BoC spins ahead of ECB dance
FX Consultant / IFXA Ltd
• FX markets trade sideways ignoring economic data
• Bank of Canada finds a doveish spin
• Will it be all talk, no action from ECB president?
FX markets are jittery and trading sideways ahead of tomorrow’s European Central Bank (ECB) meeting although AUDUSD enjoyed a boost on better-than-expected GDP data. Friday’s US nonfarm payrolls (NFP) is looming with some forecasters predicting a result much better than expected (Forecast, 218,000). Today’s ADP employment data came out below forecasts (Actual 179,000 vs. forecast of 210,000), which may serve to dampen NFP expectations although ADP is notoriously inaccurate as a predictor of NFP. The Canadian trade data missed expectations posting a deficit of USD 640 million (Forecast surplus USD 200 million) but the upward revision to the previous month’s data of USD 0.700 million offset the drop.
Chart: ADP vs. NFP (beats vs., miss correlation)
Bank of Canada finds a doveish spin
The Bank of Canada managed to put a doveish spin on the economic outlook and discounted the rise in inflation to the bottom of its target band by blaming the move on the "temporary effects of higher energy prices" (WTI oil has been above USD 97.00 /bbl since the beginning of February – how temporary is that?). The bank noted that "core inflation has drifted up slightly, partly owing to past exchange rate movements". It attempted to reopen the rate cut debate, noting that "weighing recent higher inflation readings against slightly increased risks to economic growth leaves the downside risks to the inflation outlook as important as before". The tone of this statement should confirm speculation that the Bank of Canada governor wants a weaker currency.
The outlook for USDCAD has turned bullish in light of today’s Bank of Canada statement and has been confirmed by a close today above the 1.0940-50 area. The recent spate of soft economic data releases combined with bullish USDCAD technicals support further USDCAD gains towards the 1.1060 area.
Chart: USDCAD hourly with potential target highlighted
Source: Saxo Bank
Which mindset will Mario adopt?
Much has been written about what will transpire on Thursday following the release of the ECB interest rate decision and statement. Will the ECB president be "Action Mario" or "Draghi-my-heels Mario"? A rate cut prediction is nearly unanimous although the magnitude of the action is being debated fiercely. The current ECB Refi rate is a mere 0.25 percent, which popular sentiment expects to be trimmed to 0.10 percent with the Deposit rate dipping below zero to negative 0.15 percent. These rate cuts appear to be fully priced into the current EURUSD rate. However, the rate cut is expected to be part of a stimulus package including a new Long Term Refinancing Operation (LTRO), which may not be fully reflected in the current price. The problem for traders is Mario Draghi’s penchant for failing to back up his words with actions. EURUSD has dropped more than 0.0400 points since the beginning of May leaving lots of room to bounce on disappointment. On the other hand, if, as many believe, a new LTRO policy is included with a rate cut, EURUSD could drop another 0.0400 points to test the 38.2 percent Fibonacci retracement of the July 2013-May 2014 range. Furthermore, the ongoing deflation risks to the Eurozone economy aren’t going away, which suggests that Mr. Draghi may hint at more aggressive action in the future, during his press conference.
Chart: EURUSD daily with Fibonacci retracement
Source: Saxo Bank
VIX says no risk – Don’t worry, be happy
TheWall Street Journal (WSJ) has reported that US Federal Reserve officials are concerned that investors’ apparent complacency towards risk could lead to turbulence down the road. It is worried that the low interest rate environment has led to investors strapping on more leverage than usual. This complacency may stem from Fed chairman Janet Yellen’s assertion to the Joint Economic Committee that "rates will remain low even after employment and inflation are near mandate-consistent levels, (as) economic and financial conditions may, for some time, warrant keeping the target federal funds rate below levels that the committee views as normal". The WSJ article notes that the Volatility Index (VIX) has gone 74 straight weeks below its long-run average. Although it is still early, the concerns are valid, suggesting that a US rate increase could occur much sooner than forecast.
Chart: Volatility Index
Source: Saxo Bank