RBA May Preview – Will they Cut Rates?

aud/usd Australian Dollar australian dollar forecast forex blog Kathy Lien Reserve Bank of Australia

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.

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RBA May Preview – Will they Cut Rates?

aud/usd Australian Dollar australian dollar forecast forex blog Kathy Lien Reserve Bank of Australia

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.

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Will the Bank of Japan Cut Rates Tonight?

forex blog Forex News Japanese Yen Kathy Lien

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.

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Will the Bank of Japan Cut Rates Tonight?

forex blog Forex News Japanese Yen Kathy Lien

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.

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April FOMC Preview – 3 Scenarios for the Fed and Impact on Dollar

Fed rate hike Federal Reserve FOMC forex blog Kathy Lien US Economy

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.

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ECB April Meeting Preview – What to Expect

ECB euro forex blog Kathy Lien

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.

 

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Tuesday Trading Tip – Bank of Canada Preview

Bank of Canada Canadian Dollar forex blog Kathy Lien

The Bank of Canada meets tomorrow and based on the following table, they have more reasons to smile this month with consumer spending and job growth improving significantly. Oil prices are also up 10% since March and the slowing down of Fed tightening will remove some of their worries about the outlook for Canada’s economy. So chances are the BoC rate decision will be positive for the Canadian dollar

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Forex Trading Tip – #1 Driver of FX Flows this Week

forex blog Forex News Kathy Lien

Between an emergency Fed meeting, the Bank of England and Bank of Canada monetary policy announcements, US retail sales, Chinese GDP, Australian employment, UK consumer prices and a host of other tier 1 event risks, there are no shortages of events that could drive big moves in currencies.

However, the #1 driver of FX flows this week will be risk appetite. That could be driven by the swings in commodity prices, the volatility in equities, Chinese and/or US data. At the end of this week on Sunday there’s a production freeze meeting in Doha and we are already beginning to see headlines about some producers refusing to cut production. One of the main reasons why commodity prices are performing so well this morning is because crude oil is above $40 a barrel.

Chinese data will also be important. Consumer prices were released last night and the stronger report propelled AUD/USD above 76 cents. Tuesday evening, Wednesday morning local time Chinese trade numbers are scheduled for release and on Thursday evening / Friday morning, Chinese industrial production, retail sales and Q1 GDP numbers are due. We are beginning to see signs of stabilization in the world’s 2nd largest economy but according to China Premier Li, the downside pressure on the economy remains.

And of course there’s Wednesday’s U.S. retail sales report – the market detests dollars but a blowout report could help to turn things around.

Keep an eye on the VIX:

Screen Shot 2016-04-11 at 11.26.33 AM

Top Forex Themes for 2016

ECB euro Fed Rate Cut Federal Reserve forex blog Forex News Forex Podcast Japanese Yen Kathy Lien US Dollar US Economy

Top Forex Themes for 2016 Since the next two weeks are generally the quietest periods in the financial markets, we want to take this opportunity to think longer term and share with you our currency forecasts for 2016. We’ll start with an initial review of the top themes and explore them in further detail as the week progresses in our outlook for each of the major currencies. But first -- 2015 has been a big year for the foreign exchange market. Divergences in monetary policies led to strong moves in currencies with the U.S. dollar as the best performer. The U.S. saw its first rate hike in nearly a decade while other major central banks in the Eurozone, China, Canada, Australia, New Zealand and Japan eased. In response, the greenback climbed to multiyear highs and this strength translated into significant weakness for many major currencies along with a collapse for commodities. These are some of the milestones reached in currencies this year:

 

The greatest risk for the financial markets and the global economy in the coming year is the feedback loop from the dollar and Fed policy. While the quarter point hike in December represents only a nominal increase in U.S. rates, the Federal Reserve expects to tighten 4 additional times next year which will have broad ramifications for currencies, equities and commodities. In mid-December, we published a piece outlining the Consequences of a Strong Dollar and a lot of these issues will return to focus in 2016.

The first few months of the year should be good for the dollar as long as Fed officials don’t backtrack on their hawkish views. There will be more hawks voting on the FOMC in 2016 than 2015 so the balance swings in favor of continued tightening. Between the warm El Nino weather and gas prices below $2.00 a gallon in some states, consumer spending should also rise in the first quarter. So while the dollar is rich, the path of least resistance is still in higher. However our outlook changes in the second half of 2016 as we believe rate hikes and the strong dollar will force the Fed to slow tightening making the top for the greenback and the bottom for other major currencies.

