Category: US Markets

The USD has started the new week with a bid tone after last week’s steady hammering. Looking back to last week, the Greenback reached multi-week lows against the Euro, British Pound, Swiss Franc, Canadian Dollar and the Japanese Yen. On balance the losses averaged around 1.5% but what made the weakness so significant was its relentlessness.

For example, the USD/CAD and USD/JPY did not post one session of gains while the EUR/USD traded higher everyday except Friday.

However, the technical reversal pattern in the USD Index on Thursday and Friday suggests this week could be much better for the USD. The dominate technical pattern in the USD Index has been the retracement from the 91.80 low in early May to the .9760 level posted on July 25th. In this analysis, the 61.8% Fibonacci retracement at 94.10 held to the tick last Thursday and then rallied on Friday. As a result, the RSI and stochastics have turned higher suggesting a potential to reach the 95.60/80 range in the near-term.

Since the EUR/USD makes up close to 58% of the USD Index weighting, the technicals suggest the single currency should trade lower. Fundamentally, there’s quite a bit of market moving data from the Eurozone this week including the second quarter GDP revision on Wednesday and the German IFO report on Thursday. In addition, considering the UK PMIs all printed lower recently, FX investors will be watching Tuesday’s Eurozone  PMIs for Brexit related weakness.

On balance, the EUR/USD picture is turning negative.

It hasn’t been an easy week for USD Bulls. Based on the close of NY Trade, the USD Index has fallen five consecutive days testing the 94.05 level last seen on June 24th……the day of the UK referendum.

Even though the US data flow has been on the firm side, the somewhat dovish comments out of the FOMC minutes has kept the downside pressure on the Greenback. Yesterday’s lower jobless claims, the uptick in the Philadelphia FED index and increase in the leading economic indicators were just not enough to convince FX investors that the US FED is serious about further normalization of interest rates this year.

With no first-tier data on the US schedule today, the best USD Bulls can look for will be a consolidation session which will allow investors with a longer-term time horizon to look for levels to establish better positions for the Central Bank divergence trade to re-gain market momentum. Besides, the FOMC holding on  rates is much different than the other G-7 Central banks which are still lowering rates.

Over the last three trading sessions, the best performing currency pair has been the GBP/USD. Since posting its lowest close in almost to 15 years near 1.2880 on Monday, the pair has rallied 300 points to its highest level in two weeks near 1.3175. Yesterday’s leg higher was triggered by a much stronger than expected retail sales report which posted a 1.4% gain versus a median forecast of around .1%. Clearly, the weaker Sterling has attracted tourists and boosted demand across the UK. In addition, the historically large short position in the pair reflects and unbalanced market due for a short-covering correction higher.

Looking ahead to next week, we expect the broader-based UK GDP data will reflect more negative aspects of the Brexit result and print lower than the .6% pace from two months ago.

In the lead up to the UK Referendum on June 23rd, many market commentators warned that a “Brexit” vote would have an acute and immediate impact on domestic UK assets in general, and on the price of the GBP/USD , specifically.   

After posting an intraday low of 1.2800 on July 6th, the Sterling recovered over 5% to reach an intraday high of 1.3481 on July 15th, but only managed to hold on to the 1.3340 level on a closing basis; over 120 points below the high and the highest NY close since.

From a technical perspective, this week’s price action suggests the GBP/USD has completed a bearish pennant formation based on the break of the 1.3220 trend line last week and the failure of the pair to post a NY close above last week’s low close of 1.3020 on August 5th. Following this pattern, the next key support is found at 1.2820 followed by the 1985 low at 1.2750.

An interesting aspect of this this technical pattern is the correlation break and divergence between the Sterling and the FTSE 100 Index. The UK Equities markets rallied alongside the GBP from early July on a combination of “time-lagged” UK economic data and expectations of further stimulus from the Bank of England (BoE).

However, since mid-July, several key UK growth aggregates have softened or offered little in terms of positive forward guidance. As a result, the GBP/USD and the FTSE 100 have diverged with the index posting its highest close of 2016 at 6902.00 today, and the GBP/USD picking up momentum to the downside. It’s reasonable to expect that if this recent trend continues, investors hedging out currency exposure on rising UK equity prices could add to the downside pressure on the Sterling.

Yesterday’s UK Housing Survey illustrates how the Brexit impact may be finally working its way into the overall UK economy. The GBP/USD was triggered lower as the RICS house pricing index slumped to 5% from 15% in June. This was the lowest reading in three years and underscores concerns about how heavily leveraged UK consumers are to housing, and the potential impact on retail spending if the property market continues to adjust lower.

Leading up to last Friday’s July Non-Farm Payroll (NFP) report, the USD was being offered against all the other major G-7 currencies. After the June Headline NFP number beat expectations by over 150,000 last month, many forecasters were expecting a large correction in the number of new jobs created this month. Most FX traders understood that the risk to the USD was asymmetrical and that an “as expected” reading would be USD negative.  

Instead, the robust NFP report allowed the Greenback to recoup the losses it experienced earlier in the week, the SP 500 reached an all-time new high close at 2176.00, US 10-yr bond yields hit a 3-week high of 1.60% and Fed Funds futures went from pricing a 57% chance of a 2016 rate hike to a 71% chance by the NY close.  

With the US economy posting an additional 255,000 jobs and average hourly earning increasing by 0.3%, it’s reasonable to expect that US interest rate policy will continue to move toward normalization while its peers continue to add to direct stimulus and unconventional easing measures. In addition, the forward outlook to the US labor market is improving with a jump in the participation rate, as well as, the total weekly hours worked.  

In short, by almost every metric, the US employment climate stands in sharp contrast to the dismal outlooks for the UK, Japan, most of Europe and Canada. That said, it’s our base case that seasonal factors effecting daily trade flows and a lack of any first-tier data this week could temper advances in the USD in the near-term. 

The impact of lower trading volume is best illustrated in the SP 500. Despite never trading lower than 1% below all-time high levels last week, the daily trading volume was consistently close to 25% below the 50-day moving average. With this in mind, we expect the USD, US Stocks and US Treasury rates to trade with an upward bias but with less momentum.

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.