By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
***No Daily Reports Next Week, Returning June 29
- Euro's Fate Hangs on 3 Key Events
- Will the Dollar Catch a Safe-Haven Bid Next Week?
- CAD: Hit by Weak Retail Sales
- NZD: Consumer Confidence Weakens
- AUD Drops Following Sharp Decline in Chinese Stocks
- GBP: 10 Days Without a Correction
Euro's Fate Hangs on 3 Key Events
For currency traders, last week was all about the U.S. dollar but the focus will now be almost exclusively on the euro. We are 10 days away from the June 30 deadline when Greece owes the IMF more than a billion dollars and without a new bailout package, they will be in default. Time is running out fast and the euro is weakening as traders realize they can no longer be complacent about the risks of a Grexit in the final stretch. Each day that passes without progress makes it more difficult for EUR/USD to hold 1.13.
Three key events will determine how euro trades next week. Capital controls are the main concern right now but euro traders have a lot more to worry about. The action starts with an emergency summit on Monday evening. Both Tsipras and Merkel will be in attendance so the decision makers are in place but whether either side concedes remains an open question. If an agreement is not made at the time, the next key event risk is the special summit planned for June 25-26. These two meetings are the last official opportunities for a deal to be reached. But if it becomes necessary, we are certain that emergency meetings will be held on a daily basis into the weekend and the June 30 deadline. The ECB has already extended a lifeline to Greek banks by raising its emergency funding and we are optimistic that in the eleventh hour an agreement will be reached. However there could be more resistance for the euro between now and then.
In the long run, the Eurozone is better off without Greece. Next week's PMI reports (Manufacturing, Markit Composite, Retail and Services) could show how much the Eurozone is benefitting from Quantitative Easing and a weak currency. Without Greece, the entire picture of the Eurozone is brighter. However in the short term, a Grexit is a curse and as this risk grows, more investors will consider dumping the euro. Allowing Greece to leave the Eurozone would be very costly to Europe. It could create a financial and economic crisis triggered by the fear of a deeper fracture in the union. Investors would immediately wonder if other troubled nations such as Portugal, Ireland and Spain would follow. A Grexit could easily drive EUR/USD down 5%. Yet apocalypse can be avoided. We know that the overwhelmingly majority of people in Greece want to keep the euro and Tsipras says he wants to as well. So if both sides budge just a little, an agreement can be reached.
Will the Dollar Catch a Safe-Haven Bid Next Week?
With no U.S. economic reports released Friday, there was very little consistency in the performance of the greenback. The dollar traded higher versus the euro and commodity currencies but extended its losses against the British pound and Japanese yen. It was a tough week for the greenback and its performance is counterintuitive but we remain convinced that this represents nothing more than a near-term pullback in the currency. However over the next two weeks, risk appetite could drive the dollar's performance. If the Greek debt negotiations become messier, investors could flock into the safety of the dollar. There are a number of U.S. economic reports scheduled for release next week but most of them are second tier. The most important will be the revision to Q1 GDP. Growth is expected to be revised higher and if that is the case, it could lend support to the greenback. Unfortunately it is not important enough to revive the dollar's rally. Aside from GDP, we have existing and new home sales, durable goods, personal income, personal spending and revisions to the June University of Michigan Consumer Sentiment report. Since there won't be any daily reports for the next week, I want to take the opportunity to reiterate that the long-dollar trade is not dead. Investors hoped that Yellen would be more hawkish but at the end of the day, the message from the dot-plot forecast and her press conference is clear -- rates will rise this year. If labor data improves and inflation ticks higher, the Fed will even raise rates twice this year. So in an environment where the RBA, RBNZ and ECB are either easing or talking about doing so, the dollar remains attractive.
CAD: Hit by Weak Retail Sales
All three of the commodity currencies traded lower Friday but the focus was on the Canadian dollar. USD/CAD rebounded after Thursday's strong intraday reversal on the back of weaker retail sales. While consumer prices rose 0.6%, which was more than expected, spending dropped 0.1%. Excluding autos, the decline was even steeper with retail sales falling -0.6%. Economists had been looking for a rise on both fronts and between the jump in wholesale sales and the improvement in the labor market, we also anticipated an increase but consumer demand cooled in April after strong gains in March. This is a weak start on second-quarter GDP but if the U.S. economy gains momentum and oil prices hover above $60 a barrel, there's hope for a recovery in the coming months. New Zealand consumer confidence declined adding pressure on NZD but the sharp fall in Chinese stocks was the main reason for the weakness in AUD and NZD. The Shanghai Composite dropped 6.4% Friday on the back of tighter liquidity.
GBP: 10 Days Without a Correction
The British pound has now gone 10 days without a correction. This is the longest stretch of gains for GBP/USD since April 2012 when the currency pair rallied for 10 days straight before topping out. At the time, the "top" became a strong one that took GBP/USD from a high of 1.63 to a low of 1.5270 with not much in the way of a relief rally. This is not to say that history will be repeated because the recent gains in sterling have been supported by strong fundamentals. Strong tax revenues helped to lift public-sector finances. Earlier this week we also learned that retail sales rose 0.2% in May against expectations for a 0.1% decline. For the Bank of England, this week's better-than-expected data hardens the case for an early 2016 rate hike. There are no major U.K. economic reports scheduled for release next week so the outlook for sterling hinges on the market's risk appetite and Greece. Technically, GBP/USD has already broken above the 2015 high of 1.5814. It also cleared the 38.2% Fibonacci retracement of the 2009 to 2014 rally at 1.5800. There is no resistance now until 1.60 and we believe that the currency pair is on its way to test this level. However should GBP/USD sink below 1.5750, we could see a deeper correction down to 1.55.