By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The moves that we saw in the Monday's forex market gave investors a taste of the volatility to come this week. The euro, British pound, Swiss franc, Australian, New Zealand and Canadian dollars are down sharply versus the greenback with oil prices falling 3%. After last week’s strong gains, the latest pullback in the major currencies has many investors wondering if tops are near. Fundamentally, EUR, AUD, CAD and NZD should be trading lower but the improvement in risk appetite and turnaround in commodity prices allowed all these currencies to defy fundamentals and soar to new highs. It is still premature to call a top since uptrends have not been broken and a pair like EUR/USD remains above its key 1.1050 support level. But there’s certainly enough first-tier event risk on the calendar this week for fundamentals to matter again. While the main focus this week will be the Federal Reserve’s monetary policy announcement, 3 other central banks also have policy decisions. In addition, the RBA releases the minutes from its latest monetary policy meeting tonight followed by U.S. retail sales on Tuesday, U.K. employment numbers on Wednesday, New Zealand GDP and Australian employment numbers on Thursday and finally, Canadian retail sales on Friday.
We can see that investors are buying dollars ahead of the Federal Reserve’s monetary policy announcement. While no one expects the Fed to raise interest rates, there is a very good chance that Janet Yellen will say that a 2016 rate hike remains on the table. In light of recent easing by the ECB and RBNZ, the mere prospect of higher U.S. rates has and should continue to attract flows into the dollar. Over the past few weeks we’ve seen extensive weakness in the greenback led by the recovery in stocks and commodities along with the improvement in risk appetite. Currencies and commodities have become extremely overextended versus the greenback and the FOMC announcement could be the catalyst that turns these trends around. But first we have U.S. retail sales scheduled for release and Tuesday’s report is not expected to help the dollar. According to the International Council of Shopping Centers, consumer spending growth slowed in February and the recent decline in wages does not support a pickup in spending, which may explain why economists are looking for retail sales to fall by its largest mark in a year. A contraction in spending shouldn’t change the Fed’s bias but it could be enough for USD/JPY to dip to 113.00, which would be an attractive level to buy ahead of FOMC.
Over the weekend, China reported softer industrial production and consumer spending numbers. While European traders ignored the news, U.S. traders sent AUD and NZD sharply lower. The Reserve Bank of Australia’s meeting minutes are scheduled for release tonight and while they appear slightly more worried about inflation, they offered little concern over the recent slowdown in demand in Asia and the sharp falloff in employment data in Australia. A nonchalant attitude about the economy or the region’s troubles will provide underlying support for the currency. The pullback in commodity prices also contributed to the drop in commodity currencies but the rally in USD/CAD was modest given the decline in oil prices. The currency pair is trading firmly in a downtrend and holding below its 200-day SMA.
Last night, the Bank of Japan began its 2-day monetary policy meeting and this evening, an announcement is expected.
Having just lowered interest rates to negative levels in January, no additional actions are expected from the BoJ until later this year. While many central banks have resorted to negative rates, the BoJ is experiencing significant backlash because of the anger and frustration that it has caused for the public. According to the Wall Street Journal “Mr. Kuroda has been called to parliament for questioning at this point in the year more than any other central bank chief during the same period, dating to 2002.” The fear that the BoJ could lower rates further has caused “many senior citizens to buy safes to hoard cash due to fears that commercial banks may eventually charge them interest on their deposits.” So while Japan needs another round of stimulus the earliest that we could see more easing from the BoJ is July.
The euro and British pound declined despite the healthy increase in Eurozone industrial production. After rising sharply on ECB Thursday, EUR/USD has fallen as much as 140 pips, slightly less than the amount it declined after the rate cut in December before it powered higher. The former resistance now turned support level of 1.1050 sits right below current levels. If the decline in EUR/USD were to stop – that would be the ideal level. With no major Eurozone economic reports scheduled for release next week, the direction of euro should now be driven by the market’s demand for U.S. dollars. No U.K. economic reports were released out of the U.K. but sterling will be in focus starting on Wednesday with labor data scheduled for release.