good but it is unlikely to affect the Reserve Bank's neutral monetary policy bias. Meanwhile the RBNZ left interest rates unchanged and said that rates will not rise again until April of next year.  Tonight's business PMI report from New Zealand and credit card spending numbers from Australia will most likely keep both currencies under pressure.

Sterling Extends Recovery as Concerns about Scottish Independence Ease

Based on the recent performance of the British pound, investors are finally beginning to realize that the chance of Scotland remaining in the U.K. is still higher than the chance of it seceding.  A handful of polls show the Yes camp gaining traction but more reliable surveys still show the No votes in the lead. There's a large amount of undecided voters who could swing the vote on September 18th and major companies like the Royal Bank of Scotland have announced that they will move their headquarters to the U.K. if Scotland votes for independence.  The complications of forming a new country from an economic and political perspective along with the potential consequences could deter many voters actually ticking the Yes box next week.  We continue to believe that when push comes to shove on September 18th, the majority in Scotland will vote to remain part of the U.K. Once the referendum is over, the focus will return to monetary policy. Earlier this week Bank of England officials indicated that rates will rise in the Spring next year. According to BoE Governor Carney, "the point where rates need to rise has moved closer" and according to MPC member Weale, there are signs of a pickup in wage growth. 

JPY: BoJ is Comfortable with Yen Weakness

The Japanese Yen ended the day at a fresh 6 year low against the U.S. dollar.  Interestingly enough even with this move, there was very little inconsistency in the performance of the other yen crosses.  For example EUR/JPY and GBP/JPY extended their gains while CAD/JPY and AUD/JPY traded sharply lower. The Bank of Japan appears to be very comfortable with the current slide in the Yen.  According to BoJ Governor Kuroda, the Yen's level is in line with fundamentals and is not "a minus for Japan's economy." While a weaker currency boosts the cost of energy imports, it lends support to exports and helps to drive up inflation so at the end of the day, it brings more positives than negatives for a country like Japan. Last night, BoJ Adviser Kawai said it would be "natural if Yen drops to 110 against the dollar when the Fed lifts rates" and like Kuroda he believes that "gradual yen weakening is not bad for Japan at all."  The sell-off in the Japanese Yen also reduces the urgency for more action from the central bank. For these reasons, we believe that USD/JPY will hit 110 before the end of the year.  Overnight, we learned that the sentiment of large businesses in Japan improved significantly in the third quarter, which is important because it reinforces the BoJ's optimistic outlook.