USD: Is This A Pause Or Bottom?

Since the beginning of the year, the U.S. dollar has weakened significantly. It lost more than 7 percent of its value against the euro, more than 4 percent against the Swiss Franc and British pound and more than 3 percent against the Australian dollar.  The downtrend in the dollar has been so strong that investors have practically grown accustomed to dollar weakness. Over the past week however, the sell-off in the dollar lost its momentum with currency pairs such as the EUR/USD consolidating below 1.45 and the GBP/USD below 1.64. During periods such as these, it is tempting to speculate on the possibility of a bottom in the greenback and a top in high yielding currencies. Yet before rushing to judgment, it is important to realize that the dollar remains weak and continued to sell-off against the Japanese Yen, Australian and New Zealand dollars. In fact, USD weakness drove the NZD to its highest level in more than 3 years.

Aside from the fact that the dollar has fallen significantly over a very short period of time, there is little fundamental reason for investors to buy dollars. The U.S. economy is improving but the latest economic reports give the Fed little reason to act and the U.S. central bank’s lax attitude towards normalizing monetary policy is the main reason for the dollar’s weakness. With the FOMC meeting less than 2 weeks away we do not expect Fed officials to say anything particularly positive for the dollar.   Many central bank officials have spoken over the past week and their message is clear, which is that they believe in the U.S. recovery but with muted inflationary pressures in the U.S., they are in no rush to raise interest rates. As a result, it is more likely that the current support that the dollar is finding is a pause rather than a bottom.

This morning’s U.S. economic reports showed that despite the rise in food and energy costs, inflation may be a problem for many countries, but not the U.S. Consumer prices rose 0.5 percent in March, which was right in line with expectations. Core price growth on the other hand slowed to 0.1 percent from 0.2 percent the previous month. On an annualized basis, CPI edged higher, but for the time being producers only have the ability to pass through part of their costs as weak demand prevents any meaningful price increases. Manufacturing activity on the other hand remains strong with the Empire State manufacturing survey rising to its highest level in a year. The details of the report were even stronger than the headline number with prices paid rising to its highest level since August 2008 and the employment index rising to its highest since May 2004. Industrial production also increased 0.8 percent with capacity utilization rising from 76.9 to 77.4 percent. The manufacturing sector has been one of the biggest beneficiaries of a weak dollar and stronger global demand. Yet even the continued strength in manufacturing will not convince the Federal Reserve to raise interest rates prematurely. Fed President Plosser doesn’t see the need for additional Quantitative Easing and he felt that it is “not inconceivable” for interest rates to be increased this year, but the U.S. economy needs to improve for a rate hike to be warranted. If one of the most hawkish members of the FOMC is hesitant about tightening monetary policy, there is a good chance that the U.S. central bank will be one of the last to raise interest rates.

At the end of the day, this may turn out like the story of the tortoise and the hare. The longer the U.S. leaves monetary policy easy, the more underlying support it will provide to the U.S. economy. It may keep the weak dollar but a weak currency supports the recovery. In contrast, a strong currency and higher interest rates in the Eurozone could hurt growth in the Eurozone.  The focus next week will be on housing with the NAHB housing market index scheduled for release along with housing starts, building permits, existing home sales and the House Price Index. February was a terrible month for starts, permits and home sales and a result a rebound is expected in March.  Aside from these housing market reports, jobless claims, leading indicators and the Philadelphia Fed survey are also due for release.

