10/04/2015
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In the last four trading days the euro has taken out 4 big figures. On Monday, the currency was trading as high as 1.1035 versus the US dollar and Thursday it fell to a low of 1.0637. While the divergence in Eurozone and U.S. monetary policy provides the broad fundamental driver for EUR/USD weakness, disappointing Eurozone data, positive economic surprises from the U.S. and the fact that Greece is still making headlines is bad news for the euro. The latest sell-off was driven by no less than 3 key factors -- low Eurozone yields, stronger U.S. jobless claims and reports that the Eurozone has now given Greece a 6-day deadline to come up with a revised reform proposal if they want access to further bailout funds. According to Eurogroup officials, progress is being made but so far no one is satisfied with the steps that Greece has taken and the decline in the euro clearly indicates that investors are skeptical about the country's ability to come up with and then follow through with a credible plan. For as long as that remains the case, the risk of a Grexit remains on the table. At the same time, yields across Europe remain low -- 10-year German and French yields were unchanged as Treasuries rose 5bp. With banks charging a negative deposit rate, there are few alternatives for European investors other than to convert their euros into other currencies and invest in assets like U.S. bonds. Since these conditions are not expected to improve anytime soon, we expect further losses in the EUR/USD. Now that the March 31 low of 1.0713 has been cleanly broken, the next target for the currency pair will be 1.05 as the double top in the EUR/USD plays out nicely.
1: Dollar Extends Gains, IMF Warns of Bumpy Ride Ahead
U.S. rates are on the rise, driving the dollar higher against all of the major currencies. It took a while for Treasury yields to turn positive but when they did, it helped the dollar break through key resistance levels versus the euro and yen. Thursday morning's jobless claims report helped to set off the currency's rally. Only 281k claims were filed the week ending April 4, extending the string of sub-300k prints. That was the fifth straight week with jobless claims fewer than 300k, a trend that reinforces our positive outlook for the U.S. labor market and hardens the Federal Reserve's plans to raise interest rates. Slowly but surely, investors are reloading their long dollar bets, banking on a rate hike between June and September. While we are in the later camp, a solid case could be made for raising rates sooner. An increase in rates this year is such a certainty that global policymakers have begun talking about what the world will look like once the Fed begins hiking. IMF Managing Director Christine Lagarde warns of a "bumpy ride" with emerging economies and overpriced assets taking the biggest hits. "A long period of low interest rates in the U.S. and other advanced economies has fostered a higher risk tolerance among investors" and when the Fed starts to tighten, "liquidity can evaporate quickly." In some ways she is absolutely right because stocks are hovering near record highs and the bond market has yet to correct. A rate hike by the Fed should drive both stocks and bonds lower. While many have talked about the "imminent" bond-market correction, no one is positioning for a reversal in equities. The only piece of U.S. data scheduled for release Friday is import prices, a report that is not expected to have a significant impact on the dollar.
2 : CAD: Beware of Employment Report
The Canadian dollar was the only currency pair to end the day lower against the greenback but the unchanged daily price action of AUD and NZD masks significant intraday reversals. Both of these currencies were up sharply before they choked up their gains. A surprise decline in building permits kicked off the sell-off in the Canadian dollar and Friday's employment report could exacerbate the losses. Bank of Canada Governor Poloz has been nervous about Canada's economy because of the damage imposed by the steep fall in oil prices. While the price of crude appears to have stabilized, massive inventories still pose a downside risk for oil. Poloz even used the word "recession" when explaining why stimulus is needed and with housing and manufacturing activity directly affected by the price of Canada's most important export, another rate cut is on the table. We believe Friday's employment report will show that the economy faces "significant headwinds." According to IVEY PMI, the jobs situation is deteriorating rapidly. The employment component of IVEY PMI shows how the index has moved below the key 50 mark that delineates between job growth and job losses 2 months in a row. Economists are not looking for any job losses but according to Poloz's dovish comments and the IVEY PMI report, March should have been an ugly month for the labor market. As such we expect USD/CAD to extend its gains on the back of Friday's employment report. Meanwhile, overnight AUD and NZD benefitted from strong Australian construction-sector data and comments from Prime Minister John Key who felt that NZD intervention would never work. Australian housing-market numbers were scheduled for release Thursday evening along with Chinese inflation data.
3: Sterling Hit Hard by Dollar Strength
Like the euro, sterling was hit hard by U.S. dollar strength. While the gap between U.K.-U.S. monetary policy won't be as large as the gap between EZ-US policy, the Bank of England's decision to leave rates unchanged Thursday morning highlights the passiveness of the central bank. Adding pressure on the currency was mixed economic data that made the case for a near-term rate hike even weaker. While house prices rose at a faster pace according to Halifax, the country's trade deficit ballooned to 2.9 billion pounds in February from 1.5 billion in January. Imports rose 0.3 billion while exports fell 0.9 billion. Considering that a large part of the deterioration was caused by weaker demand from the European Union, we can't help but blame this deterioration on EUR/GBP. Last month, sterling climbed to its strongest level against the euro in 7 years and clearly the trend of the currency combined with weak growth in the Eurozone weighed heavily on trade activity. Industrial production numbers are scheduled for release Friday and chances are the report won't provide much support to the currency.
