Talking Points

• Euro: PMI Contracts at Slower Pace, More ECB Easing Ahead
• British Pound: U.K. 1Q GDP Expands 0.3%, BoE to Target Inflation
• U.S. Dollar: Jobless Claims Tops Forecast- House Prices, New Home Sales on Tap

Euro: PMI Contracts at Slower Pace, More ECB Easing Ahead

The Euro advanced to an overnight high of 1.2903 as the purchasing manager index showed manufacturing and service-based activity in Europe contracting at a slower pace in May, but the rebound in the single currency is likely to be short-lived as the region remains mired in recession.

European Central Bank board member Peter Praet said the board is looking ‘at all possibilities’ to shore up the ailing economy as the region struggles to return to growth, while Governing Council member Christian Noyer noted that the central bank is looking to introduce ‘monetary policy instruments that could further reduce fragmentation’ across the monetary union as the governments operating under the single currency struggle to get their house in order.

At the same time, ECB board member Ewald Nowotny warned that there’s little ‘indication that there will be a significant improvement in the economic situation in the short term,’ and warned that ‘we may see worse numbers in the course of the year’ as he sees the economy contracting in 2013.

As a growing number of Governing Council officials turn increasingly cautious on the economy, we should see the ECB push the benchmark interest rate to a fresh record-low in the second-half of the year, and it seems as though the central bank will also introduce more non-standard measures in the coming months in an effort to boost private sector lending.

As the EURUSD retains the range-bound price action from earlier this week, the pair should continue to carve a lower top going into the final days of May, and we should see the head-and-shoulders pattern continue to take shape in June as the ECB retains a dovish tone for monetary policy. In turn, we are still looking for a move back towards the 23.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.2640-50, and we may see the EURUSD fail to maintain the rebound from July (1.2041) as European policy makers struggle to address the risks surrounding the region.

British Pound: U.K. 1Q GDP Expands 0.3%, BoE to Target Inflation

The British Pound pared the sharp decline from earlier this week, with the GBPUSD climbing to a high of 1.5093, and the sterling may continue track higher in the days ahead as the fundamental developments coming out of the U.K. dampens speculation for more quantitative easing.

Indeed, the preliminary GDP reading showed the U.K. economy expanding 0.3% in the first quarter, with private sector consumption advancing 0.1%, and it seems as though the Bank of England (BoE) is slowly moving away from its easing cycle as the region skirts a triple-dip recession.

Although the Monetary Policy Committee has ‘had a hard time rebalancing’ the economy, BoE board member Ben Broadbent said that the central bank is focus on achieving the 2% target for inflation, and we may see a growing number of BoE officials scale back their willingness to expand the balance sheet further as price growth is expected to accelerate throughout the course of the year.

As the GBPUSD continues to give back the rebound from back in March (1.4830), we may see the pair develop a broader downward trend in the days ahead, but an upward revision in the preliminary 1Q GDP report may prop up the sterling over the next 24-hours of trading as it dampens bets for more QE.As a result, we may see the GBPUSD carve out a higher low ahead of the next BoE interest rate decision on June 6, and the sterling may outperform against its major counterparts in the second-half of 2013 amid the shift in the policy outlook.

U.S. Dollar: Jobless Claims Tops Forecast- House Prices, New Home Sales on Tap

The greenback lost ground on Thursday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR)slipping to a low of 10,784, but the reserve currency may track higher during the North American trade as the economic docket is expected to instill an improved outlook for the U.K.

Indeed, U.S. initial and continuing claims both beat market expectations amid the ongoing improvement in employment, and the budding recovery in the housing market may further increase the appeal of greenback as home prices are expected to increase another 0.8% in March, while New Home Sales are projected to rise 1.9% in April.

FX Upcoming

— Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

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Chart – Created Using FXCM Marketscope 2.0

Although the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDollar) remains 0.52 percent lower from the open, we’re seeing the 30-minute relative strength index come off of oversold territory, and the greenback may track higher during the North American trade as the drop in initial/continuing jobless claims paired with the 2.3 percent rise in New Home Sales instills an improved outlook for the world’s largest economy. In turn, we should see a small rebound going into the end of the week, but the pullback from 10,876 may turn into a more meaningful correction as former trendline support appears to be acting as new resistance. Nevertheless, the bullish sentiment surrounding the reserve currency should gather pace over the near to medium-term amid the ongoing improvement in the world’s largest economy.