EUR: 1.45 REMAINS A TOUGH BARRIER

Sovereign debt troubles have come to haunt the euro. Despite stronger than expected economic data, the EUR/USD has once again failed to break above 1.45. After trying for six consecutive trading days, the resistance that the currency pair has experienced at this level means one of two things –1.45 will either mark the top in the EURUSD or a break of this level will lead to a very swift and aggressive move higher driven by the activation of stop and limit orders and the tag of option barriers. The latest economic reports from the Eurozone showed that unlike the U.S., inflation is a problem for the ECB. Eurozone consumer prices rose 1.4 percent in the month of March, more than 3 times the growth experienced in February. This drove the annualized pace of CPI growth up to 2.7 from 2.6 percent. The trade deficit for the Eurozone also narrowed, which shows that for the time being, the strong euro has only had a limited impact on demand. Next week will be a big week for Europe with PMI numbers, producer prices and the German IFO report scheduled for release. However whether the euro trades on economic data and its impact on yield differentials remains to be seen. Today for example, the euro ignored stronger data and was pressured by Moody’s downgrade of Ireland to Baa3 from Baa1. The rating agency now rates Ireland two notches below Fitch and S&P. This has not deterred other investors from buying euros. Japan’s Kokusai, which is the country’s second largest bond fund announced that it will increase its allocation of euro denominated assets. We suspect that other major players are doing the same as well.

GBP: BOE MINUTES ARE KEY

The British pound was a clear loser today, as it traded down against most of the major currencies with the exception of the euro. With no major economic news released from the UK today, MPC member Andrew Sentance came on camera to speak of the necessity of raising rates in a post-recession inflationary environment. When asked about the 4-way split in policy decision making among the 9-member MPC, Sentance expressed his concern that much of the inflationary worries have not yet been realized by his fellow members. Calling this post-recessionary environment an unusual one, he went on to say that inflation has become a “medium-term worry” that necessitates raising of rates “sooner rather than later.” Despite these worries, the majority of the Monetary Policy Committee is against a near-term rate rise, with Sentance being the only one also calling for a 50 basis point hike in rates. Earlier this week, year-over-year CPI data showed prices rising less than the 4.4% expected to print 4.0%, well above the Bank of England’s 2-3% target range. After the initial sell-off, the pound rallied back from its losses but has been unable to break past its 14-month high of 1.6427. After five consecutive months of higher prices, proponents point to the most recent drop in CPI as a possible indication of a turning point for prices. On the other side spectrum Sentence believes there to be “further upward pressure on inflation to come” with inflation to hit above 5% if left unchecked. To make matters worse, much of the price increases are unwillingly being absorbed by consumers, further dampening spending in the economy and hindering the economic recovery in the UK. The release of the minutes from the most recent monetary policy meeting next week will go a long way in showing just how concerned the central bank really is about inflation. If every one of the MPC members voted the same way in April as they did in March, it would be perceived as bearish for the GBP. If another member of the central bank voted to raise interest rates however, it would renew expectations for a rate hike which could fuel further gains in the British pound. Aside from the minutes, the U.K. retail sales report is also scheduled for release.

AUD: HIGHER COMMODITY PRICES OFFSET FEAR ABOUT CHINESE TIGHTENING

Despite a lack of major economic releases on Friday, commodity currencies edged higher amidst various market sentiments affecting the commodity market. Overnight speculation regarding further tightening from China initially led to a sell-off in key comdolls like the loonie, which is directly impacted by demand for its chief export commodity: oil. The Canadian dollar ended the NY trading session flat against the US dollar, while pairing some gains against its European trading partners. Crude oil resumed its rise, settling the day at $109.45, while the aussie and kiwi beat out virtually all its major FX counterparts. Soon after its initial pullback, crude oil futures rallied to break past the 110-level as continued turmoil in the Middle East put further upward pressure on the input commodity. This allowed the Canadian dollar to regain its overnight pip losses. Countries like Canada and Australia are net exporters while China and other emerging nations are net importers, who determine the demand of such commodity currencies as the aussie and loonie on the basis of their trade actions with those countries. Given the record-high prices of input commodities such as oil, silver and copper, worries over uncontrolled inflation in many EM nations have led many EM central banks to act. The People’s Bank of China took aggressive actions to slow down the pace of its economic growth by raising their benchmark rate and increasing reserve requirements for financial institutions. In doing so, they are directly affecting the demand for raw materials and the corresponding currencies that export such raw materials. And with the comdolls already having reached some of the strongest levels not seen in years, there is much anticipation for a pullback in these currencies, stemming specifically from such demand factors. On the supply side, continued political turmoil is ensuring that the CAD remains at the strongest level not seen over three and a half years. The New Zealand dollar has also its currency hit a three-year high of 0.7990 versus the US dollar, while the aussie is inching back up toward its record high of 1.0580 against the dollar. Next week, investors can see a number of key reports from the commodity countries with CPI data from NZ to be released on Sunday and CPI data from Canada to be released on Tuesday. CPI data is expected to confirm rising inflationary pressures from as estimates indicate that headline inflation could reach pre-recession levels

