04/10/2011 - Dollar gets slammed on monetary policy outlook

Dollar gets slammed on monetary policy outlook

The U.S. dollar has weakened significantly this past week as monetary policy divergences became more prevalent and commodities continued to soar. Precious metals marched higher with gold hitting new record highs while silver broke above $40 and oil topped $110 a barrel. Currencies whose countries export commodities were beneficiaries as highlighted by new post-float highs in AUD/USD which climbed above 1.0500 and multi-year lows in USD/CAD which fell below 0.9600. The ECB lifted rates by 25 bps to 1.25%, the first move on interest rates since May 2009 but no gave indication that it will be the beginning of a series. This is largely different from the Fed’s policy stance which has maintained its commitment to keep rates low for an ‘extended period’. Moreover, while recent speeches by some members of the Fed have suggested cutting short the plan to purchase $600 billion in assets through June, this week’s FOMC Minutes showed little evidence that the idea has gained traction among the FOMC voting members. In the week ahead, FOMC voting members Dudley, Evans, and Yellen are set to deliver speeches and we would note that these members are considered to be dovish. The monetary policy outlook remained the key driver as dollar index sunk to new 16-month lows and though budget talks and a looming government shutdown are viewed mostly political theater and are likely to have little economic impact, it gives investors yet another reason to sell the buck.

The exception to USD weakness has been against the Japanese yen which has continued its sharp reversal lower following the G7 coordinated intervention. Japan was struck with another earthquake, this time around the magnitude of 7.1. While reports of the earthquake were initially met with risk aversion, markets breathed a sigh of relief after tsunami warnings were retracted and resumed their appetite for risk. The week ahead will include the Fed’s Beige Book to give clues on the outlook of the economy, speeches by FOMC voting members, and inflation data. We would anticipate a stabilization in the buck as investors take profit ahead of key levels and events.

ECB keeps its cards close to its chest

So the ECB hiked rates as anticipated but the question now for investors is what they will do next. The market thinks there will be a further two hikes before the end of the year with the next hike coming in July, according to the Eonia swaps market.

The 11 per cent increase in the euro versus the dollar since the start of this year suggests that a lot of the expected ECB tightening is already priced into the single currency. So if things stay as they are then the euro may lose its yield advantage and could come under pressure. This would happen if investors think the ECB may not deliver as much policy normalisation as they originally anticipated.

However, on the back of last week’s meeting we know two things: firstly that the ECB has not yet decided if this will be the start of a rate hiking cycle, and secondly, that the future trajectory for interest rates depends on inflation since price stability is the ECB’s sole mandate.

So this week’s second inflation reading will be crucial for interest rate expectations in the currency bloc. The first reading saw inflation rise to 2.6 per cent in March from 2.4 per cent in February. Above target inflation is unacceptable to ECB policy makers and March’s price data most likely sealed Thursday’s rate hike. We will get the regional breakdown of the inflation figures on Thursday. We already know that inflation in Germany rose to 2.2 per cent while even debt-laden peripheral nations have experienced inflation pressures including Ireland, where EU harmonised inflation jumped from 0.9 per cent in February to 1.2 per cent in March.

It is the large jumps in inflation that the ECB want to avoid, and right now price pressures continue to build as energy prices surge to multi-year highs. If we see an upward revision to inflation next week then a rate hike before July becomes a possibility.

We think that dips in EURUSD will remain fairly shallow and a weekly close above 1.4420/30 may herald further gains to 1.4700 then 1.5000. But a caveat to this is the dollar. Arguably weakness in the greenback is pushing the euro higher and any swift resolution to the US’s budget impasse could see a reversal in short dollar positions and thus weigh on the euro in the short-term. In the long-term the direction of EURUSD depends on the clarity provided by the Fed about its intentions regarding monetary policy normalisation.

The UK: pricing out a rate hike

It wasn’t that long ago that the UK was considered the first of the major central banks to hike interest rates. Yet that seems like a long time ago now. The ECB has moved first and the UK’s growth outlook has deteriorated sharply. This has weighed on interest rate expectations and 3-month Sonia rates (GBP inter-bank swap rates that follow interest rate expectations closely) have fallen sharply.

