03/06/2011 - The Dollar sags as key EU decisions loom

The Dollar sags as key EU decisions loom

The greenback slumped further as violence in Libya escalated and fears continue to mount of unrest spreading to other, more economically significant countries in the region. Despite the largest gain in jobs since census-induced hiring in mid-2010, and other signs of improvement in US labor markets e.g. further declines in initial claims, the buck limped out at its lowest level for the year according to the USD Index. But the USD’s performance was mixed against most currencies other than the EUR, which rallied across the board on ECB rate hike expectations (see below). All in all, it could have been much worse for the USD and this suggests a safe-haven bid may be returning to the greenback. US stocks declined and Treasury yields fell on safe-haven buying of US Treasuries in spite of the ostensibly upbeat Feb. jobs report. Precious metals and commodities also continued to gain ground on the Mid-East upheaval. The focus there is firmly on efforts to oust Libyan leader Gaddafi and we would suggest it is a question of when, not if, he disappears into exile, potentially setting up a rapid reversal in safe haven assets. In the meantime, civil conflict in Libya is likely to drag on and the dollar’s descent seems likely to continue, though probably less of a rapid collapse and more of a slow grind.

Over the next several weeks, EU leaders will be meeting to tackle their debt/financial crisis, culminating in the March 25 summit that aims to produce the comprehensive crisis resolution mechanism. The end of next week will see the ‘European Competitiveness Pact’ unveiled, which aims to strengthen economic and fiscal coordination among member states. Indications are that deep divisions remain on many of the key issues, such as establishing concrete debt reduction goals, increasing the size of the bailout fund, and whether to allow it to buy peripheral government debt. The risk to recent EUR gains is that EU leaders fail to produce a credible mechanism and markets conclude sovereign defaults remain a serious threat, which may see EUR come under pressure despite rate hike expectations. Lastly, we would note the relatively minimal gains in EUR/USD since the relatively surprising ECB announcement (only about 120 pips), which we interpret as a sign most of the move was already priced in.

We see immediate upside potential for EUR/USD while the 1.3800/50 area holds. Initial resistance is at 1.4020/50, above which gains to the 1.4180/1.4200 are our expectation. Overall, a Fibonacci wave extension suggests 1.4420/25 as a potential target for the current advance, once above 1.4050.

The ECB takes its anti-inflation medicine

ECB Governor Trichet surprised the markets last week with an explicitness he has saved until the last 6 months of his term in office. He reverted to the verbal code words he used during the Bank’s previous tightening cycle when he said that “strong vigilance” is warranted with a view to continuing upside risks to price stability. In the past this signaled that a rate hike was imminent. Now the market expects Trichet to announce a rate hike at April’s meeting. But it wasn’t this stock phrase that surprised market watchers, it was Trichet’s candidness.

Although he said the ECB never pre-commits to a rate decision he added that he expects rates to rise by 25 basis points and that a rate hike next month would not signal the start of a tightening cycle. This was central bank communication at its most clear.

Immediately investors scrambled to re-adjust interest rates armed with this new information. 3-month euro Eonia swap rates surged 10 basis points to their highest level in 2 years, while Euribor – the inter-bank lending rate – also surged on the news. The extra yield boosted EURUSD, and it is now on the brink of 1.4000.

Up until last week the markets had been expecting the Bank of England to hike first. After the ECB press conference the yield differential between German and UK yields widened considerably which boosted EURGBP to 0.8600. 

So why did the ECB bite the bullet? The most likely reason is that rapidly rising oil prices don’t warrant extraordinarily accommodative interest rates. Indeed, Trichet omitted to mention that the interest rate was appropriate; instead he said the current stance of monetary policy was “very accommodative.”

But will one hike be enough? We would say probably not. Inflation in the Eurozone is running at a 2.3 per cent annualized rate. Even with a 25 bp increase real interest rates will still be negative, so the ECB aren’t going to stamp out inflationary pressure with a small, one-off rate hike. So if the Bank is serious about inflation a series of hikes seems more likely. The market has rushed to price in a more than 50 per cent chance that rates will rise to 2 per cent (they are currently 1 per cent) in 12-months’ time. 

The ECB and the Federal Reserve are now at either end of the policy spectrum, with the latter seemingly committed to providing the full $600bn allotment of QE2 to the US economy until June. The diverging paths of the two largest global central banks should benefit EURUSD. So far it has failed to break above 1.40, but in the coming weeks, based in its yield advantage, we see EURUSD back at the 1.4250 highs last reached in November 2010.

