Category: US Markets

Over the last few months, the foreign exchange market has been more sensitive to Central bank policy measures than at any other time in decades. However, the problem for the Central banks is that the FX market has largely not responded in the direction that they have intended. This is best illustrated by this year’s monetary transmission efforts by the Bank of Japan (BoJ).

The BoJ has, from a percentage of GDP basis, easily been the most aggressive of the all the G-7 central banks with the BoJ’s balance sheet reaching JPY 450 trillion early last month. Despite this aggressive easing, the BoJ has not come close to its three main policy goals of increasing consumer demand, kick-starting GDP growth and pushing domestic inflation back above 2%.

This impossible trinity of inflation, consumption and GDP growth took another hit today when the BoJ failed to satisfy the market with its most recent addition to the long running QQE policy. The Bank of Japan expanded its purchases of exchange-traded funds and doubled the size of a U.S. dollar lending program, while refraining from boosting the pace of government-bond purchases that have formed the main part of its monetary stimulus.

The central bank kept its annual target for expanding the monetary base at 80 trillion yen ($779 billion), done mainly through an equivalent increase in government bond holdings. It also left untouched the minus 0.1 % rate for a portion of commercial banks’ reserves. A dollar-lending program was expanded to $24 billion.

The last week of July has a full schedule of first tier data releases and market events. These include the FOMC and BoJ meetings, the German IFO survey, Australian inflation data and GDP reports from both the USA and UK. In general, we believe the BoJ meeting will have more market impact than the FOMC meeting, the US GDP data could surprise to the upside and a weaker Aussie inflation report may not convince the RBA that an August rate cut is the appropriate course of action. 

However, we believe one of the most important data points for the week will be when the European Banking Authority stress tests are released after the NY close on Friday.

The financial markets have recently focused on Italian banks and their swelling non-performing loan book but there is an acute risk that other Euro-Zone banks, including large German, Austrian and French banks, will need to raise capital as well. It’s worth noting that the MSCI European Bank Index lost almost 25% of it’s value after the UK referendum, including a 28% drop in the shares of Deutsche Bank.

From a FX point of view, the main significance is that the correlation between the MSCI EZ Bank Index and the EURO currency has grown. Market statistics show that the running 60-day correlation between the value of EUR and the Index now stands at a positive 50%. This is the strongest reading on the 60-day correlation since Q1 2014 and adds to the growing negative fundamentals for the single currency.

At the beginning of the week, we expected yesterday’s ECB meeting to be a significant risk event for the single currency and offer trading opportunities on new policy measures or adjustments to current stimulus operations. But Mr Draghi said nothing that surprised the FX market. 

He acknowledged the resilience of the financial markets in the aftermath of the UK referendum and noted that upcoming data, combined with new staff forecasts in September, would give the ECB a better view to assess the macroeconomic situation in the Eurozone. He also pointed out that the risks to growth and inflation remain tilted to the downside going forward.

As a result, the EUR/USD traded in a narrow, 70 point range throughout the LDN and NY trading sessions; one of the most passive ECB meetings in recent memory.

However, about two hours before the ECB announcement, comments from Bank of Japan (BoJ) Governor Kuroda that the upcoming stimulus package would not include “Helicopter” money hit the BBC newswire. This headline sent the USD/JPY plunging over 160 points to just under 105.50. Once the BBC clarified that these comments were from a June interview, the pair regained the 106.00 handle but came nowhere near the intra-day high of 107.40 and casts doubts on the FX impact of final BoJ package to be released next week.

These two examples illustrate the non-linear impact Central Banks currently have on increasingly skittish financial markets. On one hand there was a highly anticipated ECB announcement, with a live press conference, which produced little in terms of EUR/USD price action, and on the other hand, there was the release of month old radio interview which spun the USD/JPY into three hour trading frenzy.

Because of the non-traditional stimulus measures used by G-7 Central Banks, and the resultant negative interest rate environment, we have reached the point at which investors are buying stocks to capture yield, buying bonds for relative capital gains and trading currencies as a correlative by-product of the previous two.

With this in mind, officials at the Federal Reserve are, once again, talking about a rate rise before the end of the year. This, along with weak economies elsewhere in the developed world has resulted in the value of the USD increasing over last three months. As such, we maintain a long USD bias even though the trajectory higher may have a higher level of volatility due to equity related risk on/off correlations.

US Macro

Watching the close of the financial markets early Saturday morning (Sydney time), we were thinking that this FX UPDATE would be discussing a change in leadership in Turkey and how that would impact the rest of the Eurozone economics…….tanks in Istanbul, helicopters strafing government buildings; it all sounded pretty grim for Mr Ergodan’s government.   

