Weekly Outlook: 2014, May 18 - 25

Forex Weekly Outlook May 19-23

Rate decision in Japan, inflation data in the UK and Canada, FOMC Meeting Minutes, Unemployment Claims, German Ifo Business Climate and US housing data are the main events on our list. Here is an outlook on the main market-movers for this week.

Last week, major US figures came out above expectations; Annual inflation reached 2%, as expected and the monthly CPI edged up to 0.3%. Meanwhile, the annual core inflation beat forecasts with a 1.8% reading. Furthermore, the sharp drop in the number of unemployment claims reaching a 7-year low of 297,000, reaffirms the strength of the US labor market. These positive signs support the Fed’s tapering plan, indicating the US economy is getting stronger and does no longer need QE. Will the US housing data also change for the better this week.

Let’s start,

1. UK inflation data: Tuesday, 8:30. UK inflation remained below the BOE’s 2.0% inflation target in March, reaching 1.6%, the lowest reading since October 2009. This reading was preceded by 1.7% in February. This was the sixth consecutive month of low inflation narrowing the gap between wage growth and the rise in prices contributing to business stability. UK inflation is expected to increase to 1.7%.
2. Japan rate decision: Wednesday. Governor Haruhiko Kuroda maintained the BOJ’s monetary policy in April expressing confidence that the economy is advancing according to plan. However, many analysts believe the BOJ will have to ease policy in the near future to prevent a deflation trend. Kuroda told Prime Minister Shinzo Abe that he will adjust policy without hesitation in case the 2.0% inflation target may be jeopardized. No change is expected this time.
3. US FOMC Meeting Minutes: Wednesday, 18:00. FOMC minutes released in April indicate the Fed’s intention of maintaining loose monetary policy for years to come. The FOMC welcomed the pickup in GDP growth registered after the weak first quarter affected by the cold weather. The members supported a low fed funds rate for as lonf as inflation remains below the 2% target. Tapering should continue and changes to guidance are possible. The FOMC expects that the economy will improve.
4. UK GDP data: Thursday, 8:30. According to the NIESR estimates GDP edged up 1.0% in the second quarter after posting a 0.8% expansion rate in the first three months of 2014. The growth levels nearly equal the pre-financial crisis peak. NIERS forecasts a 2.9% growth rate in 2014. However, despite the pick-up, income per capita will need another three years to catch up with GDP expansion. GDP growth in the second quarter is expected to reach 0.8%.
5. US Unemployment Claims: Thursday, 12:30.Initial claims for U.S. unemployment benefits hit a seven-year low of 297,000 claims last week, confirming the strong recovery in the US economy. Claims fell 24,000 from the preceding week, indicating stronger economic growth in the second quarter. Stronger labor market and rising inflation pressures give green light to the Fed’s ongoing tapering move. Jobless claims are expected to increase to 312,000.
6. US Existing Home Sales: Thursday, 12:30. Second hand homes sales declined to their lowest level in more than 1-1/2 years in March, reaching an annual rate of 4.59 million units. However, sales were stronger than the 4.57 million forecasted by analysts, indicating that the negative trend in the housing market may be over. Supply increased as well as the number of first time buyers. Existing Home Sales are expected to rise to 4.71 million.
7. German Ifo Business Climate: Friday, 8:00. German business climate index rose to 111.2 in March, following a revised 110.7 in February. The reading was stronger than the 110.5 points forecasted by analysts. The Ukraine crisis took less attention in the survey despite Barack Obama’s warnings of additional sanctions against Russia in case it fails to reach an agreement with Ukraine. German business climate is predicted to reach 111.
8. US New Home Sales: Friday, 14:00. Sales of new U.S. homes plunged to their lowest level in eight months reaching a seasonally adjusted annual rate of 384,000 units in March. It was the second consecutive monthly drop indicating a slowdown in sales. Economists expected sales to increase to 455,000 saying the unexpected drop may be related to cold weather conditions. However, the weak demand increased the months’ supply of houses on the market to 6.0, the highest level since October 2011, from 5.0 months in February. New home sales are expected to reach 426,000.