Commodities continue to stay aloft amid tensions in MENA

This week crude oil prices rose to fresh 29-month highs ($104.30/35) amid the rapid deterioration of stability in Libya and the threat of it spreading to other MENA (Middle East/North African) nations. The persistent violence has caused supply disruptions in Libya of approximately 1 million barrels a day, which is over half of their daily output. While news that Saudi Arabia guaranteed to use spare oil capacity if needed – Saudi’s spare oil capacity is estimated to be 5 million barrels a day, temporarily calmed the markets, it’s not an exact match since Arabian oil is much heavier than Libya’s light sweet crude and is thus problematic since it needs additional refining. With the current geopolitical environment riding high emotionally, fundamentals are likely to remain in the rear-view mirror. Furthermore, even prior to the political unrest in the Middle East we saw signs of demand growth picking up in China and India, and with today’s U.S. unemployment rate falling to 8.9% it signals demand in the west may begin to pick up as well. Lastly, market participants are beginning to envision a weaker USD moving forward, based on diverging interest rate expectations between the Fed and the ECB and BoE, which has caused greater demand for commodities and ultimately adds more “fuel to the fire”.

The “flight-to-safety” trade has not just been all about oil, but was also present in precious metals as well. As noted in this week’s Commodities Corner, “with tensions in the Middle East unlikely to subside anytime soon, this flight-to-safety trade could be stronger and last longer than the market currently anticipates, subsequently traders are beginning to take action.” Over the past week gold broke to new nominal all-time highs near $1440/oz. and silver just made fresh 30-year highs of $35.35/40 at the time of this writing. Going forward, price action should remain volatile, however pullbacks could be shallower than one would anticipate as investors who have missed the current move higher in commodities may look to jump on board in the not too distant future. A resolution to the Libyan turmoil, on the other hand, could see a more serious set-back.

The BOE gets pipped at the post

After the events in the Eurozone, it now seems unlikely that the Bank of England will be the first of the major central banks to hike interest rates. The Bank meets next week to decide on policy, but it is expected to remain on hold. In fact, since the last meeting the market has slightly reduced its bets that rates will rise in the UK over the next few months as economic data has disappointed especiallyQ4 2010 GDP and the PMI services sector survey for last month. Sonia rates – GBP swap rates - have fallen from their peak and 3-month UK Libor (inter-bank lending rates) remains within its near-term range.

This has thwarted the rise in sterling and for now the top in GBPUSD is 1.6300.

EURGBP looks ripe to outperform in the near-term. After 0.8600, the 0.8900 high reached in October comes back on the radar.

Kiwi under pressure ahead of RBNZ

On Thursday March 10, the Reserve Bank of New Zealand meets to decide on interest rates. The outlook for the island nation has been very bleak after the tragic 6.3 magnitude earthquake which struck Christchurch on Feb. 22. This was the second major earthquake in 6 months, the previous quake occurring on Sept. 4. Both quakes are estimated to have cause as much as NZ$20 billion in damage and have delivered a blow to growth prospects with the risk of a relapse into recession as indicated by Q3 GDP which contracted by -0.2%. 

The 90-day bank bill rate has plummeted from about 3.20% on Feb. 21 to current levels of around 2.86%. Additionally, Prime Minister John Key said he would “welcome” an interest rate cut. He went on to say “the market has priced in a cut from the Reserve Bank. That would probably be my expectation, that the Reserve Bank would cut, but it’s for them to determine that”. While some market participants are anticipating a rate cut, the distribution of expectations is relatively balanced with about half of analysts forecasting no change in rates. Of those expecting the bank to slash rates, about half are looking for a 50bps cut while the other half is anticipating a 25bps decrease. With recent weakness in the NZD, it appears that a cut may be priced in which indicates that the risk is to the upside.

Technically, NZD/USD is facing a significant pivot around its 200-day sma which currently comes in at about 0.7380 and the Dec. lows which are around the 0.7345/50 area. The pair is trading below the daily ichimoku cloud which suggests a downward bias. A daily close below the 200-day sma and Dec. lows is likely to see further downside. Key levels to the upside include the daily Tenkan line which is around 0.7480 ahead of the daily cloud base and Kijun line which are around 0.7580/90 – just below the 0.7600 area where the 55 and 100-day sma’s converge.