As it turned out, the coup failed and order has been restored in Turkey, for now.

However, there are several other data points in the Eurozone this week which will drive trade flow in the Euro and other G-7 currency pairs. The three events that FX traders will be following are; the German ZEW data on Tuesday, the German PPI report on Wednesday and the ECB meeting and rate decision on Thursday.

The preliminary forecast for the ZEW is for a sharp fall in business sentiment from 19 to 8. This is one of the first post-Brexit readings and would represent the weakest number of the year. Wednesday’s German PPI data is expected to fall from .4% to .2%. With this series, it’s not so much the actually number but the direction of the trend. German inflation was in negative territory earlier this year and turn back to a negative trajectory is worrisome for the ECB.

US Macro

In the days following the June 23rd UK referendum, many FX market forecasters suggested the Sterling would fall sharply, perhaps even breaking below the 1.2000 handle against the USD. While these predictions may turn out to be correct, the GBP/USD has pretty much gone vertical since posting a 1.2850 low on Monday.  

And even though the consensus for the Bank of England (BoE) to cut rates yesterday was just slightly above 50/50, the GBP/USD traded sharply higher after the after the BoE voted 9 to 0 to leave rates unchanged. However, with most policymakers seeing a rate cut in August, the Sterling remains a sell into this recent reversion.

The Sterling’s reaction to yesterday’s BoE pause at .50% was an illustration of misplaced Central Bank expectations. The financial media was calling for a cut down to .25%, many FX traders believed them and when the BoE kept rates unchanged, the GBP/USD soared from 1.3250 to 1.3475 in less than five minutes……and then faded as the session progressed.

According to the minutes from the meeting, the BoE has been satisfied with how UK financial markets have functioned  post-referendum but there are some indications that businesses are delaying investment and hiring so economic aggregates are likely to be depressed in the near term. It’s worth noting that in addition to cutting rates, the BoE minutes discussed  a “range of possible stimulus measures.” We interpret this to mean a possible increase to Quantitative Easing in August.

US Macro

It’s often said that the time to worry about the US Dollar is when everyone is optimistic. With the FED seemingly on hold until 2017 and rumors of an impending US recession capping the Greenback over the last quarter, committed USD bulls have been few in numbers.

However, from both a technical and fundamental perspective, the USD had a very good week last week. The economic data points were helpful with Service Sector ISM printing its highest number of the year; including forward looking gains in export orders. The Headline Non-Farm Payroll (NFP) numbers snapped back by 287,000 new jobs, which was the strongest employment gain in eight months.

Looking ahead, we expect the US inflation data later in the week to reflect the firmer tone of the growth aggregates as the Atlanta FED GDP tracker is now showing the Q2 rebound could reach 3%. This is at a time when EU data is well and truly rolling over, the fallout from the UK “Brexit” vote is still be calibrated and Japanese officials are scrambling for solutions for rising deflation and falling economic growth.

US Macro

Due to the July 4th holiday last week, the June US Non-farm Payroll Data (NFP) will be released at 8:30 NY Time today. For FX investors, the delay was probably a good thing since the market has now had another five trading sessions to rebuild its technical indicators which were stretched to extremes during the fallout of the June 23rd UK “Brexit” vote.

However, looking back to last month’s surprisingly weak 38,000 new jobs posted on the May headline report, A solid rebound in June, combined with a positive revision, could push the major FX pairs back into the “Brexit” price ranges……..with the exception of USD/JPY.

Most economists and forecasters expect a strong recovery in in the overall NFP report with headline growth estimated between 160k and 180K. These estimates are supported by a sharp rise in the employment component of the ISM Non-Manufacturing Index (from 49.7 to 52.7) and weekly jobless claims at a four-month low. And while last month’s ADP private employment report didn’t give any indication of the horrible headline data, yesterday’s print of 172k outpaced last month’s posting of 168k.

With such a firm outlook for some “payback” from last month’s employment weakness, we expected to see the USD trading higher against the JPY. Instead, the pair has dropped for the last five sessions in a row and at 100.30 is over 450 points below the 30 day moving average at 105.00. It’s widely accepted that the strong JPY is a source of pain for Japanese industry; especially in light of the recent Chinese Yuan devaluation. In addition, the Nikkei 225 Index is down over 20% this year while most other G-7 bourses are within range of yearly highs.

The Bank of Japan meets at the end of the month and are under growing pressure to stimulate the economy further. Knowing that easing rates further into negative territory will have a limited impact on the economy (and perhaps a negative effect on USD/JPY), we wouldn’t be surprised to see a combination of policy levers announced including both monetary and fiscal measures.