The European morning has been very quiet with much of continental Europe again on a Bank Holiday. There has been no market moving news of any note. EUR/USD has edged a little higher through the session, but remains in the 1.2850-1.2900 range, EUR/GBP has inched higher over 0.8450. Main interest to start the week has come in Japan following comments from Japanese Economy Minister Amari who suggested that any further fall in the JPY would have negative effects for the economy. The JPY spiked higher overnight – USD/JPY reaching a low of 101.97 late last night. The pair has been trading in the 102.40-102.80 range this morning, a little off the recent high of 103.31. A quiet start to the week is in store in terms of newsflow, with markets looking to Fed Chairman Bernanke’s testimony on Wednesday as the major event of the week.
The USD index has eased modestly in Asian and European trade to start the week, but we expect the USD to remain firm over the first part of the week. Some market participants believe the Federal Reserve will soon signal a tapering of its asset purchases (certainly non-voting hawks have again made the case for tapering). Federal Reserve chair Bernanke’s testimony before the US Joint Economic Committee on the economic outlook and the April FOMC meeting minutes, both on Wednesday will be critical to the USD direction in the second half of the week. We expect Bernanke to dampen speculation the Fed will soon contemplate tapering its asset purchases and highlight that tightening fiscal policy will lop 1.5 percentage points off US GDP growth. As a result, we expect the USD to soften and consequently EUR, GBP, AUD and NZD to firm into the end of the week. We may receive a preview of Bernanke’s speech by two dovish FOMC voters, namely Charles Evans (1pm EST/6pm BST, speaks on economic conditions and monetary policy) and Dudley (Tuesday 1pm EST/6pmBST), speaks on “lessons at the zero bound”). But before Bernanke speaks, there is room for the USD to strengthen further.
AUD/USD direction this week is set to be driven largely by the USD side of the equation. The big USD event, as described above is Fed Chairman Bernanke’s testimony. From the AUD side of the equation, China’s May Manufacturing PMI (HSBC measure) will generate some intra-day volatility (due Friday) as will the release of the RBA May policy meeting minutes (9.30pm EST/2.30am BST on Tuesday). The RBA minutes will provide more detail as to why the RBA chose to cut interest rates earlier this month. Of note, will be how much additional emphasis the RBA ascribe to the historically high exchange rate as a reason for the reduction in interest rates. So far their commentary has been more about observations that lower “export prices and interest rates” have not generated a larger decline in the AUD to date. Nevertheless, interest rate reductions have occurred to offset the dampening effect the historically high exchange rate has made on the local Australian economy. We anticipate AUD/USD to remain largely range bound ahead of Bernanke’s speech. The outcome of Bernanke’s testimony appears binary. If Bernanke re affirms the Fed’s current open ended quantitative easing policy (as we expect) the USD will soften and AUD/USD will lift toward 0.9900. If Bernanke signals an early end to the current open ended quantitative easing policy, the AUD/USD will decline below 0.9500.
USD/JPY has started the week in volatile fashion, trading in a 100bps range in illiquid early Asian Monday morning trade. The moves stem from Japan’s economy minister, Akira Amari, who stated the yen’s excessive strength, has largely been corrected, and further weakness could be harmful “if the yen extends losses a lot, people’s lives will be negatively affected. It’s our job to minimize that”. We expect trends in USD/JPY to be dominated this week by broader USD trends; Bernanke’s speech will be pivotal. Before Bernanke’s speech, Japan’s April trade balance and the Bank of Japan’s policy meeting are held (both on Wednesday Japan time). Japan’s trade balance will stay deeply in deficit. We do not expect the BoJ to make any policy adjustments, however we do expect some comment regarding the volatility and recent rise in JGB yields, and what (if any action) the BoJ could take. Irrespective, we expect the deterioration in Japan’s trade and current account position to continue to push the JPY lower over the medium term.
EUR/USD has eased to six-week lows. Given our expectations that the USD is likely to undergo a Bernanke induced pullback, we think EUR/USD could bounce back. Nonetheless, we do not expect any EUR gains to be overly large. The Eurozone macro environment remains weak, and market expectations of further ECB policy action remain. The German US two year yield differential is now 27bpts. This is its most negative level of 2013. A significant rise in EUR is unlikely until core Eurozone bond yields lift. This week the flash estimates of the Eurozone PMIs (Thursday) and the May German IFO (Friday) are released. Any deterioration or a lack of any substantive improvement, in the business surveys will reinforce expectations that the ECB could act as soon as June. Added to this is the raft of ECB policy makers scheduled to speak this week. A key focus will undoubtedly be on ECB President Draghi. Suggestions that the ECB continues to look at further easing measures should act as an additional EUR headwind.
GBP/USD is now more than 2.5% below its early May high. In the near term, the USD side of the equation is likely to dominate moves in GBP/USD. If we are right about Bernanke and the USD, GBP/USD should recover mildly. However, there are a number of GBP centric factors that could cap any gains in GBP. A key focus will be the May BoE policy meeting minutes (Wednesday). Over recent months there has been a 6-3 vote against further asset purchases. While the UK economy has shown some improvement recently, we think the minutes will reiterate that the option of further policy stimulus remains. Lower UK inflation means the door to further easing is open. Should the incoming UK data disappoint expectations of an economic recovery (such as the April retail sales released on Wednesday), expectations of further BoE easing are likely to build once again, particularly once BoE Governor designate Carney takes the helm on 1 July. As we have outlined previously, the underlying dynamics in the UK, such as negative UK real yields, a large UK current account deficit (3.7% of GDP), a relatively weak underlying UK economy and the ongoing risk of further BoE policy stimulus suggest GBP should remain under pressure over coming months.
NZD/USD is now close to a six-month low. This week’s New Zealand data is unlikely to inspire a lift in the NZD (RBNZ survey of inflation expectations Wednesday NZT / Tuesday BST, merchandise trade Friday NZT / Thursday BST). Rather, the broader USD direction is likely to determine the NZD’s direction. We expect the NZD to remain heavy until Bernanke’s testimony on Thursday (see USD section) but should lift over the later stages of the week if Bernanke is as dovish as we expect.
USD/CAD rose back above 1.0300 last Friday for the first time since early March, reflecting both the USD’s strength, and extremely low Canadian inflation pressures. Canadian consumer prices fell 0.2% in the month, taking annual inflation down to 0.4%. Core inflation also remains weak, printing at 0.1% (MoM), and 1.1% (YoY). Very low inflation, combined with moderation in credit growth and housing activity suggest the Bank of Canada (BoC) will remain on hold for an extended period, and this is weighing on CAD. Canadian retail sales data for March (Wednesday) is unlikely to help the soft CAD with weak growth of 0.1% (MoM) expected. We do not expect BoC Governor Carney to say anything to influence interest rate expectations at his speech on 21 May, given the BoC’s Policy meeting is only one week away. The USD direction is likely to be the greater driver of USD/CAD movements this week, and in this vein, the Bernanke testimony will be pivotal.