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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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02/20/2011 - US Dollar rally fizzles; ranges hold for now, but a break may be building

US Dollar rally fizzles; ranges hold for now, but a break may be building

The past week began with the greenback testing higher, only to fail and reverse course by the end of the week. The proximate cause for the reversal came following news that a pair of Iranian warships would transit the Suez Canal en route to Syria, a move which Israel labeled a ‘provocation,’ suggesting it might respond in some fashion. Geopolitical tensions ratcheted higher, and the JPY, CHF, gold and oil all registered sharp gains as investors sought havens. The USD failed to attract any safe have demand, presumably on fears that any confrontation between Israel and Iran would then draw the US into the conflict. However, we think those concerns are overblown and will eventually recede. Still, the USD reversal has done some technical damage, and with a potential US government shutdown looming when the temporary budget expires on March 3, there are plenty of reasons to shun the USD.

Another way of looking at it, and one that ignores the geo-political themes we find suspect, is that the USD simply tested key technical resistance levels at recent range highs and failed. In EUR/USD, the key 1.3450/3500 support zone we highlighted last week was tested, but ultimately held on a daily closing basis. Reports of reserve managers buying in that area also surfaced. In USD/JPY, the 84.00/50 recent high was also approached and has capped gains for the time being. Similarly, GBP/USD, USD/CHF, AUD/USD all tested range boundaries and have all reverted back into the ranges.

On the USD index, though, we see signs of a potentially more ominous USD development. The US dollar index closed last week inside the Ichimoku cloud, but ultimately was rejected from the Kijun line and has fallen back out of the cloud to finish this past week. Also, since the beginning of February, the US dollar index formed a likely bear flag consolidation. Dollar weakness at the end of this past week broke below the base of the flag, suggesting a new leg lower in the buck may be unfolding. A daily close below 77.50 Feb. 9 lows would suggest further weakness. A similar pattern appears in EUR/USD, with the flag top at about 1.3720/25, just below recent 1.3745/50 highs. A break above that 1.3725/50 level would signal to us a potentially much larger USD decline and EUR/USD gains well beyond the 1.3860/70 highs for the year. There are certainly enough Eurozone issues to restrain further gains in the single currency, but we would conclude they are being ignored or papered over on a daily close above 1.3750. Finally, we would highlight the US holiday on Monday (President’s Day) and the tendency for breakouts to occur around US-only holidays.

Mixed messages from the Bank of England

Last week's Inflation Report was expected to give the markets a steer on how close the Bank of England is to raising interest rates. However, although inflation expectations for the next two years were revised up, the Bank revised down its growth profile. This reinforces the difficult path for monetary policy over the coming months: inflation could rise to 5 per cent this year, while the most likely outcome for growth is a fairly tepid 1.5-2 per cent, and the Bank hasn't ruled out a return to recession. Bank governor Mervyn King dampened expectations for a rate hike when he said that some people were running ahead of themselves and the Bank wasn't "pre-announcing or laying the ground for a rate rise." This caused a sell-off in sterling and UK Gilts. However, once the dust had settled, sterling closed around the 1.6050 mark versus the dollar and gilt yields had only come off moderately by the end of Wednesday.

While King, who has voted to keep rates on hold, sounded dovish when he presented the Inflation Report, it is worth remembering that he is only one member and if the majority of the MPC want to hike then rates will rise. King did highlight the wide range of views on the Committee and this was in force the day after the Inflation Report when arch-hawk Andrew Sentance said that rates need to rise to stop inflation from taking hold. This sent GBPUSD soaring 100 points. But it is worth remembering that Sentance will be leaving the MPC in May. We don't know who his replacement will be yet, but if they don't share his views then the Bank will lose its most hawkish element. We will get an update on the range of views at the MPC in the minutes from the February meeting on Wednesday.

As we close the week the market is still looking for more than 50 basis points of rate hikes by the Bank by year-end. So, although the prospect of a rate hike in the next couple of months is looking less likely post the Report, the rate curve (based on short-sterling interest rate futures) is still steep for the second half of the year. Above 1.6000 the pound is still in a technical uptrend, but the outlook for sterling is extremely volatile. Austerity cuts don't start with gusto until April this year, so we won't know until late summer what the initial impact on growth will be. But, worryingly, there are signs that the labor market is already deteriorating and the number of people claiming jobless benefit rose unexpectedly in January. This highlights the deeply uncertain outlook for UK growth as the UK embarks on a massive fiscal retrenchment, and in the coming months there is a risk that the market will reassess its expectations of any rate hikes at all for this year.

