ForeCastle

Weekly Review and Outlook: Fed Sent Stocks to Records and Weighed Down Dollar, Canadian Dollar Shone

Dollar ended the week generally lower except versus the Japanese yen and Aussie even though Fed continued with tapering of the asset purchases. Markets seemed to have ignored the slight upward revision on FOMC member's rate forecasts, but were more focus on Yellen's message of keeping rates low for extended time. The sentiments also sent stocks higher with DOW and S&P 500 hitting new record highs while keeping long term treasury yields in range. In the currency markets, Canadian dollar was the strongest one as the upside surprise in inflation data prompted speculation that BoC would shift away from its neutral stance. The Swiss franc was the second strongest one after SNB kept policies unchanged. Sterling extended recent rally against dollar and Euro but ended the week mixed overall. Aussie was the weakest, just followed by yen.

To recap some of the major events, FOMC announced to continue tapering by lowering the monthly asset purchases from USD 45b by USD 10b to USD 35b. After the reduction, the monthly purchases consist of USD 20b of treasuries and USD 15b of MBS. Fed also released updated economic projection. 2014 growth forecast was slashed to 2.1% - 2.3%, substantially down from prior estimate of 2.8% - 3.0%. 2015 and 2016 growth forecast was left unchanged at 3.0% - 3.2% and 2.5% - 3.0% respectively. Unemployment projection was revised lower to 6.0% - 6.1, down from March projection of 6.1% - 6.3%. 2015 and 2016 unemployment forecast was also lowered. Core inflation is projection to be 1.5% - 1.6% in 2014, slightly up from March projection of 1.4% - 1.6%. 2015 and 2016 projections were also revised higher. On average, policy makers are seeing the Benchmark federal funds rate at 1.2% by end of 2015 and 2.5% by end of 2016. That's an upward revision from March projection of 1.125% in 2015 and 2.4% in 2015. The long term average, however, is now forecast to be at 3.75%, down from prior forecast of 4.0%.

The IMF lowered growth forecast of US this year sharply to 2.0%, down from April's projection of 2.8%. 2015 growth projection was left unchanged at 3.0%. The cut in forecast was mainly due to contraction in Q1 on harsh winter weather. IMF also noted that "relatively high unemployment and a lot of slack in the labor market" to persist", and consumer inflation will remain well below the 2% target into 2017. Regarding monetary policy, IMF said Fed's policy rates could " afford to stay at zero for longer than the mid-2015 date currently foreseen by markets". Earlier this month, the World Bank lowered US 2014 growth forecast to 2.1%, down from prior projection of 2.8%.

Talking about IMF, it urged ECB to consider buying assets including sovereign bonds on a large scale to counter the stubbornly low inflation. IMF chief Lagarde said that "inflation is worryingly low across the euro-area countries." She welcomed recent stimulus measures announced by ECB, but she emphasized that "we are not at the end of the road."In a report, IMF note that new asset purchases would "boost confidence, improve corporate and household balance sheets, and stimulate bank lending." German ZEW economic sentiment dropped to 29.8 in June versus expectation of a rise to 35.0. Current situation gauge improved more than expected to 67.7. Eurozone ZEW economic sentiment rose less than expected to 58.4 versus consensus of 59.6. ZEW President Clemens Fuest noted that "the German economy is currently in a very good shape but further increases are becoming more difficult." And, he also said that “we had a strong first quarter in 2014 due to favorable weather conditions but signs are that the second quarter will be weaker."

In UK, BoE minutes for June meeting revealed that policy makers voted unanimously to keep rates unchanged at 0.50% and maintain the asset purchase size at GBP 375b. The minutes noted that "all members agreed that, in the absence of other inflationary pressures, it would be necessary to see more evidence of slack being absorbed before an increase in Bank Rate would be warranted." And, it warned that "a premature rise "could be associated with considerable costs in terms of lost output." However, some analysts noted that underneath the voting, the minutes showed a gradual chance in the tone of the MPC. In particular, the minutes noted that "the relatively low probability attached to a Bank Rate increase this year implied by some financial market prices was somewhat surprising". All in all, the minutes didn't provide enough "hawkishness" for markets to push Sterling further higher. Recent strength of Sterling was also dampened by lower than expected inflation data. CPI slowed to 1.5% yoy in May, down from April's 1.8%, versus consensus of 1.7% yoy. Core CPI slowed to 1.6% yoy versus expectation of 1.7% yoy.

