Forex Trading Update: Potential Make or Break Week for Australian Dollar

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Forex Trading Update by Kathy Lien BK Asset Management:

Potential Make or Break Week for Australian Dollar

The recent sell-off in the Australian dollar has taken the currency to its weakest level in 2.5 years against the U.S. dollar.  Over the past few trading days however, the Aussie appears to have stabilized, finding support above 90 cents. While other currencies extended their slide after the Federal Reserve signaled to the market they are getting ready to taper, the Australian dollar nudged only slightly lower because the currency was already deeply oversold before the FOMC meeting.  Yet this is a week when the A$ could break 90 cents or squeeze higher.  According to the latest CFTC IMM report released on June 28th, short AUD/USD positions are still near record highs.  If this week’s event risks give speculators any reason to take profit or reconsider their short positions, the liquidation could drive the AUD/USD above 92 and most likely 93 cents.

The focus this week for Australian dollar traders is 3 fold – #1 Chinese data #2 FOMC Minutes #3 Australian data.  We have spent a lot of time talking about the U.S. dollar and will discuss the Fed minutes in more detail in the dollar portion of our commentary, so we’ll primarily focus on how Chinese and Australian data could affect the Aussie.  Recent economic data shows that the Chinese economy is slowing and the government is coming to terms with the fact that their previous growth rates cannot be sustained.  This week the focus is on Chinese inflation and trade numbers.  Economists are still looking for stronger trade activity for China with a nice increase in exports and imports.  If the data meets or beats expectations, today’s AUD/USD bounce could turn into a stronger recovery.  However if export growth slows or worse, declines which we feel is more likely the AUD could be in big trouble with 90 cents potentially coming under threat.  From Australia business and consumer confidence numbers are scheduled for release but the most important piece of data will be the employment report.  Economists are not looking for any major changes in job growth but the unemployment rate is expected to tick higher which could renew the sell-off in the currency.  While the odds favor further losses in the Australian dollar, based on the PMI reports there is room for an upside surprise so we still can’t rule out the possibility of a short squeeze that could drive the AUD/USD higher.  The currency pair could move either way, which is why this could be a make or break week for the A$.

Dollar – White House Lowers GDP Forecast

With no major U.S. economic reports released today, the U.S. dollar traded lower against all of the major currencies. Having enjoyed a very strong rally in recent weeks, a pullback is not all that unusual.  In fact, there’s likely to be a bit of profit taking this week ahead of the FOMC minutes on Wednesday.  While the details from the last Fed meeting are expected to show a central bank that has grown more willing to reduce asset purchases, we are not sure if anything new will be revealed.  Given how much the dollar has risen, the minutes may need to show significant support for tapering in September for the dollar to extend its gains.  However even if the FOMC minutes do not do the trick, Fed Chairman Ben Bernanke could give the dollar a boost when he talks Wednesday afternoon in Boston.  His speech will be on economic policy and he will be taking questions from the audience, an environment that is ripe for him to say something that could cause more volatility in the dollar.  Between now and then however, investors are simply relieved that the U.S. economy continues to recover and based on the rally in stocks plus the decline in 10-year Treasury yields, they are less concerned about whether the U.S. economy could handle a reduction in stimulus.  Based on the latest GDP forecasts, the White House doesn’t necessary share this view. In their budget update, the Obama Administration said growth would be slightly slower this year than originally forecast.  They expect the drag from automatic spending cuts to slow economic growth to 2.4% compared to earlier forecast of 2.6%.  Meanwhile consumer credit was the only piece of U.S. data released today and the fact that it rose by the largest amount in 2 years is a sign that consumers are taking advantage of the low interest rate environment and borrowing. There was a particularly sharp surge in car loans, which may be a sign of stronger consumer confidence.

EUR – Shrugs Off Weaker German Data

The improvement in risk appetite helped to lift the euro against the U.S. dollar today despite softer than expected Eurozone data.  German current account, trade and industrial production all missed expectations but the impact on the single currency was nominal.  Deterioration in economic data may validate the European Central Bank’s dovish monetary policy bias but after selling off for 2 days straight, the euro shrugged off the bad news, focusing instead on the resolution to Portugal’s political crisis and the approval of the EU3 billion aid payment to Greece.  The near term shocks to the Eurozone have abated and investors are cheering the news by rallying the currency.  However given last week’s developments, particularly in Europe, we believe it should only be a matter of time before the euro trades lower.  Europe pledged to provide easy money for the foreseeable future with the Bank of England being surprisingly aggressive. The recent volatility in the short terms rates made central bankers in the region uneasy while uneven growth justifies the need for continued stimulus.  With the European Central Bank and the Bank of England going out of their way to stress their dovish monetary policy bias and the Bank of Japan considering increasing the frequency of asset purchases this week, the Federal Reserve is on a solitary path to reduce stimulus. The focus should be on yields.  As our colleague Boris Schlossberg pointed out this morning, the spread between 10 year U.S. Treasury and German Bund yields hit a 7 year high last week. The chart below compares the inverse of this spread (Bund-Treasury) with the performance of the EUR/USD and suggests that given the speed and magnitude of the decline in the spread, the EUR/USD should be trading much lower. Taking a look at shorter-term charts, the April low of 1.2746 is near term support for the EUR/USD but if we expand to the monthly chart, a series of lower peaks can be seen with a base near 1.2050. Of course, there’s a long way to go before that level is reached and the currency pair will mostly pause at 1.25 but the technical structure points to further losses once the EUR/USD drops below 1.2746.  Below 1.25, the next major support level that we will be watching is the 50% Fibonacci retracement of the 2000-2008 rally that took the pair from a low of 0.8230 to a high of 1.6038.

GBP – Busy 24 Hours Ahead

Like the euro, the British pound recovered against the U.S. dollar after last week’s deep sell-off. Unfortunately the rebound still left sterling trading below the key 1.50 level versus the greenback. The U.K. economic calendar is relatively quiet this week outside of the long list of economic reports scheduled for release over the next 24 hours. We have the BRC retail sales report, the RICS house price balance, industrial production and the trade balance. Most of these reports are expected to show a further improvement in the U.K., which would be at odds with the cautious comments from the Bank of England last week.  Mark Carney made it point to let the market know that as the new governor of the BoE, he has every intention to keep monetary policy ultra easy.  According to the latest PMI reports, the manufacturing, service and construction sectors are improving but Carney clearly does not feel that the footing is firm enough.  While this view should not be a major surprise since he’s brought in with a mandate to stimulate growth, how quickly he has moved to make his views clear was unexpected.  Therefore even if tomorrow’s economic reports improve, we don’t expect a major rally in sterling.

JPY – Uninspiring Japanese Data

It was a mixed day for the Japanese Yen, which traded higher against the U.S. dollar and Swiss Franc but lower against all other major currencies.  Last night’s Japanese economic reports were far from inspiring.  The country’s current account surplus declined and the trade deficit widened.  There has been a lot of volatility in the current account balance because of investment flows but overall it appears that the weak yen   has not had a major impact on trade activity.  Furthermore, confidence also appears to be waning with the Eco Watchers survey declining in the month of June. This index measures the sentiment of waiters, taxi drivers and barbers and reflects how the regular worker in Japan feels.  The Bank of Japan is meeting this week and they will have to take all of this into consideration.  While they may be relieved that the volatility in JGBs has settled, the economy could certainly use another jolt of momentum.  Increasing the frequently of asset purchases is still on the discussion table for the BoJ.

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