Emerging market outflows here to stay?

Capital outflows from emerging market to developed economies continued this week driven by inflationary concerns, fears of growth impacts from EM policy tightening, and improving growth outlooks in developed economies. However, of more significance than the why is the when - are these flow shifts the underpinnings of a larger scale rotation or merely a temporary correction? Improving activity in the U.S. (Feb. Philli Fed registered 35.9 vs. expected 21.0) and Euro-zone ( Jan. F PMI Manufacturing printed 57.3 vs. expected 56.9) seem to support the prior but uncertainty concerning the U.S. labor market outlook (Initial Jobless Claims 2.12 was 410k vs. expected 400k) and Euro-zone periphery are supportive of the latter. Further supporting the latter has been the commodity market reaction to EM outflows. Commodities have traded broadly higher - silver hit record nominal highs around 32.88 on Friday - which contrasts from the expected reaction for lower commodities as result of weakening EM demand. We think that the recent correction in EM-DM flows is just that – a correction and that resilient growth despite capital controls may see EM equities and inflows return to trend. Ultimately, this would be a positive for commodities and related currencies (AUD, CAD, and NZD).

Scandies surge, Norges Bank indicates higher rates

The Scandinavian currencies have been exceptional performers of late with the Swedish krona as the top performer of the G10 currencies. It has experienced a year-to-date gain of 4.24% against the U.S. dollar. The Norwegian krone, or “Nocky” as it is sometimes referred to, has also seen strong gains reaching highs against the greenback which have not been seen since January of 2010. This is largely due to higher rate expectations and relatively strong GDP growth. Additionally, Norway boasts Europe’s lowest unemployment.

The Norges Bank was the first in Europe to raise rates following the financial crisis and noted that it will increase rates again in mid-2011. Rates have been on hold at 2% since May as inflation has stayed below the 2.5% target. The pause in rates has also been attributed European austerity concerns and the potential negative impact on Norway’s exports. Exports fell 1.3% last year while the krone gained.

Newly appointed Governor Oeystein Olsen, who took office last month after the departure of Svein Gjedrem, delivered his first annual address yesterday and said that “we don’t want to take responsibility for the currency level nor the overall competitiveness of the manufacturing industry”. He went on to say, “at Norges Bank we have no specific view on any equilibrium target or views on a specific level for the exchange rate.” The central bank provided guidance through the end of 2014 and expects its benchmark rate to average 2.25% this year and 3.25% next year. This indicates an expected 25bps hike each quarter from June 2011 until the end of 2014. The policy board will meet on March 16 to discuss interest rates publish its monetary policy report which will contain an updated interest rate path.

Technically, USD/NOK has broken below key support just below the 5.7000 level and sees the 2010 lows of around 5.56000 ahead of the 2009 lows of about 5.5100 as the next significant levels of support. Key resistance may be found around 5.7800 where the daily Tenkan and Kijun lines converge. The 21-week sma, currently around 5.8730, looks to have capped the upside over the past several weeks.

Key data and events to watch next week

United States:

Tuesday – Dec. S&P/CaseShiller Home Price Index, Feb. Consumer Confidence, Feb. Richmond Fed Manufacturing Index, Fed's Kocherlakota Speaks

Wednesday – Jan. Existing Home Sales, Fed's Hoenig & Plosser Speak

Thursday – Fed's Bullard Speaks, Jan. Chicago Fed Nat Activity Index, Weekly Initial Jobless & Continuing Claims, Jan. Durable Goods Orders, Jan. New Home Sales, Weekly DOE U.S. Crude Oil Inventories

Friday – 4Q second GDP & PCE, Feb. Univ. of Michigan Confidence, Fed's Yellen Speaks

Euro-zone:

Monday –EZ Feb. preliminary PMI Composite, Manufacturing & Services

Tuesday – German Mar. Consumer Confidence

Wednesday – French Jan. CPI, EZ Dec. Industrial New Orders, German Committee Discusses Euro Crisis, ECB's Trichet & Quaden Speak

Thursday – German final 4Q GDP, EZ Feb. Confidence Indicators, German Finance Minister Schaeuble Speaks

Friday – German Feb. preliminary CPI, ECB's Constancio Speaks

United Kingdom:

