Forex Weekly Review and Outlook

Forex Weekly Review and Outlook

Dollar Weakens on Rate Outlook, Yen on Carry Trades

Carry trade and interest rate expectations were the main themes last week. On the one hand, dollar was pressured across board as FOMC minutes suggest that Fed will likely be on home this year while ECB, BoE, and RBA are all expected to raise rates further. Japanese yen, and to a lesser extend the Swiss Franc, also fell sharply across the board as carry trade is back into play. Even though the yen’s fall hesitate a little as G7 meeting approaches, further selling was triggered late Friday on rumors that G7 will make no specific comments on yen’s weakness. As a result, we saw EUR/USD making new 2 year high with EUR/JPY making new all time high, AUD/USD making new 17 years high while AUD/JPY made new 10 years high. A handful of economic data will be released in this busy week including retail sales and consumer inflation in the US but dollar will need to have a string of strong data to reverse recent weakness. The BoE minutes will also catch a lot of attention on how close the prior vote was.

Economic calendar in the US was light last week with focus mainly on the FOMC minutes. Fed members were facing risks on both growth and inflation. Regarding inflation, the minutes said that “the prevailing level of inflation remained uncomfortably high, and the latest information cast some doubt on whether core inflation was on the expected downward path,” and “upside risks to inflation appeared to have increased slightly in recent months.” All members agreed that Fed’s “predominant policy concern remains the risk that inflation will fail to moderate as expected”. Also, further policy firming might “prove necessary” to foster lower inflation. Regarding growth, the members noted that “additional evidence of sluggish business investment and recent developments in the subprime mortgage market suggested that the downside risks relative to the expectation of moderate growth had increased in the weeks since the January FOMC meeting.” Also, they agreed that the “possibility of persistently sluggish investment spending was an important downside risk to the outlook for economic growth.”

With “increased uncertainty about the outlook for both growth and inflation”, the FOMC also agreed that the statement should no longer cite “only the possibility of further firming. And that provided the answer to the the change of language in the last statement from “additional firming” to “future policy adjustments”. After all, we believe the minutes is neither hawkish, nor dovish. It’s not even neutral in a sense that the members are not comfortably certain that inflation and growth will play out as they expect with the current policy stance. The members are actually rather “uncertain” about which direction the next change will be. And it should need to take a series of consistently strong or weak data to prompt members to shift bias towards another hike or a cut. Otherwise, Fed will likely be on hold for the rest of the year.

Dollar was pressured earlier after news that US will file complaints to WTO against China, trying to reduce piracy of copyrighted intellectual properties including movies, music, software and books. The complaints, if filed, will trigger a 60 day consultation period during which trade negotiators from US and China will try to find a resolution. But if that fails, WTO hearing panels will be convened and if US wins the cases, it will be allowed to impose penalty economic sanctions on Chinese products. Chinese Ministry of Commerce Wang Xinpei responded by saying that “China very much regrets the decision and is strongly displeased”, and such complaint will “severely damage” trade relations. With US breaking a two decades long practice and imposed penalty tariffs on Chinese glossy paper imports last month, today’s news raises concern that the trade relationship between US and China will further deteriorate which would eventually hurt both economy as well as global growth.

Data from US saw export price and import price indices rose more than expected by 0.7% mom and 1.7% yoy in March. Trade deficit unexpected shrank by 0.7% to $58.4b in Feb from a revised $58.9b, better than expectation of $60b. PPI inflation data were mixed with PPI rose 1.0% mom, 3.2% yoy in Mar, higher than expectation of 0.7% mom and 3.0% yoy but core PPI was flat with 1.7% yoy increase comparing to consensus of 0.2% mom, 1.8% yoy. University of Michigan consumer confidence deteriorated further to 85.3 in Apr.

Eurozone’s focus was mainly on ECB meeting. ECB kept rate unchanged at 3.75% as widely expected. The speech from Trichet in the following conference was pretty much the same as the prior one. No “vigilance” was used by Trichet hence confirmed that there will be no hike in May. Trichet remains hawkish as he described “monetary policy continued to be “on the accommodative side” with key rates “moderate”. Even though inflation may fall in the coming few months, it’s expected to rise again towards the end of this year and hover at around 2%. Risks to price stability remains on the upside in the medium to longer term, coming from excessive money supply growth, with M3 growing at 10% and wage increases. ECB will monitor the development “very closely” and “acting in firm and timely manner remains warranted” in order to avoid these risks to materialize”. This is inline with the expectation that there will be another hike from ECB in June to raise rates to 4.00%. Trichet also said he would “not say anything today that would be aimed at changing expectations for June”, sort of indicating that market’s expectation on a June hike is correct. After all, market expects that ECB will not be done with the expected June hike and will go beyond 4.00%.

