Boris and Kathy Forex Weekly 14/8/2017
Posted on: 14 August 2017 , by: Boris & Kathy , category: Market Review
The biggest driver of currency flows this past week had nothing to do with monetary policy or economic data.
Instead, the escalation of tensions between the U.S. and North Korea sent USD/JPY sharply lower as investors worry that this heated exchange could result in military action. Although we firmly believe that the threat of war, let alone nuclear war is slim, this has been one of the most unpredictable eras in history so we have to be prepared for the impossible.
Many of our readers are asking how far the dollar could fall if the U.S. goes to war with North Korea but before discussing this, we want to point out that while the dollar is down sharply this week versus the yen, it strengthened against other major currencies such as sterling, the Australian and New Zealand dollars. So while there’s no question that war is negative for USD/JPY it can initially drive the dollar higher against high beta currencies such as AUD and NZD. As a rule of thumb, the Japanese yen and Swiss franc perform best during times of war, which means all of the Yen crosses including USD/JPY will weaken.
- CPI 0.1% vs. 0.2% Expected
- CPI Ex. Food and Energy 0.1% vs. 0.2% Expected
- PPI Final Demand -0.1% vs. 0.1% Expected
- PPI Ex. Food and Energy -0.1% vs. 0.2% Expected
- PPI Ex. Food, Energy, Trade 0.0% vs. 0.2% Expected
- Japanese GDP- Stronger trade offset by weaker retail sales so tough call
- US Retail Sales- Potential for upside surprise given stronger average hourly earnings & higher gas prices
- Housing Starts and Building Permits- Housing data is hard to predict but higher rates could curb growth
- FOMC Meeting Minutes- Fed minutes are hard to call but they were less hawkish at meeting
- Philadelphia Fed Business Outlook and Industrial Production- Will have to see how Empire State index fades
- University of Mich. Sentiment Report- Potential for upside surprise as IBD/TIPP index hits 5-month highs, stocks are at record highs
- Support 108.00
- Resistance 110.00
Taking a look at some of the major military conflicts over the past 3 decades, the Dollar Index suffers greatly when there is war. Not only does the cost of war require an expansion of money supply, commodity prices also tend to rise during this time putting additional pressure on the U.S. economy. In the 2 months from when the conflicts in Libya started the dollar index dropped nearly 5% and in the first 3 months of the second Gulf War, the dollar index fell more than 9%. We saw similar weakness after the first Gulf War and then later when there were missile attacks on Baghdad.
U.S. stocks also tend to perform poorly but generally the month before a war begins rather than the month after. This time around, how currencies behave depends largely on how China responds. If China stays neutral and doesn’t provide any support to North Korea, the Yen, Australian and New Zealand dollars would have a smaller reaction (although still a big one) than if China inserted themselves in the middle. Since there’s no doubt that North Korea will lose and lose quickly, as the tensions grow the dollar will suffer and the actual announcement of war could take USD/JPY to 105 but if it’s a swift victory the pair would also recover quickly. The bottom line is that the outlook for USD/JPY is grim and 108.50/108.00 is probably the next stop for the pair.
- BoE Votes 6-2 to Keeps Rates Unchanged, Lowers GDP Forecasts
- Manufacturing PMI 55.1 vs. 54.5 Expected
- Construction PMI 51.9 vs. 54.0 Expected
- Services PMI 53.8 vs. 53.6 Expected
- Composite PMI 54.1 vs. 53.8 Expected
- BRC Shop Prices (YoY) -0.4% vs. -0.3% Prior
- Mortgage Approvals 64.7k vs. 65.0k Expected
- Nationwide House Prices 0.3% vs. -0.1% Expected
- Industrial, Manufacturing Production, Visible Trade Balance and GDP Estimate- Potential for upside surprise given stronger manufacturing PMI index
- Support 1.2900
- Resistance 1.3200
Sterling is the most vulnerable to a deep correction as there was nothing positive in the most recent Bank of England Quarterly Inflation report and monetary policy announcement. The central bank voted 6-2 to leave interest rates unchanged, cut their forecasts for GDP and wage growth and expressed concerns about a “smooth transition to a new economic relationship with the EU.” Governor Carney said the bank’s forecast revisions factor in “uncertainty about the eventual shape of the U.K.’s relationship with the EU, which weighs on the decisions of businesses and households and pulls down both demand and supply.” They also felt that the weaker GBP was the only reason why inflation was hotter in the beginning of the year and the recent reversal should ease price pressures. As BoE member Broadbent pointed out, U.K. inflation is nearing its peak. Carney also sees growth picking up later on investment and trade with the economy supply capacity rising at a modest rate but their forecasts are predicated on the first rate hike happening in Q3 of 2018, which is too far out for a market that was hoping for a move this year. The disappointment that came out of the central bank meeting overshadowed the stronger PMIs.