Monday – Feb. Rightmove House Prices

Tuesday – Jan. Public Finances

Wednesday – BoE Feb. Meeting Minutes, Jan. BBA Loans for House Purchase

Thursday – Feb. CBI Reported Sales

Friday – Feb. GfK Consumer Confidence, 4Q GDP, BOE's Bean Speaks

Japan:

Monday – Monthly Economic Report, Dec. All Industry Activity Index

Wednesday – Jan. Corporate Service Price Index, Jan. Merchandise Trade Balance, Feb. Small Business Confidence

Friday – Feb. Tokyo CPI, Jan. National CPI

Canada:

Tuesday – Dec. Retail Sales

Australia & New Zealand:

Monday – NZ Jan. Performance Services Index, NZ Jan. Credit Card Spending

Tuesday – NZ Q1 RBNZ 2yr Inflation Expectation,

Wednesday – RBA's Stevens Speaks, NZ Finance Minister English Speaks, AU 4Q Construction Work Done & Wage Cost Index

Thursday – AU Dec. Conference Board Leading Index, AU 4Q Private Capital Expenditure, AU Nov. Average Weekly Wages

China:

Friday – Feb. MNI Business Condition Survey

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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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04/24/2011 - US Dollar on the ropes ahead of FOMC

US Dollar on the ropes ahead of FOMC

The dollar ended the week on the ropes after reaching new record lows against the Australian dollar, Swiss franc, and gold while historic lows were on the radar for several other currencies. The combination of easy monetary policy by the Fed and uncertainty with regards to the U.S. fiscal situation weighed on the outlook for the greenback while a positive start to earnings season saw equities surge resulting in heightened risk appetite. The euro continued to climb higher despite ongoing sovereign concerns and talk of potential Greek debt restructuring. 10-year yields in the periphery relative to their German equivalents widened to records levels but that didn’t stop EUR/USD from reaching new 16-month highs of nearly 1.4650. Economic data released earlier in the week suggested continued strength in the core keeping the euro supported ahead of next week’s CPI figures which will be a key driver of interest rate expectations and the common currency.

The week ahead contains key events with regards to the U.S. dollar with the FOMC rate decision at the conclusion of its 2-day meeting on Wednesday. It will also mark a new era of direct communication between the markets and the Fed as the Fed introduces regular press conferences. The Fed’s statement will now be released at 1230ET and briefings will be held at 1415ET. The briefings are scheduled to be held four times a year and are designed to “further enhance the clarity and timeliness of the Federal Reserve’s monetary policy communication”. We anticipate the Fed to maintain its commitment to follow through with the full amount of the asset purchase program through June and will be looking for comments that provide any guidance on post-QE2 policy. The advance Q1 GDP estimate is also scheduled for release next week and will be a key driver in the buck.

Euro – Up, up and away?

In a week which began with rumors of a Greek default one would easily presume to see euro weakness, however this was easily trumped by news from S&P who announced that they placed the US sovereign debt rating on negative outlook. After a few brief hours of deliberation, the market decided to dump their USD’s as quickly as possible. Ultimately, this sent the EUR/USD to levels not seen since late 2009, leading many to wonder just how high this seemingly ‘one-way’ trade will go…1.50, 1.60? While it’s true that most of the pair’s recent rise can attributed to U.S. dollar weakness rather than euro strength, we believe an imminent reversal of the USD’s fortunes is unlikely to change in the immediate future. Moreover, the euro rose against nearly all G10 currencies this past week, with exception to the Swedish Krona, whose central bank raised interest rates by 25bps to 1.75%.

Next week sees a several key data events in the EU, highlighted by Eurozone CPI, Consumer Confidence and Unemployment. With the ECB watching inflation like a hawk, all eyes will be on Friday’s April CPI number. Currently, the market is expecting headline inflation to remain steady at 2.7%. Should it surprise to the upside once again, it could prompt the ECB to act sooner rather than later, but even a number in-line with expectations is unlikely quell the ECB’s fears of ‘second round’ effects. With the Fed and ECB seemingly on divergent paths and the euro’s recent ability to shrug off peripheral turmoil, we believe the single currency is likely to remain well supported in the near-term. Therefore, we believe buying a dip towards 1.4450-75, in search of a break back above the recent highs near 1.4650 and looking for a further continuation higher, could be an idea worth considering in the week ahead.