Here are some of the themes that we are looking for in 2016:

Monetary policy gaps will expand in the first half and narrow in the second – The Federal Reserve’s rate hike ushers in a new phase of monetary divergence. In the coming year, the Fed will continue to reduce accommodation at a time when other central banks maintain and even expand their stimulus programs. While the Fed will be the only major central bank raising interest rates for most if not the entire year, in the first few months, investors will be actively thinking about who needs to move next. This speculation could accelerate as the strains of low commodity prices, slow growth and weak external demand hits many economies. But at the end of the day for most countries, the bar is high for additional easing. The global easing cycle is nearing an end as long as the Fed raises interest rates responsibility and avoids wrecking havoc on the financial markets. As such we believe that this past year’s dominant trends should continue in the first few months and reverse as the year progresses and monetary policy divergences stop widening. Another way to look at this is that while we expect dollar strength to continue, it should abate through the year.

Commodity prices will find a bottom in 2016. A strong dollar, weak global demand and high inventories have caused oil prices to collapse this year and while prices could fall further in the near term as the U.S. ends its 40 year ban on oil exports and sanctions are lifted on Iran, when the dollar peaks, commodities will bottom. The price of oil could fall below $30 a barrel but we do not see much weakness beyond that and by the end of the year we expect prices to settle closer to $40. In the long run, China’s focus on domestic demand should be positive for energy prices. We expect further easing and a lower currency in the coming year. A bottom in commodity prices would not only affect the outlook for commodity currencies but could also mark a shift in G7 monetary policies as inflation starts to stabilize and turn upwards. Lifting inflation is the greatest challenge for many central banks and while a strong dollar lowers the value of local currencies, it also adds to disinflationary pressure by lowering prices and the question then becomes which has greater impact on growth and inflation -- right now its lower commodities and not a lower currency.

2016 should also be a year of diminishing stock market returns. The era of easy money is coming to an end and the strong dollar along with Fed tightening will take a big bite out of corporate profitability. Single digit gains are the best that investors should expect in earnings growth. The prospect of a persistently strong dollar, sluggish global growth and lower commodity prices in the first half of the year means that earnings and stocks could suffer. We are looking for a correction in equities in early 2016 that could trigger a flight to safety in the currency market.

At many points in the year politics will overshadow economics. We have the U.S. election, the U.K. referendum, ongoing Eurozone refugee crisis, possible showdown with Russia and risk of more aggression by ISIS. The U.S. election is definitely a second half story and while there are a lot of different factors at play this year according to our study, the EUR/USD has a lower bias during U.S. election years. In the 10 elections going back to the 1970s the EUR/USD weakened in 8 out of the 10 periods. The U.K. referendum poses a major risk that we will explore in our sterling outlook while the risk of more aggression by ISIS, possible show down with Russia and the ongoing refugee crisis has the greatest impact on the euro. There’s a lot more to explore and we will do that in the individual currency outlooks but for now, these are some of the most important themes that we believe will dominate trading in the coming year.

Is Buying Dollars in 2016 a Smart or Foolish Trade?

ECB euro Fed Rate Cut Federal Reserve forex blog Forex News Forex Podcast Japanese Yen Kathy Lien US Dollar US Economy

