** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE
BEWARE OF FURTHER LOSSES IN FOREX
Problems in Europe and a corruption scandal for Wal-mart, the world’s largest retailer sent currencies and equities sharply lower today. All 3 U.S. equity indices fell approximately 1 percent with the series of lower highs and lower lows pointing the possibility of further losses. Technical patterns however are not the main reason why investors need to be wary of a deeper sell-off in the financial markets. Europe’s political troubles are just beginning and will most likely intensify over the next few weeks. At the same time, the three central banks convening on monetary policies will most likely have more negative than positive things to say about the global economy. Their pessimistic comments combined with a continued focus on Europe will make it difficult for the EUR/USD and risk appetite to recover. Political troubles dominate the headlines but don’t forget about Spanish bond yields which continued to creep higher, settling at 5.945 percent. Mark our words – Spain will come back to haunt the euro even though everyone’s attention is currently focused on France and the Netherlands. The week started off with softer economic data from around the world and unambiguously good news would be needed for the markets recover.
In the meantime, we are still watching the evolving situation in the Netherlands. Dutch Prime Minister Mark Rutte and his Cabinet have officially resigned after failing to reach an agreement on austerity measures. Over the weekend, the Netherlands held discussions on austerity measures and things got so heated that the leader of the Freedom Party walked out. Rutte will be delivering a press conference tomorrow and early elections will probably be held in the summer. Even though the Netherlands accounts for only a small portion of Eurozone GDP, this is a big deal for Europe because a political crisis in any Eurozone nation is bad news for the euro. Rating agencies have already threatened to strip the Netherlands of its AAA rating if it failed to agree on deficit reduction measures and another downgrade of a triple A nation is the last thing the euro needs. Also, the Netherlands has been a major supporter of fiscal austerity and a huge ally for Germany. The new government may take a different stance. France also held its first round of Presidential Elections on Sunday and Francois Hollande received the 28.6 percent of the votes versus Sarkozy who received 27.1 percent of the votes. He was expected to win the first round and is likely to win the second round in May. This is bearish for the euro because Hollande is a big advocate of renegotiating the European Treaty to emphasize growth over austerity. It took Europe a very long time to get where they are at now and to have to start from square one again would cause more problems than solutions. Disappointing Eurozone economic data also put pressure on the single currency. Economists had expected the Eurozone's composite PMI index to rise but instead, it dropped to 47.4 from 49.1 in the month April. Slower manufacturing and service sector activity weighed on overall economic activity with a particularly steep slide seen in manufacturing production in Germany. In fact, the manufacturing index fell to its lowest level in 33 months. The EUR/USD ended the NY trading session off its lows but the odds still favor additional losses in the currency as well as more risk aversion.
USD: DIVERGENCE IN POLICIES HAVING IMPACT ON CURRENCIES
Divergences in monetary policies around the world are finally having an impact on currencies. Normally on a day when equities have fallen sharply, we expect to see the U.S. dollar and Japanese Yen to trade higher against all of the majors. The Yen reacted logically by selling off globally but the dollar’s performance was inconsistent. The greenback appreciated against the EUR, AUD, NZD, and CHF but declined against the JPY and held steady against the GBP and CAD. We believe that the resilience of the GBP and CAD has a lot to do with their central bank’s plans for monetary policy. Last week we learned that the Bank of England has grown less dovish while the Bank of Canada has grown more hawkish. Although the BoE will not tighten monetary policy anytime soon, the BoC could become the only central bank to raise rates this year. How the Fed compares will determine not only how the dollar trades in general but also whether the GBP and the CAD can continue to hold firm in the face of risk aversion. Since the last monetary policy meeting in March, we have seen improvements and deterioration in the U.S. economy. Unfortunately weaker data was seen in the areas where it matters most – both retail sales and non-farm payrolls grew at a slower pace last month. There was no U.S. economic data on the calendar today but consumer confidence, the Richmond Fed manufacturing index and new home sales are due for release tomorrow. Housing and manufacturing numbers are likely to be weak following softer Philly Fed and existing home sales reports. Starting on Tuesday, the focus should shift to this week’s Federal Reserve meeting and the chance of QE3.
