Here's What's Driving The Euro And Yen Breakouts

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

The two most actively traded currency pairs — EUR/USD and USD/JPY broke above important resistance levels on Thursday. USD/JPY had been holding above 108 and flirting with resistance at 109.20 for the past 6 trading days but this level was finally breached when U.S. rates shot higher at the start of the NY trading session. The rally defies fundamentals as Thursday’s U.S. economic reports were softer than expected with jobless claims rising and manufacturing activity in the Philadelphia region growing at its slowest pace this year. Shrugging off softer U.S. data has been a constant theme for USD/JPY traders this month with the market ignoring weakness in consumer spending, inflation and manufacturing. Although the greenback has fallen against other major currencies like the euro and British pound, its resilience versus the yen is consistent with the move in Treasury rates, which increased on Thursday. With that in mind, after racing to a high of 109.45, USD/JPY failed to extend its gains and instead ended the NY session not far from 109.20. On a technical basis, this means that the breakout could still be a fake-out but there are signs of a bottom on longer-term charts. Fundamentally, the only argument for dollar strength is that the disappointment in U.S. data changes nothing about the outlook for U.S. monetary policy. The Federal Reserve is still expected to raise interest rates again this year with the hike likely to occur in September instead June. Yen weakness on the other hand is supported by Bank of Japan Governor Kuroda’s comment that the current pace of bond purchases will continue for some time. He’s promising a longer period of easy monetary policy, which stands in stark contrast to the Fed’s tightening plans. Looking ahead, momentum is still on the side of the bulls, which means that USD/JPY could make a run for 110.

Meanwhile, based on the euro's price action, forex traders are clearly not worried about next week’s French elections. It has been a great week for the euro, which appreciated nearly 200 pips versus the U.S. dollar since Monday. Although German producer price growth stagnated in March, inflation and trade data released earlier this week were better than expected. The April PMI reports are scheduled for release on Friday and given the general improvements in Germany’s manufacturing sector, we look forward to healthy data that should support the latest rally in the euro. Yet the situation in the Eurozone economy won’t be the only thing on investors’ minds on Friday. The first round of voting in the French Presidential election is on Sunday and if there is a desire for profit taking, it would need to happen on Friday. Investors don’t seem worried because Macron is leading Le Pen in the polls but as we’ve learned in the past year, there’s always the risk of an upset on Election Day.

Sterling also traded well, resuming its rise against the U.S. dollar but we have yet to see a flight to safety from euros to pounds as EUR/GBP was steady on Thursday. Bank of England Governor Carney avoided talking about the economy or monetary policy in his speech, which appears to have given investors the green light to drive the currency higher. U.K. retail sales are scheduled for release on Friday and economists are looking for spending to contract after last month’s strong rise. A pullback would be consistent with lower shop prices and softer spending reported by the British Retail Consortium. As the most important piece of U.K. data this week and a key input for monetary policy, Friday’s report could determine whether sterling hits 1.29 or falls back to 1.27.

The Canadian dollar ended the day unchanged against the U.S. dollar while the Australian and New Zealand dollars traded higher. Higher Canadian yields and steady oil prices helped prevent further losses in USD/CAD while the Australian dollar benefitted from improving risk appetite. The only country with any data on Thursday was New Zealand. Consumer prices rose 1% in the first quarter, outpacing the market’s 0.8% forecast. This drove the year-over-year CPI rate to 2.2% from 2.1%. Although part of the increase was driven by one-time rises in tobacco taxes and oil gains, data from New Zealand has consistently surprised to the upside. Dairy prices are also moving higher, providing the case for stronger relative performance for the New Zealand dollar. Canadian consumer prices are due for release on Friday. Given the sharp drop in the price component of IVEY PMI, CPI growth may have eased in March.