Is Buying Dollars in 2016 a Smart or Foolish Trade?
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2015 has been a great year for the U.S. dollar but with only 5 trading days left many investors are wondering if being long dollars in 2016 is still a smart trade. December has been a difficult month for the greenback with dollar bulls struggling to maintain control. The Federal Reserve raised interest rates for the first time since June 2006 but instead of appreciating, the dollar erased nearly all of November’s gains. Now many investors are wondering that if a rate hike and hawkish forward guidance can’t lift the dollar, is it foolish to be buying greenbacks in 2016.
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To answer that question we have to understand why investors sold dollars in December. The bet that the dollar would rise in 2015 was one of the world’s most crowded trades and according to the CFTC’s Commitment of Traders report, forex futures traders were busy adjusting positions ahead of the December 16 FOMC meeting. The biggest changes were in euro and yen where investors aggressively cut their short euro and short yen positions. This means that investors started to unwind their long dollar trades ahead of FOMC and based on the price action after the meeting, liquidated further after the rate hike. Buying dollars became a very crowded trade in 2015 and a lot of money moved to the sidelines at the end of the year.
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<strong>This means there’s money to put back into play in 2016.
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Yet positioning was not the only reason why investors bailed out of the greenback. According to the following chart past tightening cycles have not been good for the dollar and this scared many investors. While USD/JPY generally appreciated leading up to the rate hike, on a number of occasions it reversed course after tightening but this cycle is different because the first few months of the year will be good for the U.S. economy and the dollar. The warm El Nino weather and low gas prices will boost consumer consumption, which is already supported by steady job creation, wage growth and consumer borrowing. The Fed also welcomes new hawks to their roster of FOMC voters.
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<a href=”http://www.bkassetmanagement.com/wp-content/uploads/2015/12/FOMC_1.png”><img src=”http://www.bkassetmanagement.com/wp-content/uploads/2015/12/FOMC_1-610x305.png” alt=”” title=”FOMC_1″ width=”610″ height=”305″ class=”alignnone size-large wp-image-8953″ /></a>
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<strong>But first lets be clear, the Fed’s rate hikes will not cause a recession. It may slow the economy in the second half of the year but contraction is highly unlikely.</strong> Some investors are worried that the recent move by the Fed could trigger a recession but there are very few indicators and low oil prices have never caused a downturn in the U.S. Of course that could change as the Fed raises interest rates if they move too quickly. One of the greatest challenges is that higher interest rates do not hit the economy in predictable ways. They take time to percolate and it is difficult to predict the point at which the impact shifts from mild to severe. The quarter point hike is only a small tweak in rates and even if the Fed hikes by another 50 to 75bp next year (which is our preferred scenario), the impact on consumer spending and investment will be limited by the fact that most American mortgages are fixed rate, unlike Europe. Also businesses could view the Fed’s tightening as a sign of confidence in the economy and they could be slow to adjust their investments. So at the onset the biggest impact will be on the U.S. dollar.
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<strong>More Hawks in the Birdcage in 2016</strong> -- The performance of dollar hinges on when the Federal Reserve will raise interest rates again. The next meeting is on January 26-27 and as there’s zero chance that rates will be increased in the first few weeks of the New Year, consolidation in the dollar is likely. However if the Fed maintains an optimistic view on the economy, expectations for a rate hike in March will grow, leading to renewed strength for the greenback. It is important to understand that with each new year comes a new group of Fed Presidents and in 2016 4 votes rotate. Four hawks and 1 dove will replace 1 hawk, 1 dove and 2 neutrals. So the balance swings in favor of more consistent tightening. So while the dollar is rich, we believe the path of least resistance is still in higher in the first half of the year. Our outlook changes in the second half of 2016 when we believe rate hikes and the strong dollar will force the Fed to slow their pace of tightening marking the top for the greenback and the bottom for other major currencies.
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<strong>Election years are good for the dollar.</strong> The table below shows that the Dollar Index increased an average of 5% during an election year with the index rising 8 out of the last 10 periods. In 1 of the 2 years that the Dollar Index declined, the greenback lost approximately 0.5%. While it can be argued that Fed policy is not affected by elections, the time of major monetary policy shifts has often coincided with presidential elections. The second chart was created by the Washington Post and while their data only covers 6 election cycles, there’s definitely a notable trend.
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<a href=”http://www.bkassetmanagement.com/wp-content/uploads/2015/12/Elections_DXY.png”><img src=”http://www.bkassetmanagement.com/wp-content/uploads/2015/12/Elections_DXY.png” alt=”” title=”Elections_DXY” width=”182″ height=”210″ class=”aligncenter size-full wp-image-8982″ /></a>
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<a href=”http://www.bkassetmanagement.com/wp-content/uploads/2015/12/WP_FedFund_Changes.jpg”><img src=”http://www.bkassetmanagement.com/wp-content/uploads/2015/12/WP_FedFund_Changes-610x521.jpg” alt=”” title=”WP_FedFund_Changes” width=”610″ height=”521″ class=”aligncenter size-large wp-image-8980″ /></a>
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<strong>Technically there appears to be a double top forming in the Dollar Index.</strong> However 96 is a fairly significant support level that should hold and we expect the index to make another run for 100 after which it should test the 61.8% Fibonacci retracement of the 2001 to 2008 decline near 102.

<a href=”http://www.bkassetmanagement.com/wp-content/uploads/2015/12/DXY2015.png”><img src=”http://www.bkassetmanagement.com/wp-content/uploads/2015/12/DXY2015-610x288.png” alt=”” title=”DXY2015″ width=”610″ height=”288″ class=”aligncenter size-large wp-image-8981″ /></a>