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

Get the 5 most predictable currency pairs

About Author

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.

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