The market is increasingly coming to the conclusion that the Bank of England won’t hike interest rates at their next meeting in May, and instead will wait until August to do so. This is consistent with our call and we expect the BOE to remain on hold this quarter.

Economic data has been largely weak with only a couple of upside surprises. One was service sector data for March, yet we believe this was an anomaly and service sector activity played catch-up after weather-related disruption in January and February.

But, while we think the BOE may be on hold longer than the market currently expects, there are a couple of important caveats to remember. The first is the Q1 GDP release on 27 April. This is the deal-breaker in our view. Lacklustre quarterly growth – something below 0.8 per cent would be viewed as a disappointment – would make a rate hike less likely in the current environment.

Another risk is the May Inflation Report. We think the economic backdrop, the impact of austerity measures and weak wage growth will be enough for the Bank to maintain its cautious stance in May. The Bank tends to hike rates after an Inflation Report, so the next logical date for an increase in rates would be August – after the Bank’s summer Report.

This makes the pound a sell on rallies in our opinion. It has already tested 1.6400 highs, but we think it is vulnerable to a pullback especially versus the dollar and the euro since a lot of its recent strength was fuelled by rate hike expectations. With this major source of support gone, sterling strength is likely to be curtailed going forward.

Will the BoC do anything Loonie next week?

On April 12th the Bank of Canada will announce their interest rate decision. By nearly all measures the market is expecting them to remain on hold at 1.00%, but their statement will be closely watched for any potential changes to their accommodative stance. As a result of rising food and energy prices economists have begun to shift their inflation forecasts higher for 2011 and 2012, however immediate pricing pressures continue to remain subdued. Nevertheless, such a backdrop makes the BoC’s job that much more challenging as they begin to deliberate on the path of future rate hikes.

On Wednesday the BoC will release the April Monetary Policy Report. The MPR is going to provide further economic incite and will likely touch upon turmoil in the Middle East and earthquake/tsunami in Japan – which has caused a rise in oil (energy) prices, as well as provide a slightly more optimistic bias regarding GDP over the coming quarters. While the stronger CAD has restrained Canadian exports, something Governor Carney continues to highlight, it will be unable to keep the BoC on the sidelines for too much longer. Going forward we believe the BoC is likely to remain on hold until the beginning of the 3rd quarter, where we expect a rate hike of 25bps at each meeting through the end of 2011 (July, Sept., Oct. & Dec.).

The CAD has been one of the strongest commodity currencies since the beginning on 2011, appreciating roughly 4.4% year to date, as it has benefitted from strong domestic fundamentals, improving global growth and rapidly rising oil prices. Just today crude oil (WTI) made fresh multi-year highs around $112.55/60,and firm demand from both emerging & developed economies, as well as ongoing unrest in the MENA region will likely to continue to support the ‘black-gold’ going forward. Therefore, while commodities remain strong and the U.S. dollar remains offered, we’ll look to be a seller of USD/CAD on rallies towards 0.9625/35 and 0.9680/00 in the week ahead.

Key data and events to watch next week

The greenback remains on the offer, driven fundamentally by widening rate differentials between the U.S. and other CBs. The USD Index broke below its short term bear flag formation to fresh yearly lows just above the 75.00 figure. Additionally, USD weakness is being confirmed by other asset groups - gold broke above the key 1450 level, also the neckline of an inverted H&S pattern suggesting a measured move objective to the 1550/75 area. Technical developments this week suggest the greenback’s woes may continue but considering the steep rate of USD declines, pullbacks should be expected and may provide better value for those looking to establish USD shorts.

EUR/USD: The ECB’s 25bp hike to the main refi rate may be a historic step as the central bank could be initiating a tightening cycle before the Fed for the first time. Uncertain Fed policy direction continues to weigh on the buck elevating EUR/USD above key technical levels. The most significant being the weekly close above primary downtrend resistance (around 1.4300) suggesting sustainable EUR strength in the weeks ahead. 1.4450 (61.8% retracement for the 1.6035/50-1.1875/80 decline) , however, is proving to be a formidable hurdle as EUR strength was capped into it on Friday trading. Below 1.4300 sees additional support into the 1.4250 pivot which may provide decent value for EUR longs as the medium term technical outlook has now shifted to the upside.