US Dollar Rally Will Stall Without a Spark

Fundamental Forecast for Dollar: Neutral

• Though US Treasury yields were in retreat this past week, the move does not likely reflect fading Fed expectations
• There is limited impetus from the docket for a big ‘risk’ breakout this week, but a surge in sentiment doesn’t require data

The US Dollar managed to turn a close call test of 14-month lows into an impressive rebound over the past two weeks. Yet, without a strong foundation for bulls to drive from, a ‘rebound’ may be all the greenback is able to muster. There are two fundamental themes on which the currency will rely to decide its fate: the bearings for global risk trends and the market’s rate expectations. Either could turn the tides for the benchmark and global capital markets with motivation. However, the potential and probability between the two remain uneven.

Relative monetary policy is currently the most productive fundamental driver behind the dollar – for better or worse. Over the past weeks, we have seen a FOMC rate decision, a number of Fed speeches and round of data that have reinforced the time frame for the central bank’s first rate hike (mid-2015). Despite this, Treasury yields have stumbled. The rate on the favorite 10-year Treasury note dropped to a near seven-month low while the 2-year yield – more sensitive to the beginning of the rate hike regime – has similarly retreated, just not with the same degree of attrition.

Forecasts in Fed Fund futures (derivatives used to gauge central bank moves out into the future) are similarly skeptical of the projected path for rate hikes. Looking out the curve, the first hike is not fully priced in until October of 2015. Yet, as with anything in the FX market, the dollar’s situation is relative. While a late-2015 hike is a weaker than guidance, it would still mark a more hawkish bearing that the Euro (ECB pursuing stimulus), the Yen (BoJ not yet winding down its open-ended QE) and many other counterparts. From this comparative evaluation, we find that European and Asian yields were also in retreat.

Moving forward, the market will intensify its speculation for the Fed’s policy path. There are plenty of scheduled Fed speeches to gauge timing, but data is particularly light in this regards. It is unlikely that the group take a hard turn from their march towards the end of QE3 and the eventual first move to tighten. That means, the market is more likely to feel the tug of a mid-2015 time frame teasing yields and the dollar. More heat may come indirectly from more significant policy swings from the currency’s major counterparts. The ECB push towards June stimulus is a key source of strength for the greenback via EURUSD, so the Eurozone flash PMI readings will carry weight. So too will the UK CPI figures with the pound enjoying a significant rate forecast premium over its US counterpart.

While Fed forecasts will remain an engaged fundamental subject for the dollar, it is important to keep tabs on the other primary driver which may be dormant now but could quickly turn explosive with little warning: risk trends. Complacency continues to grow with exposure to ‘high risk / high yield’ assets extreme, leverage use at records and hedge exposure virtually nonexistent. These are the ingredients of a catastrophe for the financial markets, but masses can remain blissfully ignorant so long as a pullback doesn’t start to incur amplified losses. Yet, with volatility indicators already at natural lows (risk premium fully absorbed), benchmarks like the S&P 500 struggling for meaningful gains, economic activity slowing and interest rates gradually trending higher; it is only a matter of time before this volcano erupts.

Bullish USD/JPY Outlook to Deteriorate Further on Less-Dovish BoJ

Fundamental Forecast for Japanese Yen: Neutral

• Japan GDP Trumps Estimates, USD/JPY Targets 99.44 if Support Broken
• Price & Time: Watching & Waiting in the Yen

The USD/JPY extended the decline from earlier this month, with the pair slipping to a fresh low of 101.30, and the Bank of Japan (BoJ) interest rate decision may continue to undermine the bullish sentiment surrounding the dollar-yen should we see a more material shift in the policy outlook.

In light of the marked pickup in Japan’s 1Q GDP report, the BoJ may sounds increasingly upbeat on the economy, and the central bank may continue to scale back its willingness to further expand its asset-purchase program as Governor Haruhiko Kuroda remains confident in achieve the 2% target for inflation. With that said, we may see a growing number of BoJ officials soften their dovish tone for monetary policy, and the USD/JPY may weaken further in the week ahead should the board show a greater disposition to halt the easing cycle sooner rather than later.

