FX Week Ahead: Cue The ECB To Disappoint; Buying Time For Fed To Catch Up?

Submitted by Shant Movsesian and Rajan Dhall MSTA from fxdaily.co.uk

After another 'interesting' non farm payrolls report, we start the week on a quiet note as the US observes the Labour Day holiday and Canada day speaks for itself.  Plenty of volatility to expect thereafter though, as it is the ECB's turn to manage market expectations, which so far show little sign of moderating as EUR longs are keen to hold positioning into a much expected tapering signal.  

After the weaker US jobs report, which we will cover (briefly) later, we saw a well timed news report that the ECB are in no rush to make a decision next week and that plans for adjusting the APP may not be ready until December. There is no questioning the fact that the governing council want to temper the EUR rally, as they observed the 'FX overshoot' in their last meeting minutes.  Since then, the spot rate has been ramped up past 1.2000 but with limited hang time above here, and the US data induced return higher was stopped short of this psychological level before the news-wires hit.  Back under 1.1900, it looks to be another reluctance pullback, and one which now depends largely on the USD, as EUR proponents can only see one way for policy to go from here and do not seem to be too concerned as to where entry levels are!

We have however seen some moderation in EUR/GBP, where those looking for parity will have to wait a little longer.  Again, once we saw sentiment on the Pound turn in the wake of the last BoE meeting, it was one way traffic vs the EUR, but GBP resilience is developing once again - also to be covered lower down.  

As for US employment over August, it was a disappointing result, but much of the weakness attributed to seasonal factors were well communicated ahead of the release. So with the USD under pressure into the announcement, there was little fresh weakness to note, and USD/JPY and USD/CHF ended up on the day.  This also points to exhaustion in the bearish USD flow, which also saw mid curve yields basing out, and likely waiting for liquidity to improve - usually after US Labour day - before deciding on how much further to push the USD in the interim.  There are plenty of negatives one can cite for lower levels, but our focus is on value relative to time frame and these have clearly been stretched in recent weeks and months.  

Given the Fed's intent on sticking to the normalisation plan, balance sheet reduction is still expected to be announced later this month, but given its size, the details to date show they are merely scratching the surface, so rate hikes are what will add solid support to the USD.  As of yet, the odds for another 25bps onto the Fed funds rate this year remain near the recent lows, and currently fluctuate in the 25-35% range.  At this stage, and with more data to cover into year end, a move back to 50/50 is not unreasonable to believe, and this should be enough for the USD to at least correct a little more.  

Indeed, perhaps this what the ECB is banking on.  Certainly if the market has a little more conviction towards further Fed tightening this year, spreads can be held and the aggressive bid tone in EUR/USD will be relieved to some degree.  Pullbacks will find buyers again however, but depending on data levels and sentiment, the base from here could be anything from 1.1700 to 1.1450-1.1500.  

Ahead of the ECB meeting this week we get Q2 GDP out of Europe as a whole, with retail sales also out. In Germany, industrial production and trade stats will also be eyed, but the focus is on president Draghi's press conference on Thursday. 

Out of the US, there is little that can shake off the bearish bias on the greenback other than fresh news on tax reforms.  On Friday, chief economic adviser Cohn tried to revive some hopes by stating a lowering of corporate taxes would generate wage growth, but the market has had its 'fill' of talk.  Action required.  From the data, only Wednesday's ISM non manufacturing PMIs look to offer any possible drive to the greenback, with factory orders on Tuesday of modest interest and Thursday's productivity and labour costs overshadowed by ECB focus.  

North of the border, the BoC are also meeting next week to deliver their take and policy response on the Canadian economy.  Q2 GDP was measured at an annualised 4.5% to send the rate hawks into a frenzy, with some banks suggesting another 25bp move up this week.   We saw 1.2400 taken out after the potential base in front of this suggested a little move correction in USD/CAD, but 1.2000-1.2200 is the longer term target here and the release of the growth stats gave the market little reason to wait.  The BoC are likely to be little more cautious, and the majority, rather than consensus is for them to stand pat for now.  Some of the more recent data argues for a wait and see approach, and Jul trade data just ahead of the rate call and Aug payrolls on Friday will either see a test of the key support zone into 1.2300 (if we are still above here by Wednesday) or back above 1.2500 for some fresh consolidation. 

The AUD would have also faced similar prospects for fresh upside were it not for the strong component readings (construction work and CapEx) pointing to a strong GDP number on Tuesday, but forecasts are for a 0.8% rise in Q2 vs 0.3% for Q1.  This comes after we get the latest RBA rate decision, and while there is little or no expectation of a move on rates, Gov Lowe has been erring on the side of the next move being up.  We know how keen the market is to jump on soundbites, so communication will need to be calculated and measured unless they want to see the spot rate back above 0.8000 again.

AUD/NZD has already made good ground through 1.1000 now - above 1.1100 - but the first target at 1.1200 may be a good place to bank profits with the short term metrics looking overstretched ahead of the data and event risks in Oz. More data on Thursday just in case the markets haven't had enough, when we get the Aug AIG construction index, trade and retail sales both for Jul.  

Not much out of New Zealand other than the Fonterra Dairy auctions, which have offered little incentive to drive NZD trade one way or the other, but the currency has been at the bottom end of the G10 list in recent weeks, and could take a breather for now.  

In the UK, UK services PMI is the one to watch, and after a healthy manufacturing may have helped the Pound to stabilise, a rise here from 53.8 will also be welcome.  Industrial and manufacturing for Jul as well as trade of note for Friday.  Nothing fresh to look to from last week's Brexit talks as the UK-EU divide shows little sign of contracting any time soon, with not only the exit bill a point of contention but also EU citizens' rights.  We thought the latter could have seen some convergence in views at the very least.  Even so, the market looks to have developed some composure over the lengthy talks ahead, and as noted above, has recouped some ground against the EUR as the Cable rate has played catch up with the USD.  In the background, UK and German businesses have been allied in their appeals for a swift and fair negotiation, and this would and will swing the balance of sentiment towards the UK for now.  

Plenty of data out in Japan, headlined by the Q2 GDP readings early Thursday, but we need to see some real traction developing here as the BoJ stick with their inflation target of 2.0% despite calls to revise this in some way.  Foreign investments in Japanese stocks will be interesting given talk of attractive (relative) valuation levels.  

In China, trade data on Thursday is expected to see the surplus widen out again, but all eyes on the component import and export figures.  

Focus in Scandinavia is on the Riksbank meeting here we expect another no change call despite some of the strong data releases to date.  This should see some of their overly cautious rhetoric tempered to some degree and could prompt a break out in the NOK/SEK rate, but USD/SEK looks stretched on the downside.  Given the above risks to the single currency, EUR/SEK is already looking to retest the lows seen at the start of the year and this week the central bank may provide the catalyst to achieve this.