Home Calm Before the Storm:

Given the importance of the upcoming week on shaping financial market behaviour  for the next few months, global equities, with the exception of the Nikkei, have been  caught in a  rather subdued state of trading to begin the week.    Positive developments in Asia that centered around a more optimistic than forecast (albeit by a slim margin) Chinese  Manufacturing PMI and the announcement at the end of last week the Peoples Bank of China  would institute targeted reserve requirement cuts to some of its banks has helped lift sentiment, and  pushed the worrisome Japanese  inflation figures  to the back-burner for the time being.   The Nikkei finished its session up by 2.07%,  which  in turn  aided  USDJPY in its plight to move back above the 102  handle.

Price action in Europe has been less enthusiastic  midway through the trading session, weighed down by  revisions to final manufacturing PMIs across the zone that saw slippages from the  previously reported flash readings.    The  Eurozone reading came  in at 52.2 down from the original  flash print of 52.5, while Germany saw a  revision in its survey from 52.9 to 52.3.   Not helping matters is the fact that  inflation in Germany over the month of  May came in on the soft side of expectations, printing  at a 0.9% increase, down from the 1.3% registered in April and below the median forecast of a 1.1%  gain.   The downward revisions  to  manufacturing PMIs and the soft German consumer prices numbers have  EURUSD struggling to maintain its composure above the 1.36  level, while  the major equity indices like the FTSE, Dax, and Stoxx  manage to remain in positive territory.

Heading into the North American open we’re seeing cautious optimism reflected in financial markets, with S&P futures  displaying a greenish tinge and yields on the 10-year treasury creeping  back to the 2.5%  handle.   The uptick in treasury yields  is helping underpin the USD,  as the DXY ventures into the mid-80s and  USDCAD pushes back into the mid-1.08s.

Preparing for the upcoming week there  are a  number of events on the economic calendar for market participants  to be mindful of, as a  week dominated by central bank meetings and important employment data could shake currency markets from the recent bout of complacency traders have become accustomed to.

Tomorrow  will see the flash estimate of May CPI in the Eurozone released, acting as a precursor to the European Central Bank meeting  on Thursday.    Softer than expected readings from  Italy, Spain, and Germany  on the consumer price front suggest there is a slight amount of  risk the print for the overall zone comes in light of the expected 0.7% y/o/y increase, which would ratchet up expectations  the ECB  will  loosen their stance towards monetary policy and introduce  non-standard policy actions.   Right now it appears the consensus is  for a cut to key lending rates that will push the deposit rate  at the central bank  into negative territory, along with another LTRO  tied to ABS purchases or SME lending.   Should this materialize the EUR  could bounce, as  an action like this  has been anticipated for quite some time, and there is  potential to see a “sell the rumor, buy the fact” scenario emerge.   That being said, the over/under is for negative deposit rates and  some sort of “QE-light” to  help repair banks balance sheets and juice SME lending, so it would be likely to see a sharper bounce in EURUSD should the ECB only  announce rate cuts, while  outright asset purchases  would see the pair come under further selling pressure.

Although we are unlikely to see a dramatic change in either  stance or tone towards  the path of monetary policy in Canada, the central bank meeting  on Wednesday  could also give the Loonie a jolt and kick the  commodity-linked currency out of the slumber it has fallen into over the last month.   The up-tick in both core and headline inflation will most likely  keep  Stephen Poloz from sounding too dovish when  referencing the inflation situation in Canada,  though  it is possible that the central bank head  chooses to downplay the recent rise in consumer prices, reminding market participants one reading is not sufficient to proclaim a trend has emerged.    Poloz has proven to be  very pragmatic in his press conferences, and thus we  think he’ll  want to  stray from language that will strengthen the Canadian  dollar  in a material fashion, as he realizes a soft  Loonie also helps the struggling  Canadian export sector.

Turning attention  to the American economy, the  jobs report for the month of May is set  to drop at the end of the week  on Friday.   While the headline payroll report is  becoming less important than it once was given the Fed’s taper appears to be on autopilot, the number will still garner attention, especially with how the nuances of the report like weekly earnings, underemployment, and the participation rate, factor into expectations on when the Fed will begin to raise rates.   Consensus is for another relatively robust report chalking up around 220k new jobs, with  a number around or above consensus helping to stem some of the bleeding seen in treasury yields  last  week, especially if the  short covering rally in the bond market has  shaken enough of the weaker positions to put a floor on yields.

Further reading:

EU inflation figures continue to display weakness

German inflation falls to only 0.6% – pressure on the euro

Scott Smith

Scott Smith

Scott Smith is a Senior Corporate Foreign Exchange Trader with Cambridge Mercantile Group and has a diverse background in the foreign exchange industry, with previous experience in both credit and trading related functions. Scott holds a Bachelor of Commerce degree from the University of Victoria, has completed all three levels of the Chartered Financial Analyst designation, and is currently working towards the Derivative Market Specialist certification offered through the Canadian Securities Institute. Cambridge Mercantile Group.