GBP/USD: The BoE remained on hold as expected and with rate differentials driving FX, the uncertain outlook for UK rates has seen the sterling underperform relative to other majors against the buck. GBP/USD, however, looks set to close above its respective primary trendline which technically suggests a potential reversal for the primary decline from the 2.1160 peaks. 1.6500 is likely to be a psychological barrier ahead of the key 1.6825/50 daily horizontal pivot. Immediate support may be seen into 1.6275/00, broken trendline resistance, ahead of the key 1.5975/1.6000 daily pivot.

AUD/USD: Commodities have been screaming higher which has seen commodity currencies benefit substantially. AUD/USD posted post-float record highs on a seemingly daily basis this week and looks set to close near weekly highs around 1.0540/50. The 1.0600 figure is likely to provide some technical hurdles to further Aussie strength but if commodity upside continues, the 1.0900 measured move objective for the symmetrical triangle breakout may be in view next. Downside corrections may find meaningful support into the rising trendline around 1.0450 ahead of the 2010 1.0255/60 highs.

USD/JPY: Another earthquake in Japan saw USD/JPY upside capped ahead of the all-important 85.50 barrier. Rumored options related stops above 85.50 were never hit as the declining trendline from the 2007 124.10/15 peaks and the 55-week SMA effectively stunted further JPY weakness against the greenback. Immediate support may be seen into the 84.50 daily pivot ahead of 83.50 which sees the 200-day sma converge with broken daily triangle tops. Considering uncertain USD monetary policy, USD/JPY is likely to underperform relative to other JPY pairs.

EUR/JPY: With loose BoJ monetary policy now a given for the foreseeable future and the ECB possibly embarking on a tightening cycle, EUR/JPY blew through a number of key technical levels this week. 120.00, psychological barrier and Feb. 2010 lows, proved to be no match for the pair. Furthermore, EUR/JPY has managed to close above weekly Ichimoku cloud tops ( 121.90/00) suggesting upside trend continuation may be sustainable and should be a level of immediate support on downside corrections. Below may find more meaningful support into the Feb. 2010 lows around the 120.00 figure which may provide value for EUR/JPY longs.

Key data and events to watch in the week ahead

United States: Monday – Fed’s Yellen and Dudley speak Tuesday – Mar. Import Price Index, Feb. Trade Balance, Apr. IBD/TIPP Economic Optimism, Fed’s Tarullo to speak Wednesday – Mar. Retail Sales, Feb. Business Inventories, Fed’s Beige Book Thursday – Weekly Jobless Claims, Mar. PPI, Fed’s Duke, Plosser and Tarullo speak Friday – Mar. CPI, Industrial Production and Capacity Utilization, Apr. Empire Manufacturing, Feb. Net TIC Flows, Apr. prelim U. of Michigan Confidence, Fed’s Evans speaks

Eurozone: Tuesday – Mar. final German CPI, Apr. EZ and German ZEW Survey, ECB’s Stark speaks Wednesday – Mar. German Wholesale Price Index, Feb. EZ Industrial Production Friday – Mar. EZ CPI, Feb. EZ Trade Balance, ECB’s Constancio speaks

United Kingdom: Monday – Mar. RICS House Price Balance Tuesday – Feb. Trade Balance figures, Mar. CPI, RPI Wednesday – Mar. Claimant Count Rate, Jobless Claims Change, Feb. Avg. Weekly Earnings, ILO Unemployment, Mar. Nationwide Consumer Confidence

Japan: Monday – Feb. Machine Orders Tuesday – Mar. prelim Machine Tool Orders Wednesday – Mar. Domestic CGPI Friday – Feb. final Industrial Production and Capacity Utilization

Canada: Tuesday – Feb. New Housing Price Index, Feb. International Merchandise Trade, Bank of Canada Announces Interest Rates Wednesday – BOC Monetary Policy Report Thursday – Feb. Manufacturing Sales

