Will GDP Drive Yen To 110?

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

Over the past 6 trading days the U.S. dollar has been quietly consolidating its gains versus the Japanese yen, waiting for its next big catalyst. Although we have seen a broad-based recovery in the U.S. dollar, USD/JPY’s strength can be partially attributed to concerns about Japan’s economy. Wednesday’s first-quarter GDP report is expected to show Japan narrowly escaping recession but the fear is that GDP growth may have stagnated and/or remained negative between January and March. Everyone has been waiting for the Bank of Japan to ease but they put off the decision and passed the baton to Prime Minister Abe. So the general belief is that if growth falls short of expectations, the BoJ will need to ease in June or July. Japanese data does not normally command this much attention but with USD/JPY consolidating within a 145-pip range for the past 6 days — and the market itching for some central-bank action — a weak number could send the pair soaring to 110. However the risk is to the upside for Japan’s GDP report. The forecasts are low and we saw improvements in the trade balance and retail sales in the first 3 months of the year. A healthier GDP would be positive for the yen but unlike a weak release, a strong number may only drive USD/JPY to the bottom of its recent range (108.23) and not much more beyond it.

Wednesday’s FOMC minutes will also affect USD/JPY. Better-than-expected U.S. data helped the dollar hold onto its recent gains while failing to drive it to fresh highs. The sharp increase in housing starts, stronger rise in consumer prices and jump in industrial production tell a story similar to Friday’s retail sales report — one of continued recovery in the U.S. economy. The last time the Fed met was in late April and even though U.S. policymakers expressed less concern about global troubles, the dollar peaked as investors realized there was nothing in the statement to suggest they would raise interest rates in June. The overall tone of the FOMC statement was subdued with the Fed noting that inflation remains low and inflation expectations were little changed. While they liked how the labor market had been performing, they no longer saw economic activity expanding at a moderate pace. The balance of risks statement was also missing from the report. Wednesday’s FOMC minutes is expected to confirm the pision in views within the central bank and validate the market’s expectations for steady rates next month.

The euro ended the North American trading session unchanged against the greenback. EUR/USD is hovering near its monthly low, which is either a great place to buy the currency pair or a precursor to a deeper correction. We believe that it’s the former as the pair holds its 50-day SMA support. The latest economic report out of the Eurozone was strong with the region’s trade surplus growing to 22.3B from 20.6B. Economists were looking for deterioration but instead there was improvement. Eurozone consumer prices are scheduled for release Wednesday but no revisions are expected. Consumer prices fell 0.2% year-over-year in April, keeping the door open to additional ECB easing.

Sterling’s complete disregard for deteriorating data continues to astound us. The British pound traded higher versus the euro and U.S. dollar despite a surprise slowdown in consumer price growth. CPI rose only 0.1% in April, which was significantly weaker than the market’s 0.3% forecast driving the year-over-year rate down to 0.3%. While the Bank of England may be concerned about rising price pressures, this data doesn’t confirm it and perhaps that’s why there was greater emphasis on slower growth than stronger inflation in their Quarterly Report. Between the miss in CPI and the slowdown in all three PMIs (manufacturing, services, construction), sterling should be trading much lower. However nothing seems to matter more than politics for the pound. A recent poll showed that the Remain vote was pulling ahead but that account is inconsistent because there were more supporters for Remain by the telephone poll, whereas more online participants favored Leave. U.K. employment numbers are scheduled for release Wednesday and we are looking for another soft report because according to the PMIs, job growth was at its weakest level since 2013 for both the service and manufacturing sectors.

The Australian and New Zealand dollars saw strong gains on Tuesday. According to Monday night’s RBA minutes, the decision to cut interest rates was a close one, which suggests that there will be very little desire to ease monetary policy again in June or July. Australian and Chinese data have been terrible but this sentiment could carve out a near-term bottom in AUD. Still, if the currency rises to 75 cents, it would be an attractive sell. The New Zealand dollar ticked up on the back of higher dairy prices. New Zealand’s economy is certainly faring better than Australia, validating our view that AUD/NZD should be trading lower.

Despite another day of gains in oil, USD/CAD ended the day unchanged. With the psychologically significant $50 level in reach, traders are skeptical of how much more oil will rise, which means they’ve been reluctant to sell USD/CAD. Also, the 2 year U.S.Canadian yield spread hit 1-month highs, signaling that it may be time for a renewed rally in the pair. Data has been strong with existing home sales rising in April and manufacturing sales falling less than anticipated. But the real test for the loonie will be Friday’s retail sales and CPI reports.

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