- There is uncertainty about the EURCHF following the SNB's sudden policy reversal
- There may be a pause in the bearish trend for the EURUSD
- Modest upside surprises in Japan may be enough to sustain the yen rally
Monday’s a light day for scheduled economic releases, in part because US markets are closed for the Martin Luther King public holiday. But trading will be anything but boring today, thanks to last week’s surprising news – the sudden Swiss National Bank decision to drop its cap on the value of the Swiss franc, in a move that sent the currency soaring against the euro. Suffice to say that all eyes will be on forex this week.
The ongoing fallout from Zurich is one reason. Another is Thursday’s statement from the European Central Bank, an event that’s expected to bring fresh news about quantitative easing in the Eurozone. Meanwhile, the Japanese yen is showing a bit of strength these days against the US dollar. For good or ill, forex will dominate the news cycle today, and perhaps for days to come. Let’s see where we stand with a quick review of EURCHF, EURUSD, and USDJPY.
The soaring Swiss franc has brought turbulence and heightened deflation risk to Switzerland. Source: Thinkstock
EURCHF Last week’s shocking news that Switzerland would abandon its three year-old cap on the franc (and cut the already negative policy rate down to -0.75%) will continue to reverberate in the week ahead in markets around the world. The first order of business is monitoring the EURCHF, which tumbled sharply in the wake of the Swiss National Bank decision to let the crowd set the price of its currency. The former line drawn in the sand – Sfr1.20 to the euro – is history, but regime change opens up a long list of questions, including this: how long and how far will the Swiss franc rally, now that market forces are in control?
The surge in the franc is a direct byproduct of the SNB decision, but the bullish momentum in the Swissy may find support from elsewhere in the days ahead. Indeed, the European Central Bank is expected to lay out plans for quantitative easing at this week’s policy announcement on Thursday, which will add to the downward pressure on the EURCHF. In fact, the ECB’s expected policy shift may explain why the SNB gave up its battle to keep the franc stable. If the ECB is about to embrace QE, then the euro will probably weaken further, which would force SNB to work harder to keep the franc steady. Apparently the monetary gnomes in Zurich decided to give up the fight before the next phase of battle even started.
The macro implications of SNB’s volte-face point to more turbulence as the global economy comes to grips with rising deflation risk. The Swiss economy may be a victim in what’s likely to be an ongoing run of losers as the demand for liquidity and safety increases. The franc has traditionally been seen as a haven of stability, but in the current climate that’s become a burden — and one that the SNB could no longer endure. But with the spectre of the ECB’s QE policy inching closer, the burden may get heavier still as the franc strengthens, which implies that deflation risk will increase for Switzerland.
The motivation for engineering a cap on the franc in the first place was the well-founded concern that a soaring currency is a dangerous proposition for a small country that relies on exports and foreign investment. That risk hasn’t gone away; in fact, the SNB’s decision may have made it worse for Switzerland.
From a global perspective, macro turbulence for Switzerland is a minor event – Saudi Arabia has a bigger GDP. But the symbolism of another country in the developed world battling a deeper strain of deflation will create more downward pressure on yields generally. Are we headed into yet another wave of risk-off trades? In search of some advance intelligence, keep your eye on EURCHF.
A strong bearish trend for EURUSD has been conspicuous for months, but the downside risk may strengthen due to the possibility that Thursday’s ECB announcement will mark a major change in policy. But there may be a joker in the deck, namely: the Federal Reserve.
The US economy is still leading the developed world when it comes to growth, based on the available numbers to date. But last week brought a mixed bag of economic news that raises questions about the argument that the US recovery is accelerating. Headline numbers for retail sales and industrial production for December were disappointing as consumer inflation tumbled the most in six years for the monthly comparison. The US is still likely to grow in the near term, but recent events imply that the Fed may decide to delay raising interest rates, an event that until recently was widely expected to arrive mid-way in 2015.
Given the uptick in deflation risk, however, there’s rising speculation that the US central bank won’t begin tightening until late this year or even early 2016. To the extent the crowd embraces this view, the EURUSD’s widely expected slide could pause for a time or even perform the forex equivalent of a dead-cat bounce.
Macro gravity will eventually win out, and on that front there are few doubts that the US outlook will remain considerably brighter relative to the near-term prospects for the Eurozone. The gap may narrow a bit in the short term, perhaps giving the euro a small bounce at some point. But with the ECB’s QE announcement lurking on Thursday, any relief for EURUSD’s downward bias will be brief.
USDJPY The US dollar may be king these days, but the recent rally in the yen reminds us that even monarchs can suffer a rough patch.
A week ago I noted that the yen appeared to testing the dollar’s recent surge and the observation still holds today. On Friday, the USDJPY dipped to a new low for the year on an intraday basis. Japan’s economy continues to face an array of challenges, but the sharp decline in crude oil prices has boosted expectations for growth in the near term, providing some support for the yen. Japan is heavily dependent on energy imports, valued at roughly 5% of GDP. The government estimates that a 30% slide in oil prices translates into savings worth 0.8% of GDP.
An economist at SMBC Nikko Securities last week predicted that the recent slide in the price of crude “is likely to push up corporate income [in Japan], which would help bolster domestic demand".
The economic reports of late leave room for doubt, but the crowd seems willing to bet on the margins that the macro news from Japan could provide modest upside surprises in the coming weeks. In a world where the numbers seem to be moving in the opposite direction, a batch of slightly better figures for Japan may be enough to keep a yen rally bubbling.
A week ago I noted that the yen appeared to testing the dollar’s recent surge and the observation still holds today. On Friday, the USDJPY dipped to a new low for the year on an intraday basis. Japan’s economy continues to face an array of challenges, but the sharp decline in crude oil prices has boosted expectations for growth in the near term, providing some support for the yen. Japan is heavily dependent on energy imports, valued at roughly 5% of GDP. The government estimates that a 30% slide in oil prices translates into savings worth 0.8% of GDP.
An economist at SMBC Nikko Securities last week predicted that the recent slide in the price of crude “is likely to push up corporate income [in Japan], which would help bolster domestic demand".
The economic reports of late leave room for doubt, but the crowd seems willing to bet on the margins that the macro news from Japan could provide modest upside surprises in the coming weeks. In a world where the numbers seem to be moving in the opposite direction, a batch of slightly better figures for Japan may be enough to keep a yen rally bubbling.
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