By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It's going to be a very busy week in the foreign-exchange market and Monday's moves show us which currencies are the most vulnerable. GBP/USD and USD/JPY traded heavy throughout the NY session leading to a more than 1% slide in GBP/JPY. Ahead of this important week, GBP and USD traders made it clear that their inclination is to sell dollars and pounds barring any major surprises (like no hike from the Fed). The Federal Reserve’s monetary policy announcement is front and center but there are many other market-moving events on this week’s calendar and this list only scratches the surface.
7 Things to Watch this Week (In order of importance)
- Federal Reserve Rate Decision
- Bank of England Rate Decision
- US Retail Sales and
CPI - Bank of Japan Rate Decision
- Swiss National Bank Rate Decision
- Australian Employment
- New Zealand GDP
Although the U.S. dollar did not weaken against all of the major currencies on Monday, the slide in USD/JPY is a sign of how investors feel going into the monetary policy announcement. A rate hike has been fully priced in but the possibility of softer U.S. data before the announcement raises concerns about the central bank’s guidance. Investors are worried about downward drift in the dot-plot forecasts and a reduction in economic projections. The dot plot currently shows 2 more rate hikes this year (including one in June) and we don’t think this will change considering that a follow up move would not be until December. But that does not exempt the dollar from falling before and after the rate decision if the Fed disappoints in any way. There is a very good chance that USD/JPY will slip to 109.25 as this week’s inflation and consumer spending data confirm that prices are falling and consumption is easing. Commodity prices and core inflation measures have been headed in the wrong direction since the last quarterly meeting in March yet it is too early for the Fed to abandon its view that inflation is headed back to 2%. They can and will do so if prices don’t recover in the second half but they still have the luxury of time. The tone of Janet Yellen’s testimony will determine whether the dollar rebounds post FOMC. If she starts to sound less confident and less committed to tightening, we’ll see the USD/JPY on the 108 handle. However if she focuses on the drop in the unemployment rate, continued hiring and reiterates the view that inflation will return to target, it will be positive for the dollar. Either way, we expect to see more USD/JPY weakness over the next 24 hours.
Meanwhile, investors continued to sell sterling, taking the currency within pips of its pre-election low. Theresa May spent most of the weekend and Monday apologizing to her party members, especially those who have lost their seats. She said “I got us into this mess and I’m going to get us out,” but no amount of damage control at this point could change the current situation. She’s still at risk of losing her job and as she said today, “I’ll serve you as long as you want me,” which may not be very long. The Queen’s decision to delay her speech to Parliament suggests that she believes there could be more leadership changes. All of this ongoing uncertainty is weighing heavily on the currency and will most likely overshadow this week’s economic reports and the Bank of England rate decision. Inflation data is scheduled for release on Tuesday and with commodity prices falling, slower price growth is expected all around. If political troubles are combined with softer data, GBP/USD could sink below 1.26.
Monday's best-performing currency was the Canadian dollar, which saw a strong, late-day rally on the back of comments from Bank of Canada Senior Deputy Governor Carolyn Wilkins. A favorite to become the next head of the central bank, Wilkins said the central bank will assess whether less stimulus is needed. This is the first time that the Bank of Canada has hinted at a rate hike in 7 years. Wilkins is particularly encouraged by recent economic performance and she noted that diverse growth makes the recovery strong and sustainable. USD/CAD ended the day down over 1% on the back of her comments because given the recent trend of mixed CAD data and the U.S.’ view on NAFTA, investors did not expect the BoC to shift away from their easing bias so quickly. Although further losses are likely now that USD/CAD has broken below 1.34, the sell-off stopped right at the 200-day SMA, the perfect place for a shallow relief rally. The Australian dollar also ticked higher on U.S. dollar weakness but a surprising decline in card spending prevented the New Zealand dollar from participating in the rally. There are no economic reports scheduled for release Tuesday from Canada or New Zealand, but Australia’s business confidence report was due Monday evening.
While the euro ended the day off its highs, it still saw gains against the dollar for the first time in 4 trading days. The only thing holding the currency back was the yield spread, which moved slightly lower. Despite the slide in the greenback, U.S. 10-year yields ended the day higher while German bund yields of the same maturity declined. We think the euro will outperform at the start of the week as the weakness in other countries make the improvements in the Eurozone economy more attractive to foreign investors. The German ZEW survey is scheduled for release on Tuesday and while investor sentiment is difficult to handicap, they should share the ECB’s optimism. Let's not forget that last week the ECB upgraded their GDP forecasts, altered their risk assessment and dropped the word “lower rates” from their forward guidance.