Central-Bank Speak To Tax Reform: Watch This
By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Mondays are typically volatile days in the forex market because traders adjust their positions after the weekend and initiate new trades for the week ahead. Monday’s intraday swings were therefore the norm rather than the exception for front of the week trade. The
greenback
was all over the place – it traded lower initially against the
Japanese yen
only to spike ahead of the
new home sales
report but those gains did not last as USD/JPY reversed course on reports that North Korea could launch another missile test in the next few days. The dollar moved in lockstep with 10-year Treasury yields, which weaved in and out of negative territory before settling the day lower. Despite these moves in USD/JPY and U.S. Treasuries, the greenback’s weakness was limited to the Japanese yen as it actually strengthened against the
euro
,
sterling
,
Swiss franc
and
Canadian dollar
. This inconsistency suggests that risk aversion had a greater impact on the currency flows than the market’s outlook for U.S. dollars. That will change as the week progresses with Senate Republicans focused on building support for the tax bill, which they hope will move to a floor vote this week. Jerome
Powell
also faces a nominee hearing Tuesday followed by speech from Janet
Yellen
on Wednesday. While there are a handful of market-moving economic reports on this week’s calendar, central-bank speak will be the primary driver of currency flows. Monday was the perfect example as traders shrugged off the stronger-than-expected new-home sales report. Tuesday’s
trade balance
,
S&P CaseShiller house price index
and
consumer confidence
are not expected to lend much support to the greenback.
The Bank of England publishes its twice-a-year
Financial Stability Review
on Tuesday and the release will be followed by a presentation by Governor Mark
Carney
who will share his recommendations for the banking sector. When the report was last released in June, the BoE described the financial system as resilient but expressed concern that consumer credit is growing too fast and ordered banks to build counter-cyclical capital buffers in case there is a downturn. At the time, BoE's generally positive outlook helped to lift sterling but this time around the Bank of England is more cautious, especially since these are the toughest round of stress tests yet. Sterling will fall if more than one bank fails the test but if the Royal Bank of Scotland (LON:
RBS
) remains the only bank to fail the test, GBP should rally in relief. Either way, it should be an interesting day for sterling trade.
USD/CAD
shot higher Monday on the back of falling
oil prices
. The Canadian dollar will also be in play Tuesday as the Bank of Canada releases its
financial system review
. Although no surprises are expected, this will be followed by a press conference with Governor
Poloz
and Deputy Governor Wilkins. Having raised
interest rates
twice this year, the BoC adopted a more cautious approach. Given the recent slowdown in
retail sales
and
inflation
growth, Poloz and Wilkins are likely to maintain this view. This week is an important one for the Canadian dollar with
GDP
and
labor data
scheduled for release. The risk is to the downside for all of these reports, which means we are looking for USD/CAD to break 1.28.
Monday's best-performing currency was the
New Zealand dollar
, which may be surprising considering last week’s softer economic reports and today’s barren calendar. NZD was driven purely by
U.S. dollar
weakness and NZD short covering. Like the BoE and BoC, the Reserve Bank of New Zealand releases its Financial Stability Report Tuesday evening. The report itself isn’t expected to be a big market mover but
NZD/USD
traders will be watching the release along with a speech from Finance Minister Robertson Friday for any insight on the new government’s plans. The
Australian dollar
on the other hand gave up earlier gains to end the day unchanged. Although there were no Australian economic reports on the calendar, the currency’s gains were hampered by weaker Chinese industrial profits.
Last but certainly not least,
EUR/USD
ended the day at its lows after hitting a high of 1.1961. A reversal as strong as Monday’s is generally a precursor to further weakness. It is difficult to say what caused the currency’s underperformance but 1.1975 was about the level where ECB President
Draghi
described currency moves as 'volatile.' Back in September when EUR/USD was trading near 1.1975, he said “the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring.” We doubt this view has changed much given Germany’s political troubles and the low level of inflation but that along with the weakness of German yields are the main reasons for the euro’s underperformance. The technical structure of the pair signals a deeper correction to 1.1850.

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