Despite the fresh 2013 high in the USDOLLAR, we’re seeing the relative strength index persistently come off of resistance (78), and the greenback remains poised for a larger correction as the oscillator falls back from overbought territory. However, the shift in the Fed’s policy outlook should limit the downside for the reserve currency, and we will be looking for a higher low in the index as we anticipate the bullish sentiment surrounding the dollar to get carried into the second-half of the year. Indeed, St. Louis Fed President James Bullard, who also serves on the FOMC this year, added to the discussion of scaling back on quantitative easing and said the committee is more like to taper its asset purchases than expand the non-standard measure, and argued that the central bank should become a too big of a player in Mortgage-Backed Securities (MBS) as he sees the economy expanding 3.0 percent this year.

The greenback weakened across the board, led by a 1.48 percent rally in the Japanese Yen, but the near-term correction in the USDJPY should produce a higher low in the exchange rate as the upward trend from earlier this year continues to take shape. Indeed, the pullback from 103.72 may gather pace in the days ahead as the Bank of Japan (BoJ) moves to the sidelines, but the deviation in the policy outlook should produce fresh highs in the dollar-yen as Governor Haruhiko Kuroda pledges to retain an aggressive approach in achieving the 2 percent target for inflation. In turn, the pullback in the USDJPY may offer a buying opportunity in June, and we should continue to see a series of higher highs and higher lows in the exchange rate as the BoJ remains poised to further embark on its easing cycle in the second-half of the year.

— Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong.

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The Japanese Yen looks likely to extend as supportive US economic data underpins bets on near-term reduction in Fed stimulus, driving risk aversion.

Talking Points

• Yen Soars as Asian Stocks Plummet on QE3 Reduction Bets, China PMI Miss
• Eurozone PMIs Boost Euro But Fail to Turn the Tide of Broad Risk Aversion
• Improved US Home Sales, Jobless Claims Data May Fuel Risk-Off Momentum

The Japanese Yen soared in overnight trade, adding as much as 2.1 percent on average against its leading counterparts, as risk aversion gripped Asian stock exchanges and prompted an unwinding of carry trades funded in the perennially low-yielding currency. The MSCI Asia Pacific regional benchmark index slid 3.6 percent in a move the newswires chalked up to hints of near-term QE3 reduction from Fed Chairman Ben Bernanke and a disappointing Chinese Manufacturing PMI report. Figures from HSBC suggested factory-sector activity unexpectedly contracted for the first time in seven months in the world’s second-largest economy.

Looking ahead, a nominally supportive set of Eurozone PMI figures seems to be doing little to underpin risk appetite in early European trade. The data showed manufacturing- and service-sector activity contracted at a slower pace than economists expected, although the overall trend still firmly points to continued recession in the second quarter. The Euro advanced on the results but S&P 500 index futures continue to trade sharply lower, hinting the dour mood seen in Asia is likely to carry forward as Wall Street comes online. Updated first-quarterUK GDP numbers printed in line with earlier estimates and likewise offer little that can meaningfully derail established momentum.

On balance, this points to continued Yen strength ahead. US New Home Sales and weekly Jobless Claims data are on tap ahead, with improvements expected on both fronts. That is likely to reinforce the idea that the Fed may taper asset purchases over the next several FOMC meetings, which ought to feed into continued risk aversion. For the US Dollar, the most profound response to these developments is likely to be reflected as continued USDJPY weakness.

Asia Session:

Euro Session:

Critical Levels:

— Written by Ilya Spivak, Currency Strategist for Dailyfx.com

To contact Ilya, e-mail ispivak@dailyfx.com. Follow Ilya on Twitter at @IlyaSpivak

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The story of the European and Asian session remains the massive gains in the Yen, as USD/JPY fell 250 points and below 101.00 for the first time in nearly two weeks. The Yen strength accompanies significant losses in European and Asian equities, as well as a US Futures showing a sharp tradeoff, therefore suggesting that the Yen strength is due to risk aversion.