At the same time, we are likely to get more of the same with the Federal Open Market Committee (FOMC) Minutes as Chair Janet Yellen remains reluctant to move away from the zero-interest rate policy (ZIRP), and a further deviation in the policy outlook may encourage a more bearish outlook for the USD/JPY as it threatens the bullish trend carried over from the previous year.

In turn, the fundamental developments coming out next week may encourage a more bearish outlook for the USD/JPY, and we may see a more meaningful run at the 101.00 handle as the BoJ turns increasingly upbeat towards the Japanese economy.

Gold at Risk for Major Break Next Week- FOMC Policy Outlook in Focus

Fundamental Forecast for Gold: Neutral

• USDOLLAR, Gold Setups Target Key Resistance- Breakouts Pending
• Gold Oscillates Around 200 Day Average

Gold prices are marginally higher this week with the precious metal inching up 0.18% to trade at $1291 ahead of the New York close on Friday. Bullion has held a tight range for some time now and while our immediate bias remains neutral, a clear setup presents itself as we head into next week with the technical outlook warning of a possible near-term break in gold prices.

Broader market sentiment remains uneasy heading into the weekend with all three major stock indices closing markedly lower on the week as the yield on the US 10Yr dropped to its lowest levels since October 2013 at 2.47%. The key data print came on Thursday with the US consumer price index showing an uptick in both m/m and y/y core CPI. The data could begin to undermine the Fed’s dovish tone and with the labor market recovery seemingly on proper footing, the inflation outlook is likely to remain central focus for the central bank moving forward.

Looking ahead to next week, the release of the minutes from the April FOMC policy meeting will be central focus as investors continue to search for clues as to the central bank’s outlook on interest rates. Highlighting the economic docket next week will be an update on the housing market with existing homes sales on Thursday and New home sales on Friday. Data on Friday showed housing starts jumped 13.2% m/m in April, far surpassing expectations for a gain of just 3.6% m/m and strong data next week could further weigh on gold as prospects for policy normalization from the fed begin to take root. Existing home sales are expected to rise by 2.1% m/m after a 0.2% contraction in March with consensus estimates calling for new home sales to jump by 10.6% m/m, rebounding from a contraction of more than 14% the previous month.

From a technical standpoint, gold has continued to trade into the apex of a multi-week consolidation pattern off the April highs and a break-out ahead of the May close is in focus. A break below 1260/70 is needed to put the broader bearish trend back into play targeting $1216/24 and the 2013 lows at $1178. Interim resistance and our near-term bearish invalidation level stands at $1307/10 with a move surpassing $1327/34 shifting our broader focus back to the long-side of gold. Bottom line: look for a decisive break of this pattern next week with a move surpassing the May opening range to offer further clarity on our medium-term directional bias. The broader outlook remains weighted to the downside sub $1334.

British Pound at Risk Ahead of Key Data, Trades at Critical Support

Fundamental Forecast for Pound: Bearish

• British Pound falters as Bank of England shows no rush to raise rates
• Cable nears critical price levels, next move is key

The British Pound pulled back further from multi-year highs as a drop in UK yields and a broader US Dollar reversal produced the second-consecutive week of GBPUSD declines. Key economic data may need to impress to spark a larger GBP bounce.

A highly-anticipated Bank of England Inflation Report showed officials are likely to keep interest rates unchanged for some time to come. The disappointment sent UK yields considerably lower, and the interest rate-sensitive GBP followed in kind.

Those same interest rate and FX traders will watch upcoming UK Consumer Price Index inflation figures, Retail Sales results, and Q1 GDP growth numbers for greater clarity on the future of domestic interest rates.

Risks to the British Pound seem weighed to the downside as the BoE dashed hopes that strong growth figures would be enough to force the bank into action on interest rates. And indeed short-term government bond yields matched their largest single-week drop on the year. Given strong correlations between interest rates and the GBP, any further deterioration could sink the Sterling for the third-consecutive week.

Consensus forecasts for upcoming inflation, consumption, and growth figures are relatively tame; the recent tumble in yields suggest we need to see strongly positive surprises to force a material Sterling bounce. From a technical perspective it’s important to note that the GBPUSD trades near pivotal support, and its next moves could guide price action for some time to come.

It’s shaping up to be an important week for the previously high-flying GBP. And though it remains relatively close to multi-year peaks, continued failure at these levels suggests that the uptrend may be over.

