Has The Tightening Bias Dropped?
Forex Weekly Review and Outlook
Has The Tightening Bias Dropped? Bernanke in Focus Again
Interest rate expectation came back to dominate the forex market last week after
the risk aversion and carry trade theme faded. This could be characterized by dollar’s weakness after the dovish FOMC statement against higher yield currencies including GBP, AUD, NZD and even CAD when interest rate expectation on these currencies changed. Yen and swissy,
being the low yield currencies, weakened across the board too. And the net
effect was further amplified by strong rallies in yen and swiss crosses. Meanwhile, Euro ended the week mixed.
The biggest event last week was the FOMC meeting. Though the Fed kept rate unchanged at 5.25% as widely expected, there were some important changes in the language of the accompanying statement. Firstly, growth outlook was somewhat downgraded from “firmer economic growth” to recent indicators have been “mixed” and with “some tentative signs of stabilization have appeared” changed to “the adjustment in the housing sector is ongoing”. Secondly, regarding inflation, the statement has clearly spelled out that “risk that inflation will fail to moderate as expected” is still
the Fed’s predominant concern.
The most important change was the last part of the statement. In the Jan 31 statement,
the Fed minutes stated that “the extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” This was changed to “Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” This was taken as a sign that Fed has abandoned its tightening bias and has raised the probability of a rate cut in second half of the year. Dollar was sold off after such statement.
However, as another school of thought quickly came up afterwards with interpretation that
the Fed hasn’t really abandoned the tightening bias. The argument is that while the economic outlook was downgraded, the Fed did sound more hawkish and uneasy with inflation and dollar recovered towards the end of the week. There were a number of Fed member speeches after the FOMC meeting but none of them has offered any insight. Markets will be turning focus to Bernanke’s testimony this Wed for more clues. In our view, the recovery in dollar was mainly due to profit taking after the subprime market triggered selloff has reached a climax right after FOMC meeting. The current sentiments on dollar remains fragile and should Bernanke sound dovish, another round of dollar selling will be triggered.
On the data front, reactions to highly anticipated housing market data were muted. NABH housing market index dropped more than expected to 36.0 in Mar. Housing starts rebounded more than expected to 1.53m in Feb while building permits missed consensus of 1.55m and recorded 1.53m only. Existing home sales unexpectedly rose by 3.9% in Feb, faster pace in three years. Sale rose to an annualized rate of 6.69m, much better than expectation of 6.31m and revised 6.44m in Jan. Viewed together with a stronger than expected rise in housing starts earlier this week, these data suggest that there may be ‘sign of stabilization’ in the housing market, rather than continuous ongoing adjustment. Leading indicators dropped -0.5% in Fed, below expectation of -0.3%.
Data from Eurozone saw German PPI rose 0.3% mom, 2.8% yoy in Fed. Import price rose 0.5% mom, 0.8% yoy. Eurozone Trade balance unexpected turned to -7.8b deficit in Fed. Jan current account surplus came in above expectation at 2.7b. Industrial new orders dropped -0.2% mom only and grew 12.0% yoy in Jan. ECB officials remained hawkish by reiterating that monetary policy is still accommodative. In his testimony to Parliament, Trichet repeated that current ECB line of a strong economy with upside inflation risks. He also highlighted the concentration on money supply data as an indicator of expectations in the economy. Weber, a known hawk, said that he saw a strong price pick up in inflation and could well surpass 2% at the end of 2007 and into 2008.
Bank of Japan kept rates unchanged at 0.5% as widely expected. Fukui emphasized again that the central bank will keep rates low for some time and adjustment in monetary policy will continue to be gradual. Monthly economic assessment was kept unchanged, saying that economy is “expanding moderately” and private consumption “has been firm”. Feb trade surplus rose more than expected to 979.6b on strong exports that grew 9.7% yoy. The yen continued to retreat across the board as stock market rebounded. Reactions to PBoC’s rate hike was also muted.
Sterling rode on some solid economic data despite a more dovish than expected MPC minutes. CPI rose 0.4% mom in Fed, pushing yoy rate to 2.8%, up from prior 2.7%. Core CPI also accelerated from 1.6% to 1.7%. Meanwhile, both RPI and core RPI also came in stronger than expected. RPI increased 0.7% mom, 4.6% yoy vs expectation of 0.5% and 4.3%. Core RPI rose 0.5% mom, 3.7% yoy vs expectation of 0.4%, 3.5%. Retails sales rebounded strongly by rising 1.4% mom, 4.9% yoy comparing to consensus of 0.7%, 3.9%. However, BoE minutes revealed that the decision to keep rate unchanged at 5.25% in Mar was made by a 8-1 vote, wider than expected 7-2 with Blanchflower even voting for a rate cut. After all, even though expectation of a rate hike in Apr was scaled back a bit after the minutes, it’s still likely that BoE will have another raise before Jun. And if remember that MPC members will see that next set of inflation data before the markets and hence, BoE may yet surprise the market again in Apr. Nevertheless, if the next round of growth and inflation data remains solid, expectation that another hike is needed beyond Q2 for BoE to bring down inflation to its 2% target will continue to build up.