GBP: FRESH 20 MONTH HIGH AGAINST EUR
The British pound held steady against the U.S. dollar and rose to a fresh 20 month high against the euro. The Bank of England published the Asset Purchase Facility Quarterly Report – 2012 Q1 today. The report stated that nominal gilt yields in the BoE’s portfolio rose in the first quarter of 2012 and on average are 30 basis points higher than last quarter. The report also shows that the bond market and commercial paper market continued to function well thereby increasing investor sentiment. U.K. inflation will not be in the government’s 2 percent target range for the third year in 2012, according to research by a leading thinktank – and will not hit its goal until another three years after that. The Center for Economic and Business Research (CEBR) says high oil and commodity prices will keep adding to increases in the cost of living in Britain this year and that inflation will only slow in the fourth quarter of 2012 to 2.7 percent. The economy, however, will expand at a faster-than-expected rate, the CEBR said. The report said that inflation in the U.K. used to be driven by labor costs; now it is driven by high and rising demand for oil and other primary commodities from the emerging economies. As crude oil hovers around $120 a barrel and the United Nations reports of soaring food prices for dietary staples, inflation above target may be a longer-term issue. The Bank of England had forecast that inflation would fall rapidly throughout 2012, before hitting its 2 percent target by the end of this year. A small rise in inflation in March halted the decline – U.K. inflation came in at 3.5 percent, following February’s 3.4 percent. The Bank England has been pursuing a quantitative easing program which is now valued at 325 billion pounds. The original target was 200 billion pounds and has undergone two increases since January of 2009. The current target value of the program is up for review when it ends in May. The monetary policy committee is expected to hold off on any expansion in the interest rate given the jitters over current inflation forecasts. The Bank of England has been dealt the worst possible hand of cards: high inflation and slow growth on a persistent basis. Any decision the policy makers undertake at this point could be criticized from at least one perspective.
AUD: WEAK CPI WILL PUSH THE RBA TO CUT RATES
The Canadian dollar held steady against the greenback while the Australian and New Zealand dollars extended lower. As mentioned in the dollar portion of our commentary, the Bank of Canada is one the world’s most hawkish central banks. Last week, they said that an interest rate hike may be needed, citing strength in the overall economy. Today, we learned that wholesale sales jumped 1.6 percent in the month of February. This was a big surprise because economists had predicted another monthly decline but sales rose by its strongest pace since May 2011. Wholesale sales tends to have a strong correlation with retail sales and for this reason, we also expect tomorrow’s consumer spending report to show a strong increase in demand. The BoC would not have been so optimistic if there was any chance of spending being weak. The Australian dollar on the other hand was an easy victim of risk aversion following last night’s surprise decline in producer prices. For the first time since the fourth quarter of 2009, producer prices declined, falling 0.3 percent against expectations for a 0.4 percent rise. Weaker demand from China and a strong currency has lowered inflationary pressures significantly. The RBA had previously signaled that they could cut interest rates if weaker than expected growth slows consumer inflation. Tonight CPI numbers are due for release and a soft reading would increase the possibility of a rate cut next month and could potentially drive the AUD/USD below its year to date low. No economic data was released from New Zealand overnight but credit card spending numbers are scheduled for release this evening.
JPY: A DRIVE TO SAFETY
The Japanese yen strengthened against all the major currencies today as political turmoil in Europe spurred demand for safe haven assets. No new economic was released this past weekend. Over the weekend finance leaders of G20 nations agreed to provide additional capital of $430 billion that will be directed in increased lending in the Eurozone. Japanese Finance Minister Jun Azumi’s calls for support before the meeting were heard: He said “More than a dozen countries said that given Japan has pledged funds, they would do the same.” Investors were cautious at the start of this week as speculation mounted that the Bank of Japan may expand its $800 billion asset purchase program. The central bank is expected to step up the fight against deflation this week by increasing the size of its asset-purchase fund, but could hold off for now from buying bonds with longer maturities. This move would signal that the BoJ is committed to its recently stated goal of a 1 percent increase in the price level, but also that it won’t let its policy be dictated by market expectations. Speculation that the bank will introduce more easing is widespread. A surprise easing in February, when the bank boosted its government-bond buying by 10 trillion yen and introducing a stated inflation target, succeeded in pushing down the yen and boosting share prices. This invited expectations that more drastic measures could follow. Adding fuel to hopes of further easing, the yen has been gradually rising from lows hit after that February surprise. However, the central bank will be reluctant to pull a surprise move again for fear of damaging the credibility of its policy judgment. The bank is already under strong political pressure, with some politicians even calling for it to be stripped of its independence. Last week Economy Minister Motohisa Furukawa said that buying bonds with longer maturities was an option for the BoJ. It has been buying bonds with remaining maturities of up to two years. "For the time being, the bank will aim to achieve the goal of 1 percent inflation in terms of the year-on-year rate of increase in the CPI and continue to pursue powerful monetary easing until the goal is in sight," BOJ Gov. Masaaki Shirakawa said in a speech last week in Washington. The policy board will release its forecast for consumer prices at the Friday meeting.
USD/CAD: Currency in Play for Next 24 Hours
Our currency pair in play for the next 24 hours is USD/CAD. We expect Canadian retail sales at 8:30 AM ET / 12:30 GMT. From the United States we have April consumer confidence, March new home sales and February house price index scheduled for release at 10:00 AM ET / 14:00 GMT.
USD/CAD has been compressing lately and is currently trading range-bound, which we determined using our double Bollinger bands. Nearest support is at last week’s low of 0.9864. Should the pair decline further, more significant support will be found at the 2012 low of 0.9841. To the upside, nearest resistance is at 0.9998, where the upper first standard deviation Bollinger band lies. Should the pair break out from there, heavier resistance will be found at the recent high of 1.0051.