Australia & New Zealand: Tuesday – NZ Finance Minister English speaks, Mar. AU NAB Business Confidence and Conditions Wednesday – Mar. NZ Food Prices, Apr. AU Westpac Consumer Confidence, Apr. AU DEWR Skilled Vacancies Thursday – RBA Governor Stevens to speak, Mar. NZ Business NZ PMI

China: Sunday – Mar. Trade Balance Friday – Mar. Industrial Production, Retail Sales, CPI, PPI, Industrial Production, Fixed Assets Investment, 1Q GDP

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02/27/2011 - US Dollar weaker on diverging policy expectations while safe havens surge

US Dollar weaker on diverging policy expectations while safe havens surge

The past week saw a decline in the greenback as expectations that the Fed will lag other major central banks in lifting interest rates mounted and as commodities surged amid continued turmoil in the Middle East. Tensions in Libya drove commodities higher led by rising oil prices and saw significant flows into the CHF, JPY, and gold as investors sought safety. CHF reached a record high against the US dollar, USD/JPY approached long term lows, and gold neared record highs against the buck as risk aversion took hold. Higher commodity prices due to supply shocks have fed into higher headline inflation which has prompted central banks to step up the hawkish rhetoric. MPC minutes from the Bank of England showed Spencer Dale joining Andrew Sentance and Martin Weale in voting for a rate hike, while ECB council members Axel Weber and Yves Mersch this week noted the need for the bank to be alert and ready to raise rates as inflationary pressures persist. Keep in mind that these hawks are still in the minority as other policy makers view inflation as temporary, however second round effects are a concern and the ECB and BOE have indicated their alertness. On the other hand, the Fed continues its asset purchase program as planned and the second estimate of 4Q GDP disappointed expectations with lower consumption and government spending than previously thought. The divergence in policy expectations has resulted in a weaker USD.

The elevated oil prices have also benefitted the Canadian dollar. USD/CAD fell to multi-year lows as it traded at levels that have not been seen since early 2008. The Bank of Canada, European Central Bank and Reserve Bank of Australia will meet in the week ahead to announce interest rates although we do not expect any change in policy rates. With several central bank meetings scheduled next week, we will gain valuable insight into policy expectations. Additionally, geopolitical events and developments in the Middle East will remain a focus as this has directly impacted the price of oil and the safe havens.

Key technical levels are coming into focus with a significant pivot in the USD index just below 77.00 where the lows of February can be found. While this may support the pair in the near term, a break below suggests further downside potential for the buck. EUR/USD sees a key level to the topside at the February highs of around 1.3860. A sustained break above this level is needed to see the rally continue. In cable (GBP/USD), the key level is around the 1.63 area which is resistance dating back to November. We would note that the dollar has weakened to multi year lows and record lows against the CAD and CHF respectively and appears vulnerable as it is testing key levels against the other majors.

Pricing in that the Bank of England won’t bite the bullet

Earlier this month the market thought that the UK would be the first major central bank to raise interest rates to stem the economy’s sticky inflation problem. But as we get close to month-end investors are scaling back their expectations of rate hikes. The 3-month sterling swap price, which moves closely with interest rate expectations, fell 5 basis points last week, and the June short sterling futures contract is also higher (yields lower).  Interestingly, this has happened even though we found out that another member of the Bank of England Spencer Dale, the Bank’s chief economist, voted for a 25 basis point rate hike at the MPC meeting early in February.

Interest rate expectations have fallen just as investors’ focus has shifted. Earlier this month inflation pressures dominated the headlines, but now the pendulum has swung back to growth. And the news was not good. Q4 2010 GDP was revised lower to -0.6 per cent and a CBI retail trade survey fell to its lowest level for 8-months suggesting that the UK’s economic recovery is extremely fragile and certainly wouldn’t be able to withstand a global oil price shock if the Middle East tensions escalate in the near-future.

This is negative for sterling especially versus the euro. Above 0.8550 we expect the pair to move back towards the 0.8650 highs from January, before embarking on the 0.8900 peak reached back in October 2010.