Japan’s equity index Nikkei closed down 7.32%, the biggest daily decline since October 2008. The decline in Nikkei was attributed to comments from Fed Chief Bernanke suggesting an unwinding of QE if economic signs stabilize and due to a weaker than expected China Manufacturing PMI.

Japan’s officials immediately jumped into action and tried to return confidence to the markets. Economy Minister Amari said the decline today was a reaction to China, and said recent equity gains in Japan were faster than expected. He further remarked on the Yen move by saying hat it is natural for currencies and stocks to move together. Finance Minister Aso also spoke today, but declined to comment on the Yen level.

The Swiss Franc is also a big winner in today’s trading, which makes sense in a risk-aversion environment. However, what’s strange is USD is losing to most major currencies in today’s trading. USD is usually a risk-aversion correlated currency when trading against high-yield currencies like Aussie and Kiwi. Furthermore, many are saying Bernanke’s less-dovish comments were responsible for this risk-off trend, but less-dovish comments from the Fed should be US Dollar positive.

In economic releases, Euro-zone PMI’s slightly beat expectations in a preliminary release for May. The Euro rose slightly following the news. UK GDP was confirmed to have expanded by 0.3% in Q1, in line with a previous estimate released in April.

In Spain, 3,5, and 12-year bonds sold for 4.08 billion Euros, beating a maximum target of 4.0 billion Euros. 2026 bonds were sold for a 4.54% yield versus 4.336% on May 9.

USD/JPY seems to have found some interim support around the 101.00 line, but it is unclear if that means the decline is over. A rising trend line from May may provide resistance around 101.48.

(Did you understand all the terms used in today’s report? If so, test your skills with DailyFX’s Trading IQ Quiz.)

USDJPY 4-Hour: May 23, 2013

Chart created by Benjamin Spier using Marketscope 2.0

— Written by Benjamin Spier, DailyFX Research. Feedback can be sent to bbspier@fxcm.com .

• Dollar Rallies after Fed Talks QE3 Exit, Will EUR/USD Break 1.2800?
• Japanese Yen Traders See the Limits, Ill Side Effects of BoJ Stimulus
• British Pound: A Round of Data and Nothing Went the Sterling’s Way
• Euro Optimism to be Tested by Recession Warning in PMI Data
• Australian Dollar Slides Further on Stimulus Concerns, Chinese Data
• Canadian Dollar Breaks from Multi-Year Range with Help of Retail Stats
• Gold: Steady Fed and BoJ Stimulus Programs Dollar Bullish, Gold Bearish

Dollar Rallies after Fed Talks QE3 Exit, Will EUR/USD Break 1.2800?

The markets have sought out guidance on the future of the Federal Reserve’s QE3 plans to shape their speculation, and that is exactly what Fed Chairman Ben Bernanke and the FOMC minutes offered. Tentative but tangible commentary about the eventual reduction in the current $85 billion-per-month program spurred the traditional ‘risk aversion’ move from the capital markets. For the S&P 500, an intraday reversal tore the index from fresh record highs to a dangerous shift in momentum that threatens a deeper rollover. Leading the safe havens – and a direct victim of the supply-and-demand elements of the US money supply – the Dow Jones FXCM Dollar (ticker = USDollar) surged above 10,850 to its highest level since July 2010. These are both meaningful developments, but they don’t exactly confirm conviction just yet. Just like a technical breakout does not necessarily guarantee a lasting trend, a fundamental volatility swell does not ensure a systemic shift in capital.

To determine whether the market will finally pitch into a fear-driven deleveraging and risk aversion spiral, we need to see the proper fundamental catalyst to unite investors’ fears about their exposure. The Fed’s commentary does a little more than sow the seeds of doubt. The action began in the New York morning session when central bank head Bernanke testified before Congress’ Joint Economic Committee. Much of what he offered were words of caution. He clearly warned that premature tightening could undermine the US economy’s recovery. Yet, tightening and tempering are two different concepts. For speculators that have accessed record levels of leverage through the NYSE and have driven carry-favored yen crosses far off track of their yield differentials, what really stuck out was his suggestion that “in the next few meetings…(they) could take a step down in (their) pace of purchases.” How much in the way of capital gains can investors hope to squeeze out in just a few more months – because interest / yields / dividends aren’t up to par.