Given how much GBP/USD rose in the last 4 months (from 1.24 to 1.3250), the tone of the central bank and the healthy U.S. non-farm payrolls report means 1.3270 is most likely the top in GBP/USD. On a technical basis, this is also where the 20-day SMA on the monthly chart and the 23.6% Fib retracement of the 2014 to 2016 sell-off converge, making it the perfect stopping point for the pair after a prolonged rally that took it from 1.20 in October of last year to 1.3270 this month. This week’s industrial production and trade balance reports are not significant enough to change the market’s appetite for sterling.
- GE Retail Sales 1.1% vs. 0.2% Expected
- EZ Unemployment Rate 9.1% vs. 9.2% Expected
- EZ CPI Estimate (YoY) 1.3% vs. 1.3% Expected
- EZ CPI- Core (YoY) 1.2% vs. 1.1% Expected
- GE Manufacturing PMI 58.1 vs. 58.3 Expected
- GE Unemployment Change -9k vs. -5k Expected
- GE Unemployment Rate 5.7% vs. 5.7% Expected
- EZ Manufacturing PMI 56.6 vs. 56.8 Expected
- EZ GDP (QoQ) 0.6% vs. 0.6% Expected
- EZ PPI -0.1% vs. -0.1% Expected
- GE Services PMI 53.1 vs. 53.5 Expected
- GE Composite PMI 54.7 vs. 55.1 Expected
- ECB Economic Bulletin says that consumer goods prices and wages are still growing at a slow pace
- EZ Services PMI 55.4 vs. 55.4 Expected
- EZ Composite PMI 55.7 vs. 55.8 Expected
- EZ Retail Sales 0.5% vs. 0.0% Expected
- GE Factory Orders 1.0% vs. 0.5% Expected
- GE Construction PMI 55.8 vs. 55.1 Prior
- GE Retail PMI 50.7 vs. 54.5 Prior
- EZ Retail PMI 51.0 vs. 53.2 Prior
- GE Industrial Production- Potential for upside surprise given stronger factory orders
- GE Trade and Current Account Balance- Will update after Industrial Production but factory orders healthy, suggesting stronger numbers
- Support 1.1600
- Resistance 1.1900
The euro also pulled back sharply on Friday and some traders may find it interesting that the decline on a percentage basis was greater than sterling and the Australian dollar, even though fundamentals in those countries are less positive but the explanation is simple. Many of the other currencies lost momentum earlier this month and the euro is finally catching up. At the end of the day we expect the euro to outperform up until the point where the ECB begins to talk it down. Unlike other countries there’s been more positive than negative data and the central bank is widely expected to upgrade their economic forecasts next month and could begin tapering asset purchases. The latest economic reports show German factory orders rising strongly but retail demand is slowing according to the PMIs. While we are bullish euros, the currency is up 10% this year and that will eventually catch up to the economy. We have already seen some areas of weakness and suspect that next month’s economic reports may not be as good as the last one. Either way, for the time being until there is data weakness, the euro should outperform other currencies. Germany’s industrial production and trade balance are due for release this week – these reports are not expected to have a significant impact on the currency. The next big focus will be ECB President Draghi’s speech at Jackson Hole later this month. EUR/USD has support between 1.1630 and 1.1670. The Swiss Franc extended its losses this week, driving EUR/CHF above 1.15. Outside of profit taking there is very fundamental or technical reason for the pair’s trend to change.