Flip-flopping Trichet may flip back to hawkish camp

The market gets another briefing from ECB President Trichet on Thursday after the ECB’s monthly rate-setting meeting. We do not expect the Bank to raise interest rates; however, there is growing expectation that Trichet will regain his hawkish tone after sounding more dovish at the February press conference. Inflation pressures have arguably increased in the last few weeks: Germany, the currency bloc’s largest economy, reported that prices were growing at an annualized 2 per cent rate in February – the top of the ECB’s price range. Also, the sharp appreciation in the oil price and the continued risks of a supply shock due to political tension in the Middle East are likely to be cited as factors by Trichet that “warrant much attention, to ensure price expectations remain well anchored.”

Traditionally the ECB has been tough to stamp out price pressures, more so than the Federal Reserve and the Bank of England. Although the economies in Europe’s periphery are weak and heavily indebted, the ECB has to consider the threat of a German economy growing at a 4 per cent quarterly rate causing price pressures to become entrenched. Currently the market is not expecting the ECB to hike rates until the summer, but euro-swap rates are back at their 4-week highs, suggesting that momentum is gathering in financial markets for the ECB to normalize monetary policy.

The risk is, of course, that Trichet is less hawkish than the market expects. This could weigh on EURUSD, which is currently trading at 1.3750-1.3800.  If the market perceives that Trichet is trying to tone down market expectations of rate hikes, then we could see back to the 1.3450 level (50-day moving average) extremely quickly. This is because much of the recent strength in the single currency has come from higher Eurozone yields. This also supported the euro during the recent bout of risk aversion caused by the violence in Libya.

But we still continue to believe that the ECB won’t hike rates unless the EU authorities come up with a credible long-term solution to sort out the peripheral nations’ debt woes. A solution should include bond buy-backs to reduce long-term interest rates, less erroneous interest rates for the countries that have already requested bailouts, possible fiscal transfers between the strong and weak nations, structural economic reforms and plan for an orderly mechanism for default. If the authorities can agree on this then it becomes far easier for the ECB to hike rates. We will find out more in mid-March at the next EU Summit, when the currency bloc’s leaders will debate the issue.  German voters may be the spanner in the works, however. They remain opposed to any further help to indebted nations and they go to the polls at the end of March. If Germany is not on board with a long-term solution we think the chance of its success and effectiveness are slim.

If no plan is formed, then EURUSD could dip back to the January lows sub of 1.3000. But if a harmonious plan is hatched at the upcoming summit then EURUSD at 1.4000 looks possible in the coming weeks.

Aussie, Aussie, Aussie, Oi! Oi! Oi!

Over the last few months the AUD/USD had every excuse to sell-off and yet it remained firm. Analysts cited everything, flooding and cyclones in Australia, significant overvaluation according to PPP, China raising interest rates, a pullback in commodities, and of late tensions in the Middle East; and while slight pullbacks have occurred along the way, their declines have lessened with each passing week. Even in the face of recent risk aversion, the Aussie has been able to attract foreign inflows due to the higher commodity prices. Furthermore, even if precious metals prices falter in the short-term we still believe iron ore and base metal prices will remain at elevated levels as continuing demand from Asia will sustain the need for Australia’s resources.

Since the turn of the year, AUD/USD has been trading within a triangle pattern. Currently resistance resides just above current levels near 1.0160/70, while support can be found just below parity at 0.9980/90. Technically speaking, since the trend prior to this consolidation pattern was higher and a triangle pattern is considered a continuation pattern, then it is reasonable to expect a breakout to the upside over the coming days. More specifically, it appears we have just completed wave-d within the triangle pattern, consequently the finally pullback towards 1.0050/1.0100(wave-e) should be viewed as a buying opportunity before a breakout higher. Keep in mind a direct move higher is still plausible and would not invalidate the pattern or our view as we still anticipate higher prices in the week(s) ahead. Depending upon the actual point of breakout, the measured move objective on a move higher is approximately 1.05 to 1.06.

Next week sees a plethora of high impact data in the land down under which could potentially spark such a move. On March 1st there is the Feb. PMI-Manufacturing, RBA meeting, Jan. Retails Sales and 4Q Current Account Balance, the 2nd sees 4Q GDP and Jan. New Home Sales and the 3rd sees Feb. PMI-Services, Jan. Building Approvals and Jan. Trade Balance (dates are local to Australia).

Higher commodity prices here to stay?

