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FX-Still Watching Bernanke And China
Perspective | 15 July 2013
By: Kathy Lien
Articles (9) Profile

This article is written by Kathy Lien, Managing Director of FX Strategy at BK Asset Management, and has been republished with permission on Shares Investment.

The volatility in the forex market in the week (8 July-12 July 2013) was driven primarily by disappointing economic data out of China and dovish comments from Fed Chairman Ben Bernanke. Unfortunately these same factors will also dictate currency flows this week. The action heats up immediately on Monday when China releases its second quarter GDP numbers. Economists are looking for growth to slow from 7.7 percent to 7.5 percent but last night, China’s Finance Minister said he expects growth this year to come in at 7 percent, which means that either growth will crash in the second half of the year or Q2 GDP will miss expectations with growth in China slowing more gradually throughout the year. Weaker Chinese growth has proven to be not only negative for the commodity currencies but risk appetite in general. So if Chinese GDP numbers surprise to the downside, all of the major currencies could weaken, translating into potential strength for the dollar against everything except for the Japanese yen. Of course, if there is an upside surprise and growth accelerates which we find highly unlikely, it would help all of the major currencies enjoy a much needed recovery.

China’s economic reports are important but the impact should only last for a day or two before the market shift’s its focus back to Fed policy. Bernanke will be delivering his semi-annual testimony on the economy and monetary policy to the House on Wednesday and the Senate on Thursday. While we can’t imagine the comments from the central bank head deviating much since his speech this week, under tough grilling by Congress, he may be forced to provide further clarity on monetary policy. The US retail sales report is also scheduled for release and a continued pickup in consumption is needed to sustain the rally in the US dollar. Today, the greenback attempted to regain momentum and successfully traded higher against most of the major currencies. Throughout the last week, we were surprised by the magnitude of the dollar correction because we did not feel that Bernanke’s comments altered the timing for tapering enough to warrant the sharp reversal in the greenback. Barring any surprise deterioration in US data, we believe the Fed will begin reducing asset purchases in September. With two months to go before this meeting, if the US economy continues to recover, the central bank may opt to become more vocal about their intentions to prepare the market for a change in monetary policy and as that occurs, the process should be positive for the dollar.

EUR – More Dovish Comments From ECB
The euro resumed its slide against the US dollar on the back of weaker economic data and renewed political troubles in the region. Eurozone (EZ) industrial production dropped 0.3 percent in May after rising 0.5 percent the previous month. We have seen nothing but disappointments in EZ data and this trend is likely to continue with next week’s German ZEW survey of investor confidence. While the sell-off in the euro was driven primarily by dollar strength, Portugal asked the Troika to delay its quarterly review of reforms until late August / early September. This suggests that the country hasn’t gotten its finances in shape for the audit but the government says its request is tied to political uncertainty. Either way, Portuguese 10 year bond yields jumped 50bp today, as a result. ECB member Constancio reiterated Draghi’s position on easy monetary policy. He said “Europe is behind the US in economic recovery and inflation risks which implies that monetary policy has to stay accommodative for a longer period of time”. ECB Chief Economist Praet also indicated that there is intensive discussion within the ECB to release minutes for policy meetings. We feel that the euro will be a dog in the currency market but with no major releases on the EZ calendar next week outside of the ZEW survey, its performance will hinge largely on the market’s reaction to US retail sales, Bernanke’s comments and Chinese data.

AUD – Driven To Fresh Lows On China Concerns
The Australian dollar was hit hard by US dollar’s strength, dropping as much as 1.5 percent to its lowest level in 2.5 years but so far 90 cents still holds. New home loans rose less than expected but the catalyst for AUD weakness is the increasingly grim prospects for China’s economy. Whether or not 90 cents gives way could be decided today when China releases its second quarter GDP report along with industrial production and retail sales. If the data shows growth slowing, the sell-off in the AUD should gain momentum. At this stage, given the deterioration in China and Australia’s economy, there is a case for another rate cut by the Reserve Bank. At the last two meetings, the RBA reaffirmed their dovish bias, ignoring the simulative impact of a weaker currency. Based on incoming data, Australia has not received much support from the decline in its currency. The economic calendar for Australia is light this week, leaving Chinese data and Bernanke’s comments as the primary catalyst for AUD’s volatility. Given the fundamental dynamics driving the US dollar higher and the Aussie lower, we feel that it should only be a matter of time before support at 90 cents is broken. The New Zealand dollar continues to fall in sympathy with the Australian dollar while the Canadian dollar gave up some of its recent gains, shrugging off the rise in oil prices. The Bank of Canada meets next week and monetary policy is expected to remain unchanged.

GBP – Looking Into The Mind Of Carney
After two strong days of gains, the British pound ended the day lower against the US dollar. As the new Bank of England (BoE) Governor, Mark Carney has made a point to increase the transparency of the central bank. This week, we will get a much better sense of his degree of dovishness with the release of the BoE minutes. Despite the strong volatility in sterling this week, very little economic data was released. Carney’s dovishness raised skepticism about the strength of the UK recovery that was later validated by weaker industrial production and trade figures. There is a tremendous amount of top tier UK data scheduled for release this week and these releases will give us a better assessment of whether the recovery is really at risk or if Carney is being overzealous during his first week on the job. The numbers that we are watching include consumer prices, jobless claims and retail sales. The BoE minutes will also be very important. If Carney takes over King’s bias and votes in favour of more stimulus, which is very possible, we could see a renewed sell-off in sterling.

Will USD/JPY Ever Recapture Its Highs?
For most of last week, the performance of the Japanese Yen has been mixed. While Japan’s currency weakened against the US dollar, it held firm against the euro. This divergent performance of the yen suggests that the big moves are happening outside of Japan and the yen is at the whim of the volatility of the forex market. Part of the reason why yen driven momentum at the beginning of the year has faded is because Japan is comfortable with its current level of monetary policy. Last night, the Bank of Japan (BoJ) upgraded its assessment of the economy, saying that “Japan’s economy is starting to recover modestly.” No imminent changes are expected from the BoJ and steady monetary policy is the main reason why there has been no consistency in the performance of the yen. This means that the outlook for USD/JPY hinges on the outlook for the US dollar. At the beginning of this year, we said three criteria needs to be fulfilled for USD/JPY to reach new highs. This was a rally in the Nikkei, rise in US 10 year bond yields and Japanese purchases of foreign bonds. After having fallen 20 percent from its May highs, the Nikkei has rebounded 14 percent. According to this week’s report, Japanese investors were net buyers of foreign bonds for the first time since May. The missing element in this equation is US yields and until they rise again, it will be difficult for USD/JPY to recapture its highs. Next week will be a critical one for USD/JPY but volatility in the pair should come from US and not Japan.

Kathy is a well-known expert in the Forex world and has over 10 years of trading experience in the forex market. She is frequently seen and quoted on international media platforms such as CNBC.

Please click here for more information about this author.

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