- Ranges hold and the chop continues
- Carry trade meltdown increasingly likely
- FOMC rate decision due next week
- Key data and events to watch next week
Ranges hold and the chop continues
Currency traders are certainly having their patience tested as most major pairs continue to bounce around in relatively well-worn ranges. The outlook for a break of recent ranges is pretty weak at the moment, given the ongoing data battle between high inflation readings and slowing growth indicators. And those data jousts are taking place in virtually every G-10 economy as the rise in inflation pressures and the slowdown in economic growth are global phenomena. I think traders should continue to approach the market from a range-trading perspective, and only go with a break-out if there is significant ‘new’ news out.
Scanning the horizon for potential catalysts that might lead to a break-out, my primary focus is on oil prices at the moment, and they too are rangebound between $130/140/bbl. The inverse correlation between oil prices and the USD (oil down/USD up and vice versa) remains intact and depending who you ask, it’s either oil driving the USD or the USD driving oil. Demand destruction, the market’s euphemism for reduced demand due to higher prices, is taking place, with China the latest player to address soaring energy prices by reducing fuel subsidies, effectively raising prices by about 18%. But for every indication of reduced demand, there seems to be an offsetting supply (Nigerian rebel attacks) or other sort of disruption (Israel reportedly rehearsing for a strike on Iran) that sees oil prices hold firm. Still, the laws of supply and demand remain in effect and reduced demand is more likely to permeate prices at some stage than not.
In terms of price levels, I am watching the $130/bbl level with great interest. It is both a key Ichimoku level (Kijun line is at 130.32 currently, and price is below the Tenkan line at 135.35, suggesting a downside shift is taking place) and round number psychological support. A break below that level is likely to see a sharp drop to the Ichimoku cloud, currently at the $121-122/bbl level, but rising to about $125 by the end of next week. The $140/bbl level is the upside trigger. A break lower in oil prices will in turn lend strength to the USD and pressure EUR, GBP and other key currencies.
Carry trade meltdown increasingly likely
Another potential spark to break us out of recent ranges is a fresh wave of carry trade liquidations (selling of long JPY-cross positions, like EUR/JPY or GBP/JPY). Recent stock market declines have so far been characterized by relatively low levels of volatility, which have allowed carry trades to resist sharp set-backs. But this week’s declines have seen the VIX index perk back up, though it’s still below the 25 level. Newly unsettled financial markets are just beginning to rumble, and I expect volatility to intensify as renewed doubts over financial and consumer cyclical shares increase. Ratings downgrades spanning the spectrum of businesses continue to keep the outlook sensitive, and I think it’s only a matter of time before risk aversion rears its head again and investors run for cover. Interest rate hikes by key central banks, Mexico today and the ECB expected on July 3, all in the name of fighting inflation, are undermining growth outlooks further, leading to a negative cycle of stagflation in many economies. As a proxy for carry trade weakness, I’m looking at 166.70/80 in EUR/JPY and the 106.50 level in USD/JPY as likely trigger points to major JPY-cross selling.
FOMC rate decision due next week
The main event next week is the Federal Open Market Committee meeting on interest rates and accompanying press statement. The two day meeting runs from June 24-25 with the press statement released at 14:15ET on Wednesday, June 25. The idea that the Fed will leave interest rates unchanged has been fully embraced by the market, with all 96 Bloomberg estimates looking for a steady 2.00% result and the futures market pricing in a slim 2% chance that the Fed hikes 25 basis points. As such, the focus falls squarely on the press statement.
We look for the Fed to make some minor tweaks to the economic and inflation assessment while their take on financial market stress and deep housing contraction will be unchanged. Bernanke’s speech two weeks ago at the Boston Fed will likely prove prescient in what we can expect. The characterization of economic activity will likely be upgraded to something that notes lower risks of a substantial downturn, echoing Bernanke’s comments. On household spending we expect the Fed to point out that the fiscal stimulus has thus far led to a tangible pickup in consumer spending -- the latest retail sales report showed this loud and clear.