Risk aversion reared its ugly head this week as jitters of spreading turmoil in the MENA (Middle East and Africa) region jolted market participants. Flows poured towards safe haven assets which saw precious metals and US treasuries surge higher – XAG/USD made record nominal highs around $34.33/oz. this week. Crude oil was the biggest beneficiary of MENA unrest with close to +10% (WTI) weekly gains on heightened fears of supply disruptions out of Libya.

While safe haven flows have been noted as the main source to the recent commodity boom, accommodative monetary policy has played a more significant role in the broader uptrend. Low global policy rates have significantly accelerated commodity price gains in the last decade relative to the slower pace of acceleration witnessed in the decade prior when global policy rates were broadly higher.

Recent developments have seen a number of central banks consider tightening sooner rather than later, mainly the ECB and BOE. However, the efficacy of renewed hiking cycles in controlling global commodity prices is debatable. Global growth outlooks have been improving but remain hampered by rising geopolitical and economic uncertainties. The extent of monetary policy tightening that both the UK and Euro-zone would be able to absorb considering their respective situations – negative GDP prints in the UK and EZ periphery issues – is likely on the lower end of the spectrum. Furthermore, target rates in the U.S. and Japan are likely to remain near zero for the entirety of 2011 and will likely see depressed policy rates for developed economies for the remainder of the year. We think this may continue to support commodities with the pace of price acceleration to depend on external risk events. Judging from what we’ve seen with Egypt and now Libya in just a matter of weeks, the possibility for a continuation in rapid commodity price gains cannot be dismissed.

Key data and events to watch next week

United States: Monday – Jan. personal income & spending, Jan. PCE deflator, Feb. Chicago PMI, Feb, NAPM-Milwaukee, Jan pending home sales, Feb. Dallas Fed manufacturing activity index, Fed’s Dudley to speak Tuesday – Jan. construction spending, Feb. ISM manufacturing and prices paid, Fed Chairman Bernanke to give semiannual testimony at Senate Wednesday – Feb. ADP employment change, Fed’s Beige Book, Fed’s Bernanke to give semiannual testimony at House Thursday – Weekly initial jobless claims and continuing claims, 4Q F nonfarm productivity and unti labor costs, Feb ISM services, Fed’s Bernanke and Kocherlakota speaks Friday – Feb employment report, Jan. factory orders, Fed’s Yellen speaks

Euro-zone: Monday – German Jan. import price index, EZ Jan. CPI Tuesday – German Feb. unemployment change and rate, German Feb. final manufacturing PMI, EZ Jan. unemployment rate Wednesday – EZ Jan PPI Thursday – Feb final German and EC services PMI, 4Q prelim EZ GDP report, EZ Jan. retail sales, ECB announces interest rates & press conference Friday – ECB’s Noyer, Weber, Draghi & Orphanides speak in Paris

United Kingdom: Tuesday – Feb. Nationwide House prices, Feb. manufacturing PMI, Jan. net consumer credit, mortgage approvals Wednesday – Feb. construction PMI Thursday – Feb. hometrack housing survey, services PMI

Japan: Monday – Jan prelim industrial production, retail trade, large retailers’ sales, Feb. small business confidence, Jan. vehicle production, housing starts, construction orders Tuesday – Jan jobless rate, household spending Thursday –4Q capital spending

Canada: Monday – 4Q current account, Dec. and 4Q GDP Tuesday – Bank of Canada rate announcement Wednesday – Jan. industrial product price and raw materials price index Friday – Ivey PMI

Australia & New Zealand: Monday – NZ trade balance data, AU 4Q inventories, AU Jan private sector credit, Feb. NBNZ activity outlook and business confidence Tuesday – NZ 4Q terms of trade, AU Feb. AiG performance of mfg index, AU 4Q current account balance, net exports, AU Jan. retail sales, NZ ANZ commodity price, RBA announces cash target rate, RBA commodity price index Wednesday – AU Jan HIA new home sales, AU 4Q GDP Thursday – AU Jan building approvals, trade balance, AU Feb. AiG performance of service index

China: Tuesday – Feb. manufacturing PMI Thursday – Feb. services PMI

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