JPY: ECO WATCHERS SURVEY AT 2 YEAR LOW

The Japanese Yen strengthened against all of the major currencies today with the exception of the New Zealand dollar, while the Nikkei fell marginally and demand for Japanese Government Bonds increased significantly. Bond futures gained for the third consecutive day as data released by the Chinese government showed that consumer prices rose more than expected yet again, sparking speculation that Asia’s largest economy will step up tightening measures in the second quarter to tame growth. Bank of Japan Governor Masaaki Shirakawa mentioned that there had been 12 auctions for new JGBs worth 35 Trillion Yen since the disaster, with the latest successful auction of 5-year JGBs yesterday, and said “it is still possible to issue securities at low interest rates in a stable manner.” The Yen fell below the 83.00 level against the US dollar after hitting the 85.50 level less than two weeks ago. The EUR/JPY pair dipped under the 120 level after crossing the 123 mark earlier this week, while the GBP/JPY fell over 500 pips since last week to the 135 level. The Ministry of Economy, Trade and Industry reported revised Japanese Industrial Production growth figures from the previous 0.9 percent to 1.8 percent in the month of February on a monthly basis and showed a healthy 2.9 percent increase on a yearly basis. Meanwhile, the Capacity Utilization rate rose 2.9% although the pace of increase fell from the previous month. The Economy Watchers’ Survey index for current economic conditions released today fell to a two-year low as the March 11 catastrophe severely hurt public sentiment. At a press conference yesterday, Sadakazu Tanigaki, the head of Japan’s largest opposition party said “the time has come for the prime minister to decide whether to stay or step down.” Mentioning Naoto Kan’s handling of last month’s disaster and the nation’s ongoing nuclear troubles, he added “to continue under this structure would be unfortunate for the Japanese people.” Japan’s Economic and Fiscal Policy Minister Kaoru Yosano said today that levying a new type of tax to finance the nation’s reconstruction efforts is a choice the government is currently contemplating. Yosano also mentioned that he expects the G7 major nations and G20 emerging market economies to state that they are ready to help Japan rebuild. On the calendar for Japan next week are March Consumer Confidence, Machine Tool Orders, Imports & Exports, and Leading Index figures.

NZD/USD: Currency in Play for Next 24 Hours

The NZD/USD will be our currency pair in play for Monday. New Zealand is expected to release Consumer Price Index figures on Sunday at 6:45 PM NY TIME / 22:45 GMT. From the United States, we expect the National Association of Home Builders’ Housing Market Index figures at 10:00 AM NY TIME / 14:00 GMT, followed by a speech on the nation’s economic outlook by Dallas Federal Reserve President Richard Fisher at 12:30 PM NY TIME / 16:30 GMT.

The NZD/USD gained for the fourth consecutive day, and remains within a very strong uptrend for the 17 ^th straight day, which we determined using Bollinger Bands. The pair has been in a strong bullish channel since hitting its 2011 low of 0.7114 last month, rallying nearly 900 pips or 11 percent. The pair is trading within 200 pips or less than 3 percent of its historic February 2008 high. The nearest level of support is channel support at 0.7900. If the pair falls below this level, the 10-day simple moving average of 0.7822, which coincides with the upper one-standard deviation Bollinger Band should provide further support. The closest level of resistance is channel resistance at 0.8100. If this level is crossed, the high of 0.8214, reached in February of 2008, should serve as major resistance.

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