What Will Drive The USD Next Week

  Unfortunately these Tier 2 economic reports will only have a limited impact on the U.S. dollar.  The reason is because none of next week’s data points are considered important enough to alter the Federal Reserve’s outlook for the U.S. economy, let alone change their monetary policy plans.  In all likelihood, the data will be mixed with a slightly weak bent that confirms the sluggish pace of the U.S. recovery.  So if next week’s economic reports are not expected to have much impact on the U.S. dollar, then what will?  The answer is the end of Quantitative Easing and flight to quality.

Back in November of 2010, the Federal Reserve announced a plan to buy $600 billion in long term Treasuries in an operation that was set to last for 8 months.  This program was aimed at stimulating the economy by keeping interest rates low.   Having dropped the Federal Funds rate to a record low in December 2008, the central bank has resorted by buying Treasuries to drive rates even lower.  The first round of Quantitative Easing ended in April 2010, but the program failed to effectively stimulate the economy and as a result, the central bank announced another round of asset purchases with the hopes that it will have a more significant impact on the economy.  Taking a look at how the U.S. is performing at this time, the Fed’s success is questionable.  The pace of recovery has slowed materially with the unemployment rate still at uncomfortably high levels.  The central bank will argue that without QE2, the economy would have grown at an even slower rate, but for many people, this is hard to believe.  The Fed’s Quantitative Easing program received significant criticism, which is a big reason why the central bank did not opt to extend its asset purchases.  Instead, the program will come to an end next week as scheduled.  However the economy is not performing well enough for the Fed to completely remove stimulus, which is why they will reinvest principal payments of maturing securities for as long as they deem necessary.  Without a big buyer like the Fed coming in everyday to buy Treasuries, yields should begin to trickle higher, which should be positive for the U.S. dollar.  In fact, the end of Quantitative Easing should mean the beginning of a longer-term dollar rally that could begin as quickly as the end of next week.

However in the beginning of the week, the dollar will fluctuate based upon the developments in Greece.  The Greek Parliament will be voting on the country’s Austerity program and the fate of the financial markets will hinge upon the outcome of that vote.  U.S. economic fundamentals may be important but the dollar is also a safe haven currency and with such a big event risk happening in the early part of the week, the desire for safety will determine whether the dollar rises or falls.  If the Austerity Package is passed by the Greek Parliament, safe haven flows will recede as investors celebrate by buying high yielding currencies.  In this case, the dollar should fall sharply against currencies such as the euro, British pound and Australian dollar.  If Greece fails to approve the package, investors will become very nervous and we will most likely see a massive flight to quality into safe haven currencies such as the U.S. dollar and Swiss Franc.

EUR: GREEK AUSTERITY VOTE

Next week is a very big week for Greece and the financial market as a whole.  After surviving the no confidence vote last week, Greek Prime Minister Papandreou has spent all of his time trying to gain support for a EUR28 billion 5 year Austerity Program that will determine whether Greece receives its next tranche of aid from the EU and IMF or any additional monetary policy thereafter.   The EU/IMF have pledged to do all that they can to help Greece but if the Greeks do not help themselves first by passing this package, their European neighbors may end up stepping to side, forcing Greece to default on their debt.  A default by Greece would have severe repercussions which is why European officials are so motivated to get a deal done and investors around world are holding their breath for the announcement.  According to a Greek Parliament official, debates on the package will begin on Monday and continue through Wednesday morning of next week (June 29), after which a vote will be taken. Then a separate debate will occur on the implementation and a vote on the implementation legislation will occur on Thursday (June 30).  The Greeks have an internal deadline of June 30 ^th to get Parliamentary approval for the bill, which is days before the Eurozone Finance Ministers meeting on July 3 ^rd .  EZ finance ministers have given Greece July 3 ^rd as the drop dead date to pass the bill, otherwise they risk losing their next aid payment.  Although there has been some speculation that the EU/IMF/Greece have reached an agreement on an aid package, getting enough support in Parliament is not a done deal.  With thousands of protestors screaming and yelling in front of Parliament, the talks could fall apart, leaving Greece with no choice but to default on part if not all of their debt.  Central banks around the world have warned that a default by Greece could trigger a financial tsunami across Europe with waves that will reach the shores of the U.S. and Asia. Greece may be a tiny country with a small GDP but European banks are heavily exposed to Greek debt.  Banks in France and Germany have the most exposure and even though direct lending by U.K. and U.S. banks are not as substantial, credit guarantees by banks in those countries put them at greater risk.  A default by Greece would touch almost every single person in the developed world because it would probably tip off a global financial market sell-off that could be as bad as Lehman Brothers.  Defaults by governments are extremely rare and when one occurs, it creates panic and losses for investors around the world.  This is why the world needs Greece to pass their austerity program next week and currencies and equities will live and die by the vote. German retail sales and unemployment numbers will also be released next week but these reports will easily be overshadowed by the developments in Aegean Sea.

GBP: COULD THE BOE RESTART QE?