The Swiss Franc consolidates with the yen too as risk aversion theme faded on rebounding stock market. SNB Jordan stated that further interest rate increases were still necessary as a normalization of policy, although the need was now less pressing given the low inflation forecasts. Canadian dollar was boosted by stronger than expected CPI data which saw CPI rising 0.7% mom in Feb vs expectation of 0.3%. Core CPI growth also accelerated to 0.5% mom, 2.4% yoy versus expectation of 0.3%, 2.1%. Even though retails sales was a touch weaker than consensus, dropping -0.2%, the Loonies closed higher against dollar as that has eliminated the chance for BoE to cut rate any time son. The Aussie continued to rode on expectation of further tightening from RBA in Q2 as well as weakness in yen, breaking above 04 high of 0.8004 an reached as high as 0.8090.
The Week Ahead
Last week’s FOMC statement left the financial markets with an important question. Has Fed dropped
the tightening bias? Some believe so, some don’t. Such a question has put Bernanke’s testimony to Joint Economic Committee on the coming Wed into focus. On the data front, Chicago Fed survey, new home sales, conference board consumer confidence, durable goods orders, final Q4 GDP, Feb PCE Chicago PMI and construction spending will be released. Durable goods orders will catch most interest on whether it can rebound, by 2.3% as consensus estimates, after a sharp fall of -8.7% in Jan. Also, markets will like to know whether core PCE could moderate after Jan’s rise to 2.3%.
Focus in eurozone will be mainly on Germany’s Ifo index. This business climate index has peaked at 108.7 in Dec 06 and is expected to retreat further to 106.5 in Mar. Another set of important indicator will be German HICP inflation in Mar which is expected to accelerate from 1.9% yoy to 2.0%. Eurozone HICP is also expected to accelerate from 1.8% to 1.9% too. Eurozone M3 money supply will also be closely watched. M3 growth beat expectation by growing 9.8% yoy in Jan. However, comparing to the upward revised 9.8% in Dec, grow hasn’t accelerated in Jan. It will be interested to see this closely watched data has peaked in Jan. German Gfk consumer confidence, unemployment and retail sales will also be featured.
Minutes of Feb BoJ meeting, which raised rates by 0.25%, will be released on Monday and should give the markets some clues on the board member’s view on inflation. This should well prepare the markets for the inflation data to be released on Friday which is expected to show CPI dropping -0.1% in Feb .
Sterling somewhat ignored a dovish MPC minutes last week and reacted to strong inflation and retail sales data by surging across the board. Though another hike is generally expected from BoE in Q2, opinion on the timing is divided with some expecting BoE to act as early as April. BOE Governor King’s testimony on Feb inflation report on Tue will therefore be closely watched for further hints on the timing.
Other important data of this week include Swiss Mar KOF, Canadian Jan GDP and Feb PPI, New Zealand Q4 GDP.
GBP/USD
Cable’s rebound from 1.9183 extended further last week, reaching as high as 1.9726. Break of short term falling trend line (1.9913 to 1.9672) confirmed that correction from 1.9913 has already completed at 1.9183. More importantly, cable’s failure to break firmly below 1.9215/17 cluster support (50% retracement of 1.8517 to 1.9913 at 1.9215, 38.2% retracement of 1.8090 to 1.9913 at 1.9217) indicates that such fall from 1.9913 should be a correction to the rise from 1.8517 only. Hence further rally is now expected to follow to retest this 1.9913 high.
From a near term angle, a short term top should be formed at 1.9726 after 4 hours MACD was dragged down to below signal line by subsequent retreat. Further consolidation is in favor towards 1.9552 support or lower. But such pull back is expected to be contained above 1.9395 cluster support (61.8% retracement of 1.9183 to 1.9726 at 1.9390) and bring rally resumption. Break of 1.9726 will indicate rise has resumed for 1.9913 high. However, below 1.9390/95 again will argues that the rise from 1.9183 has completed and will bring this lower into focus again.
In the bigger picture, with bearish divergence conditions being displayed in weekly RSI and daily MACD a medium term top should be around the corner. The up trend from 1.7047 should make a top after reaching 2.0046/0106 cluster resistance zone (1992 high, 100% projection of 17047 to 1.9024 from 1.8090 at 2.0067, 61.8% projection of 1.8517 to 1.9913 from 1.9183 at 2.0046. And hence, focus will be on reversal signal as cable approaches these levels. On the downside, sustained break of 1.9215/17 cluster support will indicate that the whole up trend from 1.7047 might have completed earlier then we thought and should the bring deeper correction to 1.8834 cluster support (38.2% retracement of 1.7047 to 1.9913 at 1.8818) first.
In the longer term picture, the break above 1.9554 resistance (04 high) is favoring the case that long term up trend from 1.3680 has resumed after correction from 1.9554 was supported by 55 months EMA. However the structure of the medium term rise from 1.7047 is not clearly supporting this yet. And, we’re still skeptical on it. The structure of the fall after finishing the current up trend from 1.7047 should reveal more information.
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Shing-Ip Tsui is the founder and CEO of
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