AUD, NZD, CAD
- NAB Business Confidence 12 vs. 8 Prior
- Westpac Consumer Confidence -1.2% vs. 0.4% Prior
- AUD Home Loans 0.5% vs. 1.5% Expected
- Chinese Current Account Balance $52.9b vs. 18.4b Prior
- Chinese Trade Balance $46.74b vs. $45.0b Expected
- Chinese CPI (YoY) 1.4% vs. 1.5% Expected
- Chinese PPI (YoY) 5.5% vs. 5.6% Expected
- RBNZ keeps rates steady at 1.75%, Expresses Concern about Currency
- Business NZ Manufacturing PMI 55.4 vs. 56 Prior
- Housing Starts 222.3k vs. 205.0k Expected
- Building Permits 2.5% vs. -1.9% Expected
- Housing Price Index 0.2% vs. 0.5% Expected
- CH Retail Sales and Industrial Production- Chinese data is very market moving but hard to call
- RBA August Rate Meeting Minutes- Potentially negative AUD since RBA lowered GDP forecasts at last meeting
- AU Employment Report- Potential for upside surprise given major gains in employment component of PMI services, construction and manufacturing
- PMI Services and Retail Sales- Sales component of PSI rose but card spending mixed so difficult call
- Producer prices - Potential for downside surprise given big disappointment in CPI
- CPI- Potential for upside surprise given Sharp rise in price component of CPI
- Support AUD .7800 NZD .7200 CAD 1.2600
- Resistance AUD .8000 NZD .7400 CAD 1.2800
Meanwhile the risk aversion created by U.S./North Korea tensions also put significant pressure on commodity currencies. The New Zealand dollar was the worst performer and more losses are likely in the coming week. According to Governor Wheeler, the Reserve Bank is not happy with the value of the currency because he brought up the possibility of intervention after this month’s monetary policy announcement. The RBNZ left interest rates unchanged at 1.75% and said inflation could decline further in coming quarters. Wheeler also talked about how currency intervention is always an option. Assistant Governor McDermott emphasized the significance of Wheeler’s comments by saying the RBNZ changed the NZD language to signal their unease and this is the first step towards possible intervention. The RBNZ opened up a can of worms and this week’s PMI services, retail sales and producer price reports probably won’t lend much support to the currency especially after the slowdown in manufacturing PMI index. We see NZD/USD falling back to 0.7250 and possibly even 0.7200.
Unlike the New Zealand dollar, the Australian dollar quietly drifted lower this past week and that’s because the threat of war is positive for gold and commodity prices which helps AUD. U.S. Treasury yields also fell more aggressively than Australian bond rates and this change in the yield spread helped to limit the slide in AUD/USD. With that in mind, the Australian dollar is still a high beta currency and for that reason it will not be able to escape the pressure of risk aversion. The only hope is this week’s Australian employment report because according to the latest PMI numbers, solid job growth was seen in the manufacturing and service sectors. But before we get to that, the RBA minutes will be released and given the central bank’s downgrades, the tone isn’t expected to support the currency. AUD/USD traders should also be watching China’s latest retail sales and industrial production numbers and resistance at 0.7950.
It was a week of recovery for USD/CAD, which experienced its first down day in 10 trading days on Friday. No major economic reports were released but for most of the week the pair was lifted by short covering, the sell-off in risk currencies and $50 resistance in oil. However, fundamentals still support a stronger currency and we think there could be a recovery for the Canadian dollar and a sell-off in USD/CAD this coming week. The only piece of Canadian data worth watching will be Canadian CPI and the data is expected to be positive for the currency as the price component of latest IVEY PMI report increased sharply over the previous month. If inflation and employment conditions strengthen, loonie traders will start to argue for another Bank of Canada rate hike this year.
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