The British pound continued to trade lower against the U.S. dollar, breaking below the technically significant 1.60 level in the process.  No major U.K. economic reports were released last evening but investors are starting to position for the possibility of more Quantitative Easing from the Bank of England. U.K. gilt yields have declined across the board while interest rate expectations went from pricing in a rate hike in May 2012 to July 2012.  In the beginning of the year, the market was looking for the central bank’s first rate hike to come in May of this year and now rate hike expectations have been pushed out by 14 months, showing just how worried investors have become about the outlook for the U.K. economy.  Interestingly enough, even though the GBP/USD is trading more than 600 pips lower than its May high, it is not far from its January levels.  Weaker economic data and dovish BoE minutes have prompted an aggressive adjustment in both rate hike expectations and sterling positioning.   In his speech related to his new role as Chairman of the Financial Policy Committee, Bank of England Governor Mervyn King warned about the risks that the EMU crisis poses to the U.K. economy and this concern is yet another reason why the central bank leans towards easy monetary policy.  Regardless of whether the BoE opts for more QE, unless there is a material improvement in the U.K. economy, the British pound should continue to underperform relative to other major currencies.  The final first quarter GDP numbers are expected from the U.K. next week followed by the index of services and manufacturing PMI.

CAD: DECLINES AS OIL CONTINUES TO FALL

While the price of oil continued to its decline, the US dollar traded higher against all three commodity currencies – Australian, New Zealand, and Canadian dollar. The market saw the International Energy Agency’s release of emergency stockpile yesterday as another attempt to stimulate the lagging recovery. As the news caught the market by surprise, there would likely be more volatility in the short-term market. Nevertheless, the effect on the Canadian dollar could be minimal. A similar measure was adopted after Hurricane Katrina disrupted the supply of oil in the Gulf region. On September 2 ^nd , 2005, 21 million barrels of reserve oil were released by the IEA. Although the WTI spot price drifted lower, the loonie advanced against the dollar throughout the month of September. Since the US consumed about 15 million barrels of oil per day, the addition of 60 million barrels served a more psychological effect in curbing speculation in the market. On a fundamental level, the export performance and the weak US recovery are hindering the Canadian economic expansion, according to Bank of Canada Governor Mark Carney. In addition to the gloomy outlook of US recovery, the current strength of the loonis is hurting the largely export dependent country. “In an environment of substantial head-winds,” Mr. Carney said, “monetary policy may still need to be stimulative in order to close the output gap and get inflation back to target.” The BoC is in a very precarious position juggling between the head-winds in the economy and the possible overheat of the housing market. The CAD would likely remain at the current high until the market sees more encouraging signs out of the US. We expect a few key pieces of data from the commodity countries next week – trade balance and building consents from New Zealand, home sales and PMI from Australia, CPI and GDP from Canada.

JPY: TANKAN DUE NEXT WEEK

The Japanese Yen strengthened against every major currency with the exception of the Swiss franc.  The risk-averse mood in the markets is persistent as investors seek safer assets in response to the global economic slowdown.  Focus is on Japan’s quarterly Tankan survey, scheduled for release Friday July 1 ^st .  It is expected to fall significantly m due to the effects of the March 11 natural disaster.  The Bank of Japan posted an explanation of the report’s survey method to their homepage earlier in the day.  It said that the “Great East Japan Earthquake may cause unprecedented effects on the survey results” and gave explanation on how to interpret the release.  This could be the central bank’s way of preparing the market for a weak number. Some of the businesses usually surveyed may have difficulty responding to the survey under current circumstances.  In order to meet public interest, the central bank will release the number of reporting companies and the response rate in detail, together with the Tankan Summary on July 1 ^st .  The Cabinet Office said damage to buildings, roads, and ports from the disasters is estimated at 16.9 trillion yen ($209.8 billion), which is at the low-end of the government’s previous estimate. (Previous range was 16 to 25 trillion yen.)  Japan’s bonds headed for a second weekly gain before European finance officials decide on July 3 ^rd whether Greece has met conditions for its next tranche of aid approved a package last year.  Last night 10-year securities touched the lowest level this year on concerns Greece’s PM George Papandreou will struggle to pass austerity measures.  Japanese corporate service prices printed worse at -0.9 percent indicating that the economy is still struggling to regain its footing.  However, Japan’s slump following the March 11 natural disasters may be too short-lived to be called a recession by the textbook definition of two consecutive quarters of contracting GDP.  The fall was rapid and steep and if the economy bottoms out quickly, a V-shaped recovery is still possible.

NZD/USD: Currency in Play for Next 24 Hours

The NZD/USD will be our currency pair in play for Monday.  From New Zealand, we expect the trade balance and exports and imports for the month of May on Sunday at 6:45 PM EST / 22:45 GMT.  From the United States, we expect core personal consumption expenditure, personal spending, and personal income for the month of May at 8:30 AM EST / 12:30 GMT.

The NZD/USD has been steadily rising over the past few months and is now trading rangebound, which we determine using Bollinger bands.  The pair has recently come off its three year high.  The nearest level of support is 0.8100, which is psychologically significant level and a level of contention.  Should the pair fall below this price, support should be found at the 50-day simple moving average of 0.8040.  To the upside, first resistance is at the upper first standard deviation Bollinger band price of 0.8212.  If the pair breaks out of this level, resistance may be encountered at its more than three year high price of 0.8300.

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