Aussie Dollar at Risk as US Data, FOMC Minutes Hurt Risk Trends

Fundamental Forecast for Australian Dollar: Bearish

• Lull in Australian Economic News-Flow Puts Spotlight on External Catalysts
• Upbeat US Data, Hawkish FOMC Minutes to Hurt Aussie Amid Risk Aversion

Another quiet week on the Australian economic data front keeps the spotlight on external factors, with the evolving outlook for Federal Reserve monetary policy in focus. A central theme driving markets since the beginning of the year has been the disparity between soft US news-flow and the Fed’s commitment to continuing to “taper” its QE effort. That encouraged investors to suspect that the central bank may pause or abandon the process of reducing the size of its monthly asset purchases.

For its part, the Fed has steadfastly reduced the pace of balance sheet expansion by $10 billion/month since the cutback process was initiated in December. Fed Chair Janet Yellen and her colleagues on the rate-setting FOMC committee argued that the slowdown in US economic performance in the first quarter was transitory and didn’t warrant a change of course. The markets were duly skeptical of this position absent hard evidence to support it. This may be changing at last.

A Citigroup index tracking how US economic releases stack up relative to expectations found a bottom in early April and started to reverse upward, finishing last week at the highest level in three months. That suggests analysts are underestimating the resilience of US recovery, opening the door for upside surprises. In the week ahead, that means measures of April’s new and existing home sales may yield rosier results than consensus forecasts envision.

The item of greatest significance is likely to be the release of minutes from the Fed’s April monetary policy meeting. Traders will be keen to gauge policymakers’ confidence in QE reduction continuity in the early weeks of what is increasingly looking like a re-acceleration of US growth. Recognition of the transition in its infancy would go a long way toward brandishing the Fed’s ability to read the business cycle, bolstering the central bank’s credibility and scattering doubts about the likelihood of an end to QE by autumn.

Unencumbered speculation about the culmination of stimulus expansion and the commencement of interest rate hikes thereafter sparked liquidation across the spectrum of risky assets last year, when then-Chairman Ben Bernanke first introduced the concept of “tapering”. As one of the higher yielders in the G10 FX space, the Australian Dollar is highly sensitive to broad-based risk aversion, meaning another mass exodus from sentiment-geared assets stands to punish currency.

Nikkei forecast for the week of May 19, 2014, Technical Analysis

The Nikkei tried to rally during the week, but as you can see found a lot of resistance at the 14,500 level. The area is a large, round, psychologically significant number that the markets will try to respect, but eventually the market will need to break above the top of the shooting star in order to go further to the upside, the move we expect to see. The breaking below of the 14,000 level will send this market falling significantly in the meantime. The upside is what we prefer, and think is most likely to happen.

DAX forecast for the week of May 19, 2014, Technical Analysis

The DAX broke to the upside during the week, but found the €9800 level to be a bit too resistive to overcome. With that, we pulled back and formed a massive shooting star, but the €9600 level is in and of itself a significant support level. Because of this, we feel that ultimately the market will follow the trend that it’s been in for some time, sending this market back above the €9800 level. With that in mind, we have no interest in selling this market and can only follow the longer-term trend.

NASDAQ forecast for the week of May 19, 2014, Technical Analysis

The NASDAQ when back and forth during the sessions of the last week, and as a result it appears that the market really is a ready to go anywhere quite yet. The 4000 level has offered significant support previously, and as a result we feel that the market will ultimately go higher, as we are simply sitting on top of a significant amount of support. However, we also recognize that there is a nice potential for a large uptrend line that we are touching now. On a break above the highs from the last couple of weeks, essentially the 4200 level, we believe that the market goes much higher.

S&P 500 forecast for the week of May 19, 2014, Technical Analysis

The previous week for the S&P 500 was back and forth and as a result we ended up forming the neutral candle that you see on the chart. This market is essentially consolidation between the 1900 level on the top, and the 1860 level on the bottom. With that, it appears that we are going to continue to go sideways for the short term, but ultimately we need a break above the 1900 level in order to start going long. That being the case, we believe that this market at that point in time would go to the 2000 level.