By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
This past week was a brutal one for the U.S. dollar. The greenback traded lower against all of the major currencies with particularly stinging losses experienced against the Japanese yen and New Zealand dollar. USD/JPY dropped from 105.60 down below 102 after the Bank of Japan announced a very modest increase in monetary stimulus. With the economy deteriorating rapidly and the yen strengthening, investors were looking for a strong dose of easing that would convince the market that the BoJ will stop at no means to turn the economy around. Unfortunately, the central bank offered the smallest amount of support by increasing ETF purchases and doubling its dollar lending facility. This was the minimum that the market expected -- the BoJ did not cut interest rates, increase bond purchases or go for the unconventional-like helicopter money and investors sent the yen soaring in response.
Has the BoJ reached its limit? Maybe, maybe not. We do know they will conduct a more “comprehensive assessment” of their monetary policy tactics and deliver the results at their next meeting in September, which tells us one of two things -- the BoJ is throwing in the towel and passing the baton to Abe or they are planning something big for September. Central bankers around the world have long called for more action by fiscal governments and for a long time, Abe’s government had the BoJ do most of the heavy lifting. This coming Wednesday Prime Minister Abe will announce a new economic stimulus package. The market is looking for the package to exceed 28 trillion yen and the greater the program, the greater the potential for a rebound in USD/JPY. Aside from the total size of the package, how it is allocated will also impact the currency -- if the supplementary budget is small, investors will be disappointed. Given the proximity of Abe’s announcement, we don’t rule out the possibility of Kuroda leaving the surprise element to Abe. Now that USD/JPY has dropped below 103, the risk of verbal intervention is high, along with incoming headlines about Abe’s announcement on Wednesday and the BoJ’s plans for September. With that in mind, however, the path of least resistance for USD/JPY is still lower with a move to 100 appearing likely.
Friday’s disappointing U.S. economic reports also played a big role in the meltdown of the U.S. dollar. GDP growth in the second quarter was significantly lower than expected. The economy expanded by only 1.2% in Q2, against expectations for a 2.5% rise. First-quarter numbers were also revised lower to 0.8% from 1.1%. Although the Chicago PMI index beat expectations, manufacturing activity is down from the previous month and the University of Michigan consumer sentiment index was revised lower for June. While the Fed recognized the improvements in the economy this past week, the market completely ignored their hawkish bias, which is a clear example of misplaced expectations. The Fed may be the least dovish G10 central bank, but investors expected more from the BoJ and their disappointment combined with softer U.S. data and overall skepticism about the possibility of a June hike gave everyone very little reason to buy dollars post FOMC. This will be an important point to remember going into next week’s Reserve Bank of Australia and Bank of England monetary policy meetings. For the U.S., it will be another busy one with manufacturing ISM and non-manufacturing ISM on the calendar followed by Friday’s nonfarm payrolls report. Job growth rebounded strongly in June but it is unlikely that corporations kept up that pace of hiring in July and if that’s the case, it could hurt more than help the dollar.
The second-best performing currency behind the yen was the New Zealand dollar. Most of this week’s New Zealand economic reports were weaker than expected with the trade balance shrinking, exports falling, business confidence slipping and activity growth slowing according to ANZ. The only “good” news was building permits, which rebounded strongly last month. Yet NZD performed exceptionally well for no reason other than yield. The RBNZ may be talking about lowering interest rates but there’s no meeting next week so for the time being, preservation of yield has drawn investors into the New Zealand dollar. Employment numbers are scheduled for release next week and while the RBNZ plans to ease, labor-market conditions have been improving according to the PMIs.
However between the two currencies, the Australian dollar will be the greater focus with a Reserve Bank of Australia’s monetary policy meeting on the calendar. The last time we heard from the RBA, they sounded open to the idea of easing if data supports it but since the last meeting in July, consumer prices increased, full-time job growth rebounded, business confidence improved and the participation rate is up. Granted consumer confidence is down and the unemployment rate ticked up, we’re not sure if this is enough for the RBA to pull the trigger on easing in August. They may wait another month or so before taking action, which could have a profound affect on AUD. Aside from RBA, Chinese PMI numbers will also affect how the Australian dollar trades. Meanwhile the Canadian dollar traded higher against the greenback every day this week despite softer GDP numbers. The loonie has been oil's whipping boy, which rebounded on Friday. In the coming week, Canada has its employment report and IVEY PMI scheduled for release.
Of all the major currencies, we expect the greatest volatility in sterling. Not because it is generally a bigger market mover but because the Bank of England will release its Quarterly Inflation Report and monetary policy announcement on Thursday. After Brexit, expectations were running high for a rate cut in August, especially after Governor Carney said their forecasts would be updated. However since Britain decided to leave the European Union, U.K. data hasn’t been terrible. Of course, most of the reports do not reflect the impact of Brexit and the outlook is grim, but considering that Carney has been unabashedly clear about his negative outlook for the U.K. economy post Brexit, an insurance cut is definitely possible. Before the U.K. rate decision, we’ll be getting the PMIs, which will help shape the market’s expectations for BoE.
Finally, EUR/USD broke out on Friday on the back of broad-based U.S. dollar weakness. The Eurozone economy expanded by 0.3% in the second quarter, which was right in line with expectations while consumer prices rose 0.2%, slightly stronger than anticipated. Data from the Eurozone was mostly better than expected, highlighting the outperformance of the EZ economy, particularly when compared to the U.K. data. There’s not much on the Eurozone calendar in the coming week, which means EUR/USD will most likely trade on the market’s appetite for greenback.