SNB left the target range for the three-month Libor unchanged at 0-0.25%. Also, the EUR/CHF floor is held at 1.2. SNB president Jordan emphasized that the central bank will closely monitor the "impact of the recent interest rate reductions in the euro area on Switzerland. And he noted "we've said repeatedly that we don't exclude any measure and that the introduction of negative rates is a possible option." SNB lowered inflation projection for the next two years. CPI is expected to be at 0.3% in 20156 and 0.9% in 2016. 2014 inflation forecast was raised slightly to 0.1%. Swiss State Secretariat for Economics (SECO) lowered growth forecast of the economy. 2014 growth is projected to be 2.0% in 2014 versus prior forecast of 2.2%. 2015 growth is projected to be 2.6%, downgrade from prior forecast of 2.7%. SECO noted that "the economic picture is still split, with a good domestic economic trend on the one hand and muted exports on the other."

Canadian CPI rose 0.5% mom 2.3% yoy in May versus expectation of 0.2% mom, 2.1%. Core CPI rose 0.5% mom, 1.7% yoy versus expectation of 0 0.2% mom, 1.5% yoy. The headline CPI is back above 2% level for two consecutive months. That's also the highest figure in 27 months. And core CPI is heading back to 2% target. BoC left rates unchanged earlier this month, noting that "the timing and direction of the next change to the policy rate will depend on how new information influences the balance of risks." The set of inflation data could probably trigger a move away from such neutral stance in the coming policy statements.

RBA minutes showed that interest rates will likely be on hold in the foreseeable future. It note that "given this outlook for the economy and the significant degree of monetary stimulus already in place to support economic activity, the board judged that the current accommodative stance of policy was likely to be appropriate for some time yet." The central bank said that pace of growth will likely be "a little below trend" for the rest of the year. There will be "substantial falls in mining investment, "below-average growth of public demand" and subdued non-mining investment. Regarding the exchange change, RBA reiterated that it remained high by historical standards.

Technical Highlights

As noted in our USD/CAD weekly report, the pair has just resumed the medium term corrective fall from 1.1278 and should now be heading to 50% retracement of 1.0181 to 1.1278 at 1.0730 and below. However, as such decline is viewed as a correction only, we'd start to look for bottoming signal below 1.0730, and above 1.0608 cluster support (61.8% retracement of 1.0181 to 1.1278 at 1.0600). But before that, in near term, USD/CAD's outlook will stay bearish as long as 1.0960 resistance holds.

EUR/CAD also extended the decline from medium term top of 1.5585 and reached as low as 1.4593. Such decline is expected to extend to 161.8% projection of 1.5585 to 1.5003 from 1.5305 at 1.4363. However, similar to USD/CAD, such fall is viewed as a correction for the moment. Thus, we'd be expecting strong support below 1.4363, and above 38% retracement of 1.2126 (2012 low) to 1.5585 (2014 high) at 1.4262 to contain downside and at least bring a sustainable rebound.

As for trading strategy, our take on EUR/GBP short didn't yield any result last week as Sterling lost steam. We remained skeptical on the overall strength of the pound as GBP/USD should be facing strong resistance above 1.7043 key level. GBP/JPY will also face similarly important resistance at 174.84. But overall, as Euro's outlook remains bearish in most pairs except EUR/USD. In particular, even the EUR/CHF has taken out near term support at 1.2162 and is heading southward. We'd hold on to the position on EUR/GBP short.

Meanwhile, it would be noted that recent sluggishness in the dollar index is mainly due to the relatively equal weakness in both dollar and euro. This could be seen as EUR/USD is struggling to find a direction after hitting 1.3502 and was then stuck in range. From the above analysis of Canadian pairs, we could also see the bearishness in USD/CAD and EUR/CAD is rather clear, at least for near term. So we'd prefer to buy Canadian dollar this week to ride on the bull run. And, since we're relatively neutral on EUR/USD, and we're also short in EUR/GBP, we'll sell USD/CAD.