A weak USD week boosting commodities…

The greenback was slammed this week as a U.S. credit outlook downgrade, thin liquidity from the Easter weekend, and the upcoming FOMC rate decision kept USD longs on the sidelines. Loose Fed monetary policy continues to dominate USD direction and until expectations for Fed tightening ramp up, the buck is likely to remain under pressure. The weak USD week, however, underpinned the rally in commodities – XAG/USD reached multi-decade highs above $47, XAU/USD now trades above the $1500 mark, and oil prices resumed their uptrends to above $112 (WTI)& $124 (BCO), respectively. To be fair, USD weakness was not the only contributor to commodity strength as resurfacing Eurozone peripheral debt concerns have instilled doubt in regards to the single currency’s long term stability sending additional flows towards tangible assets. Considering all the external risk events surrounding the current market environment (uncertainty in Japan, MENA region unrest, & EZ periphery concerns) alongside declining confidence in fiat currencies, the path of least resistance for commodities seems higher.

Silver has consistently outperformed gold over the past year as evidenced by the parabolic 50% decline in the gold/silver ratio to current levels near 30. There are a number of factors underpinning silver’s near vertical upside trajectory. Firstly, much of silver demand derives from industrial applications. The prospects for massive 2H2011 reconstruction efforts out of Australia, New Zealand, and Japan are likely to keep industrial silver demand well supported throughout the year. Additionally, the simple fact that silver is a tangible asset – something that will not be lost in an accounting scandal or Ponzi scheme – has given market participants confidence of its role as a credible hedge in escalating ‘risk off’ environments. It does seem a bit contradictory for XAG/USD to be tagged as both a ‘risk on’ and ‘risk off’ play but its greater than +30% rise over the past 30 days provides substantial evidence of its appeal regardless of market sentiment. Accordingly, we think silver prices will continue to trend higher, although at a slower pace, underpinned by firm demand and its growing appeal as a safe haven security.

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Key data and events to watch in the week ahead

United States: Monday - Mar. New Home Sales, Apr. Dallas Fed Manf. Activity Tuesday - Feb. S&P/CaseShiller Home Price Index, Apr. Consumer Confidence, Apr. Richmond Fed Manufact. Index Wednesday - Mar. Durable Goods Orders, weekly DOE U.S. Crude Oil Inventories, FOMC Rate Decision, Bernanke Speaks at Fed Press Conference Thursday - Mar. Chicago Fed Nat Activity Index, 1Q advance GDP report, weekly Initial Jobless Claims, Fed's Duke, Mar. Pending Home Sales Friday – 1Q Employment Cost Index, Mar. PCE Core, Personal Spending, PCE Deflator, Personal Income, Apr. Chicago Purchasing Manager, Apr. U. of Michigan Confidence, Bernanke Speaks

Eurozone: Wednesday - ECB's Orphanides speaks, Feb. Industrial New Orders, German May GfK Consumer Confidence Survey, German Apr. prelim Consumer Price Index Thursday – German Mar. Import Price Index, German Apr. Unemployment Figures Friday – Mar. Euro-Zone M3, Apr. Euro-Zone CPI Estimate, Business Climate Indicator, Euro-Zone Consumer Confidence, Economic Confidence, Indust. Confidence, Mar. Euro-Zone Unemployment Rate, German Mar. Retail Sales

United Kingdom: Tuesday - Apr. CBI Trends Total Orders & Business Optimism, Bank of England's Andrew Sentance Speaks Wednesday – 1Q advance GDP, Feb. Index of Services, Mar. BBA Loans for House Purchase, Apr. GfK Consumer Confidence Survey

Japan: Tuesday – Mar. Retail Trade, Large Retailers’ Sales, Apr. Small Business Confidence Wednesday – Mar. Jobless Rate, Apr. Tokyo CPI, Mar. National CPI, Mar. prelim Industrial Production Thursday – Mar. Vehicle Production, Housing Starts, Construction Orders

Canada: Canada: Wednesday - Teranet/National Bank HPI Friday – Feb. GDP

Australia & New Zealand: Tuesday – AU 1Q Consumer Prices, RBA Trimmed, RBA Weighted Median, NZ Apr. NBNZ Business Confidence, Activity Outlook Wednesday – AU Mar. Private Sector Credit, RBNZ Official Cash Rate Thursday – NZ Mar. Trade Balance, Exports, Imports

China: Wednesday – Mar. Industrial Profits Friday - Apr. MNI Business Condition Survey

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