By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Sterling traded sharply higher Thursday after the Bank of England left interest rates unchanged. Yet with most policymakers seeing a rate cut in August, the currency remains a sell. If you were lucky, you sold GBP/USD when it jumped to 1.34 or when it revisited that level the hour after BoE announced. But anywhere between 1.33 and 1.35 is a great area to sell sterling for a move back down to 1.31 and possibly even 1.30 in the coming days/week. We also like buying EUR/GBP, targeting 85 cents. Sterling’s reaction to BoE is a classic example of misplaced expectations. Economists were calling for a cut, investors believed them and when the BoE kept policy unchanged, sterling jumped from 1.3250 to 1.3475. However the rally faded as the day progressed because the main takeaway from BoE is simple -- rates will be lowered in 3 weeks and Vlieghe wanted that move to happen Thursday. According to the minutes from the meeting, the central bank is pleased with how the markets functioned post referendum. Yet there are indications that some businesses are delaying investment and hiring so activity is likely to be depressed in the near term. What is interesting to us is that they discussed a “range of possible stimulus measures”, which suggests that come August, we may see a rate cut combined with more Quantitative Easing. For the 3 next weeks, GBP rallies should be sold.
There was no consistency in the performance of Thursday's dollar but that should change with Friday’s U.S. retail sales report. Between the slowdown in wage growth, lower gas prices, sluggish labor-market activity and a softer spending report from Johnson Redbook, the risk for retail sales is to the downside. The only problem is that the forecasts are low and even a small surprise could give the dollar a boost. Either way, U.S. data is in focus on Friday and retail sales is significant enough for the dollar to take control of market movements. USD/JPY ran as high as 105.93 on renewed speculation of strong stimulus from Japan. The decision to bring in helicopter Ben for a consult has everyone excited about the possibility of powerful combination of fiscal and monetary stimulus at the end of the month. The next 2-day BoJ meeting begins July 28. Japanese policymakers have said that helicopter money is a risky gamble but they also believe that coordinated fiscal and monetary action is needed. This suggests that while a new unconventional monetary policy program may not come out of this month’s meeting, we could still see aggressive action from the government.
While GBP was the best-performing currency, NZD was the worst. The New Zealand dollar was crushed by the Reserve Bank’s decision to provide an update on the economy on July 21. The last RBNZ meeting was in June and the next meeting will be in August. But the central bank’s unusual decision to provide an economic update makes us worried that it may have concerns about the economy. There’s no question that the New Zealand dollar is strong and the central bank does not want to see it rise further over the next month -- especially since low inflation is a problem according to RBNZ Assistant Governor McDermott who spoke Wednesday night. At the same time, house prices are too high in New Zealand, which binds the central bank’s hands for the time being.
Meanwhile the Australian dollar extended its gains thanks to employment numbers that were “good enough” and new highs in U.S. stocks. Only 7.9k jobs were created in June, which was slightly less than expected. The unemployment rate also increased 5.8%, but May data was revised higher, the participation rate rose and all of the gains were in full-time jobs, which is exactly what investors wanted to see. Aside from the data, AUD was also supported by AUD/NZD, which rose to a month high. Chinese industrial production, retail sales and second-quarter GDP numbers were due Thursday evening. The focus is of course on GDP growth, which is expected to slow to 6.6% from 6.7%. Anything more than that and AUD could give up its gains quickly. USD/CAD extended its losses for the third day in a row as oil prices rose above $45 a barrel.
Finally, euro appreciated against the greenback Thursday but continued to flame out near the 20-day SMA. The pair traded around the 1.11 level and stayed relatively muted as French markets were closed for Bastille Day. Price action in the EUR/USD was mostly spurred by action in euro crosses. The BoE’s decision to leave rates unchanged this month sent EUR/GBP up 1% while demand for EUR/JPY also lent support to the currency. Eurozone CPI and trade balance are scheduled for release Friday but these second-tier reports will take a backseat to U.S. data and EUR/GBP flows.