The hand wringing intensified a few hours later when the transcript of the Federal Open Market Committee’s (FOMC) last meeting was released. While the group noted that ‘many’ members thought that further progress was necessary to slow the policy cadence, shift away from certainty was unmistakable. Furthermore, ‘some’ on the Committee believed QE3 could be slowed as early as the June meeting. In the end, it is not confidence of growth, but fear of disastrous side effects (a market bubble) that would ultimately encourage the shift – and such fears were also noted. This is far from confirmation of a change in bearing for the world’s most prolific stimulator, but it offers a clear reason for doubt. And, at record price and exposure (leverage) levels, that may be enough to start the contagion.

Japanese Yen Traders See the Limits, Ill Side Effects of BoJ Stimulus

As expected, the Bank of Japan decided to keep its monetary policy bearing unchanged from the already remarkable objective of increasing the country’s money base by ¥60-70 trillion yen a year. This serious policy move was made little over a month ago, so a period of ‘wait and measure’ is to be expected. Yet, that may be little comfort for FX traders who have driving the yen down between approximately 25 percent in the span of six months – an extreme move for the liquid currency market. While pairs like AUDJPY, EURJPY and USDJPY probe multi-year highs, the carry (yield differential) that they offer are at historical lows. Capital gains through expectations of a constant bid are the only hope of real return. Meanwhile, the BoJ is facing a serious problem. With an aim to end deflation, interest rates will inevitable rise in Japan. However, the 10-year JGB yield surged a fourth day by 4 percent. It is now double its low in April. This is dangerous for a country with so much debt…

British Pound: A Round of Data and Nothing Went the Sterling’s Way

There was plenty of fundamental fodder on the UK docket this past session, and none of it was good for the sterling. Retail sales figures dropped the most in two years (1.4 percent) while the CBI manufacturing activity trends report posted a deeper contraction than expected. What is really troublesome in these times of stimulus, the disappointing figures are unlikely to encourage more BoE support. The BoE minutes showed the same 3 MPC members were outvoted to keep policy unchanged. Coming up, watch the second read of UK 1Q GDP to see critical details.

Euro Optimism to be Tested by Recession Warning in PMI Data

As blatant as the updates on monetary policy for the UK, Japan and UK were this past session; there seems a lack of appreciation for the subtlety of Europe’s policy regime (if few people are speculating on a change, such a move will have greater impact down the line). Worth noting though, ECB member Praet remarked on the group’s exploration of SME (small and medium-size business) loans and quality reviews of asset backed securities. In the upcoming session, we will be reminded of Europe’s biggest problem – recession – with the monthly PMI figures.

Australian Dollar Slides Further on Stimulus Concerns, Chinese Data

If there is a fear of risk, the Australian dollar will certainly take a brunt of the hit. This currency was already suffering while other benchmarks for sentiment – like equities – were still holding steady. A new addition to the currency’s troubles was added this morning when the HSBC Chinese Manufacturing PMI report for May reported a dip back into contractionary territory (49.6). A near-term rebound only works in a risk stable market.

Canadian Dollar Breaks from Multi-Year Range with Help of Retail Stats

Since October 2009, USDCAD has been guided lower by a consistent descending trendline. This past session, the pair finally closed above the high-profile technical level. The unique strength of the US dollar and general risk aversion support the break above 1.0300; and if sentiment really starts moving, that will be the catalyst for a trend. Meanwhile, the Canadian retail sales miss may hint at trouble in economic paradise.

Gold: Steady Fed and BoJ Stimulus Programs Dollar Bullish, Gold Bearish

Gold is first and foremost an alternative store of wealth for traditional fiats nowadays. That being the case, the metal found little support in the developments of the past 24 hours. Fed talk of tapering their balance sheet expansion curbs the unnatural depreciation of the world’s reserve currency. Furthermore, the BoJ has said it would stick to the course for now and the BoE is no closer to watering down their own currency. Selling was met with the highest volume in months, an uptick in the Gold Volatility Index and ETF holdings hit a fresh multi-year low.