BoJ left rates unchanged at 0.5% on unanimous vote as widely expected. Economic assessment was left unchanged noting that economy is expanding moderately and should continue to do so. CPI is still expected to trend higher in the long run. The yen continued to remain pressured on carry trades. Further weakness could be seen as yen weakness was not directly mentioned in the official statement concluding the G7 meeting in Washington. The group only mentioned that recovery in Japan’s economy is on track and they will monitor exchange rates “closely”. Indeed, Yuan was the only currency that was singled out as the statement said it was “desirable” for the yuan to move to help close global trade imbalances

There were little UK data released last week. BRC retail sales and RICS house price both accelerated by growing 3.9% and 25.5%. Trade deficit widened to 6.8b in Feb from a revised 6.4b. The main market moving news was the Financial Times article which said that Treasury will propose allowing British based multinational companies to repatriate foreign profits free of tax, which is equivalent to the Homeland Investment Act in US. It’s believed that this proposal will bring UK tax system in line with mainland Europe and improve UK’s competitiveness. Sterling ended higher against dollar and yen but remains range bounded against Euro.

Commodity currencies remained strong last week as supported by rising commodity prices, their high yield status and expectation for further rate hike. In particular, Kiwi was boosted by much stronger than expected retail sales which nearly quadrupled expectations by accelerating 1.9% compared to a 0.5% consensus. Canadian dollar extended rally against dollar after stronger than expected new house price rise but rally was limited after narrower than expected trade surplus.

The Week Ahead

A handful of important indicators will be released this week with particular focus in US and UK. From US, special focus will be on retail sales and CPI. Retail sales was weak since Jan (flat with ex-auto rose 0.2% only) and Feb (rose 0.1% with ex-auto dropped -0.1%). Core CPI bottomed at 2.6% in Nov and Dec and re-accelerated to 2.7% in Jan and Feb. Markets expect a rebound in retails sales in Mar and moderation in core CPI and such data will provide some comforts to Fed members to remain on hold. Other data include empire state manufacturing index, TICS capital flow, housing starts, industrial production and Philly Fed index.

The economic calendar of UK is an equally important one with PPI, CPI, employment report and retail sales. In addition, the highly anticipated BoE minutes will be featured. Markets widely expect BoE to raise rate by 25bps in May and will look into the BoE minutes and the vote split for clues on confirming such view. More importantly, there are increased speculations that BoE will go beyond the May hike and need at least one more raise to bring interest rates down to it’s 2% target. This week’s data will be important in validating or invalidating this speculation.

From Eurozone, German ZEW economic sentiment, which bottomed at -28.5 last Oct is expected to rebound further to 10.0. Consumer inflation in Germany and Eurozone in March are both expected to revise higher in the final release. Other important data include Q1 CPI in New Zealand which is expected to rebound by rising 0.5% qoq. Canadian CPI and retail sales will also catch some interest.


EUR/USD surged sharply against dollar last week after finally taking out 1.3440 resistance decisively and reached as high as 1.3554 to close the week strongly. From a short term angle, with EUR/USD still staying comfortably within short term rising channel, the rise from 1.2865 is still in progress and should extend to 1.3668 (04 high). However, late Friday’s retreat suggest that an intraday top is formed after touching upper resistance of the short term rising channel (now at 1.3554). Hence initial outlook will be consolidative this week and some pull back will likely be seen towards 4 hours 55 EMA (now at 1.3424). But downside should be contained above 1.3404 support and bring rally resumption.

In the bigger picture, outlook remains unchanged. EUR/USD is still trading comfortably within medium term rising channel (1.1639, 1.2483, 1.2978) and medium term up trend from 1.1639 is still in progress. Such up trend is interpreted as having first move completed with three waves up to 1.2978, subsequent sideway consolidation completed at 1.2483. Rise from 1.2483 has made a top at 1.3364 but subsequent correction has completed with three waves down to 1.2865 already. The current rise from 1.2865 should represent resumption of this whole up trend and further rise is still in favor to retest 1.3668 (04 high).

Having said that, on the upside, risk of medium term reversal will increase as EUR/USD approaches 100% projection of 1.1639 to 1.2978 from 1.2483 at 1.3822 and focus will be then on reversal signals. On the downside, break of the lower support of the short term rising channel (now at 1.3325), will indicates that the rise from 1.2865 has completed. More importantly, this will be the first warning that the rise from 1.2483 has ended and thus the whole up trend from 1.1639 too. Focus will then be back to medium term rising channel (now at 1.2935).

In the longer term picture, it’s still early to conclude whether medium term rally from 1.1639 represents resumption of multi-year up trend from 0.8223 or just part of a large scale consolidation that started at 1.3668. But, the three wave corrective nature of the rise from 1.1639 to 1.2978 suggest that this whole rally from 1.1639 will be corrective in nature, thus, favoring the latter case. And therefore, as discussed above, focus will be on reversal signal when EUR/USD enter into resistance zone of 1.3668 (04 high) and 100% projection of 1.1639 to 1.2978 from 1.2483 at 1.3822. But sustained break of this resistance zone will path the way towards 95 high of 1.4523.

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