The main focus tonight will be on Australia and the Reserve Bank’s monetary policy announcement. At their last meeting the RBA left rates unchanged and said, “Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy.” Investors interpreted these comments to mean discomfort with the current level of the currency and sent AUD tumbling lower as a result. There’s a small subset of investors looking for the RBA to ease this month because CPI declined in the first quarter and activity slowed according to the PMIs. However according to the following table, consumer spending rebounded, business confidence improved, the unemployment rate declined and market indicators ticked upwards. So like many of their peers, the RBA may opt to wait and see how the economy performs in the next month before taking additional action.
Over the past few trading days we have seen a very nice breakout in USD/JPY. The move was driven entirely by expectations for this week’s Bank of Japan meeting. There are reports that the BoJ could introduce negative lending rates to complement negative deposit rates.
With the Japanese economy struggling under the weight of a strong Yen and slower global growth and speculators holding a record amount of long yen positions, the chance of easing by the BoJ is high. Take a look at how Japan’s economy changed since the March meeting in the table below.
The Japanese avoided intervening in the currency market when USD/JPY dipped below 108 because they prefer monetary intervention and their next opportunity to help the economy comes next week. With traders so aggressively short USD/JPY, this news could lead to more aggressive short covering ahead of and on the back of the BoJ rate decision.
Investors are buying New Zealand dollars ahead of the Reserve Bank’s monetary policy decision. This demand suggests that traders don’t expect the RBNZ to signal any immediate plans to lower interest rates. Having just surprised the market with a rate cut last month, no additional easing is expected but when the Reserve Bank eased, they also warned that further stimulus may be required. So the big question is whether this view will be emphasized in April.
The RBNZ’s primary concern last month was low inflation – the central bank lowered their 2016 Q1 annual inflation outlook from 1.2% to 0.4% and their Q4 2016 annual inflation rate to 1.1% from 1.6%. They worried that prices would remain low for some time and that domestic risks would contribute to falling inflation expectations.
Thankfully consumer prices rebounded in the first quarter with the year over year rate ticking up to 0.4% from 0.1%. From an inflation perspective, the RBNZ has less to worry about but consumer spending, service and manufacturing activity weakened in the month of March, leaving the central bank with many areas of concern.
So while the RBNZ may not go as far as lowering rates in April, they could maintain their dovish bias, which would renew the decline in the New Zealand dollar.
Here’s a look at how New Zealand’s economy performed between the March and April meetings
In 24 hours the Federal Reserve will announce its monetary policy decision and everyone expects interest rates will remain unchanged. The Fed has done a great job of preparing the market for steady rates but no changes to monetary policy doesn’t mean no volatility for the U.S. dollar.
The reason why the April FOMC meeting is important is because it will help to shape expectations for June. There’s no monetary policy in May so if the Fed wanted to prepare the market for possible tightening, they would need to tweak this month’s FOMC statement. The problem is that the odds of a dollar positive and negative outcome is roughly balanced. With the global markets stabilizing and commodity prices moving higher, the Fed has less to worry about internationally but domestically, growth has slowed. So even though no changes in monetary policy is expected at this month’s meeting, the greenback could still have a meaningful reaction to FOMC based upon the Fed’s assessment of the economy.
Now lets run through the possible scenarios:
Scenario 1 – The FOMC statement remains virtually unchanged = Mildly negative for the dollar because it would imply an ongoing split within the Fed and reluctance to raise interest rates.
Scenario 2 – Fed acknowledges deterioration in data and leaves out risk assessment = Dollar Bearish
The balance of risks statement was removed from the last 2 monetary policy statements because policymakers could not agree on the outlook for the economy. So if the risk statement is absent again, the dollar could spiral lower as the market interprets it to mean no rate hike in June.
Scenario 3 – Fed acknowledges deterioration in data but describes it as transitory AND the risk statement returns = Dollar Bullish
If the risk statement reappears and the Fed describes the risks are balanced, the dollar will soar as the chance of a June hike increases significantly. Aside from the risk statement the central bank’s comments about recent data disappointments will also be important. If they say the deterioration is transitory, it will help the dollar.
The following table shows how the U.S. economy performed between March and April. An initial glance shows more deterioration than improvements with consumer spending, labor market activity, inflation, production and trade weakening. However there are glimmers of hope. The rally in U.S. stocks helped to boost consumer confidence as measured by the Conference Board’s report, consumer prices are still moving upwards as gas prices increased. New and pending home sales rebounded and most importantly manufacturing and service sector activity accelerated. With average hourly earnings on the rise, the Fed could argue that the economy will regain momentum in the near future and with prices rising, they need to get ahead of inflation expectations. In other words while the data suggests that the Fed should be less hawkish, they could also find reasons to stick to their plan of raising rates twice this year.
Thursday’s ECB meeting is one of the most important event risk this week. EURO has been biding its time trading between 1.1235 and 1.1475 pre-ECB. Which end of this range breaks hinges upon Mario Draghi’s tone. If he’s concerned about the strong euro and talks about the possibility of more stimulus, then 1.1235 could give. If he simply says they need more time to see the effects of stimulus and points to recent data improvements as a sign of their easing measures working, euro could break 1.1400 and aim for recent highs.
The following table shows how the eurozone economy changed since the ECB last met – from a data perspective, the central bank has less to worry about in April vs. March when there was significantly more deterioration than improvement. So the question is whether the 3 to 6 cent rise (depending where you’re measuring from) in EURO since easing rings alarm bells for the central bank.