**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar

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— Written by: John Kicklighter, Chief Strategist for DailyFX.com

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Talking Points

• Euro: EU Pledges to Combat Unemployment, ECB to Remain Accommodative
• British Pound: U.K. Retail Sales Disappoints, BoE Votes 6-3
• U.S. Dollar: Chairman Bernanke, FOMC Minutes in Focus

Euro: EU Pledges to Combat Unemployment, ECB to Remain Accommodative

The Euro climbed to an overnight high of 1.2954 asEuropean Union Economic and Monetary Affairs Commissioner Olli Rehn pledged to do whatever it takes to combat record-high unemployment, but it seems as though the European Central Bank (ECB) will come under increased pressure to further support the monetary union as Mr. Rehn anticipates monetary policy to remain accommodative.

However, German Finance Minister Wolfgang Schaeuble argued that the Governing Council should not keep interest rates low for an extended period of timeas the governments operating under the single currency become increasingly reliant on monetary support, and we may see the EU make further attempts to buy more time as the group struggles to meet on common ground.

As European officials scale back their push for austerity, we should see the ECB continue to embark on its easing cycle in the second-half of the year, and it seems as though the central bank will introduce more non-standard measures in the coming months to help steer the region out of recession. At the same time, there’s growing bets that President Mario Draghi will deliver another 25bp rate cut at the June 6 meeting, and we may see a growing number of ECB officials favor a negative interest rate policy (NIRP) for the euro-area as the economic downturn threatens price stability.

Indeed, the head-and-shoulders formation in the EURUSD should continue to take shape as long as the pair holds below the 38.2% Fibonacci retracement from the 2009 high to the 2010 low around 1.3120, and the policy outlook is likely to produce further declines in the exchange rate as interest rate expectations falter.

British Pound: U.K. Retail Sales Disappoints, BoE Votes 6-3

The British Pound slipped to a fresh monthly low of 1.5073 as U.K. Retail Sales tumbled 1.4% in April amid forecasts for a 0.1% rise, but the shift in the policy outlook may prop up the sterling over the near to medium-term as the Bank of England (BoE) appears to be slowly moving away from its easing cycle.

Indeed, the BoE Minutes showed another 6-3 split within the Monetary Policy Committee, with Governor Mervyn King, David Miles and Paul Fisher continuing to push for another GBP 25B expansion in the Asset Purchase Facility, but it seems as though the central bank will carry its wait-and-see approach into the second-half of the year as the board sees inflation holding above the 2% target over the policy horizon. At the same time, the BoE did note that the persistent weakness in the euro-area may push up the Pound, but it seems as though the majority will stay clear of expanding the balance sheet further as more quantitative easing would complicate the exit strategy.

As the GBPUSD continues to give back the rebound from back in March (1.4830), we may see the pair develop a broader downward trend in the days ahead, but an upward revision in the preliminary 1Q GDP report may prop up the sterling over the next 24-hours of trading as it dampens bets for more QE.

U.S. Dollar: Chairman Bernanke, FOMC Minutes in Focus

The greenback managed to hold its ground ahead of Fed Chairman Ben Bernanke’s testimony, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR)tagging a high of 10,814, and the reserve currency may continue to track higher during the North American trade should the central bank head strike an improved outlook for the world’s largest economy.

Beyond the testament, market participants will also be paying close attention FOMC Minutes coming out at 18:00 GMT, and the fresh batch of central bank rhetoric may heighten the appeal of the USD should we see the committee adopt a more neutral to hawkish tone for monetary policy. In turn, we may see a fairly muted reaction to the Existing Home Sales report, and the policy outlook may push the dollar higher in the second-half of the year as we see a growing number of Fed officials show a greater willingness to scale back on QE.

FX Upcoming

— Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

To be added to David’s e-mail distribution list, send an e-mail with subject line “Distribution List” to dsong@dailyfx.com.

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