That said, the most pertinent part of the communiqué will undoubtedly be how the Fed’s assessment on inflation and risk bias changes. We look for the committee to note an uncomfortable increase in inflation expectations and a more pronounced risk of rising inflation on the back of higher food and energy prices. They might even go as far as to change their symmetric risk assessment (risks balanced between growth and inflation) to focus more on inflation. Indeed, Bernanke noted how the FOMC will strongly resist an erosion of longer-term inflation expectations and thus it is quite possible that the Fed will harp on this further. In our view, however, the FOMC is likely to leave the risk assessment balanced towards both growth and inflation. Given the continued deterioration in housing, stressed financial markets, a weakening labor market and the unknown about how post-stimulus consumer spending will hold up, we believe the Fed will be prudent and will not shift their overall bias.
In terms of what this means for the USD pairs, we would expect to see a USD bullish reaction to the initial headlines as the market is likely to focus on the hawkish inflation characterization and bid the buck up. However, anything short of the FOMC changing their bias towards inflation or suggesting that current rates are now accommodative is likely to see initial knee-jerk gains in the USD dissipate, potentially presenting a short-term trading opportunity.
Key data and events to watch next week
US data kicks off on Tuesday with the April S&P/Case Shiller home price index, June consumer confidence, June Richmond Fed index, and the first day of the FOMC meeting. Wednesday morning sees May durable goods orders and May new home sales, followed by the FOMC rate decision in the afternoon. Thursday sees final 1Q GDP and PCE, weekly jobless claims and existing home sales for May. Friday concludes with May personal income and spending, May PCE and final June Univ. of Michigan consumer sentiment.
Top tier data abound for the Eurozone next week, kicking off with June PMI manufacturing and services surveys for France, Germany, and the Eurozone and the June German IFO surveys on Monday. Tuesday sees May French consumer spending and July German GfK consumer confidence. May French producer prices, Eurozone April current account and Eurozone consumer confidence for June round out the rest of the week. Note that German CPI is scheduled for release between Wednesday and Friday as well. For central bank speakers we have the ECB’s Trichet scheduled on Tuesday and Weber on Wednesday. Both are likely to continue to bang the table on inflation, further solidifying rate hike expectations for July.
Japan is bustling with economic data releases next week, starting with the trade balance for May on Tuesday and small business confidence for June on Wednesday. Thursday is a busy one with the jobless rate, consumer prices, industrial production, and retail trade all for the month of May due up -- so expect some price action here. The speaking circuit looks light with only BOJ Board Member Nakamura on tap on Wednesday.
In the UK, home price data early in the week could set the tone for the Pound. Rightmove June house price data is scheduled for Sunday evening while Wednesday brings nationwide house prices for the same month. Also on Wednesday, we get the all important CBI distributive trades report for June. GDP and current account data for 1Q round out the week on Friday. The BOE’s Governor Mervyn King, Deputy Governor John Gieve and Executive Director Paul Tucker, will testify to Parliament's Treasury Committee on the inflation report on Thursday.
The Australian data calendar is relatively light, starting with new motor vehicle sale data for May on Monday. Thursday we will see the Conference Board’s leading index for April and job vacancy data for May. Lastly, in central bank speak we will hear from RBA Assistant Governor Debelle on Friday.
The Canada schedule looks even skimpier next week. The action kicks off with a speech from the BOC’s Deputy Governor Sheryl Kennedy in Alberta on Monday. Then in terms of data we only have May industrial and raw material price indices due out on Friday. Given the attention to inflation, these data points could prove market moving.
New Zealand is bit busier, though just moderately so. It all starts with credit card spending data for May on Monday. Then on Wednesday, the June Westpac McDermott Miller consumer confidence index and 1Q current account balance data are on deck. The final noteworthy data points will come our way on Thursday in the form of 1Q GDP and the May trade balance – both should elicit some price action in Kiwi.
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