USD may rally again this week

This week opened with the dollar giving back some of the gains from the previous week as the post-SNB announcement panic diminished somewhat.  The dollar is trading at an 11-year high against the euro and near 2-year high against the pound.  The Swiss franc dropped by 15 percent on Thursday and remains close to a 3-year low against the dollar.

That said, the dollar is in a good position to rally again this week. Most analysts believe the SNB abandoned its euro-franc floor last week to cut its losses in anticipation of the European Central Bank (ECB) launching an aggressive bond buying effort. They hope this effort will further weaken the euro to combat deflation and inject more credit into the financial system.  Had the SNB not dropped the euro-franc floor, a weaker euro would have added more pressureand forced the bank to buy more euros to maintain the rate at 1.2000.

Leading up to the ECB announcement this week, more questions and uncertainty will preoccupy the foreign exchange market.  What if the ECB’s program is too small?  What if the ECB offers no details?   The uncertainty will support the dollar this week since it stands as a leading safe-haven currency.

This week, there are several secondary market data releases – including the Weekly Jobless Claims on Thursday and the January Manufacturing Purchasing Managers Index on Friday.

EUR is waiting on the ECB announcement

The euro has rebounded somewhat from the previous week but is expected to weaken ahead of the European Central Bank’s monetary policy decision on Thursday. With an inflation rate falling into negative territory last month, ECB President Mario Draghi may have no choice but to launch a bond buying program to fight deflation in the Eurozone.

Buying bonds is akin to printing money and with more money in circulation, Mr. Draghi is betting the euro will devalue further.  This will help raise import prices and provide a cover for domestic producers to also raise their prices.

The ECB established its inflation target rate at 2 percent to help borrowers, including governments, to pay off their debts and help stimulate spending.  Note that deflation or a continually falling price level makes existing debts more costly to pay off and stifles economic activities.

All eyes will be on the ECB monetary policy meeting on Thursday.

GBP is waiting on the BOE

The pound has held its ground amidst currency turmoil that razed the middle of Europe last week.  However, that could change this week when the Bank of England (BOE) releases its policy meeting minutes from two weeks ago and also makes this month’s interest rate decision on Wednesday.

The BOE is expected to keep the short term interest rate unchanged in response to a sharp drop in consumer prices in December.  An inflation fell to 0.5 percent in December compared to the previous year – this marked the lowest rate since May 2000.

Bank of England Governor Mark Carney spoke after the release of the December inflation report and proposed that the inflation rate could remain well below the bank’s target rate of 2 percent for many months, suggesting that the bank may hold off on raising the short term interest rates.

Wednesday’s release of the minutes from the bank’s December meeting will shed more light on how long the monetary policy committee members plan to wait on the rate hike.  If the wait is longer than what the market is expecting then the pound may lose its ground, particularly against the dollar.

CAD is under pressure

The Canadian dollar is expected to remain under pressure as the Bank of Canada (BOC) is expected to keep the policy rate at 1 percent on Wednesday.  BOC Deputy Governor Timothy observed that a recent plunge in oil prices has been a net “bad” to Canada’s economy, and the bank has as revised its growth and inflation forecasts down for 2015 and 2016.

Most analysts do not see the BOC lowering the policy rate this year, and affirming this market view, the Canadian bond yields fell to record low levels today.   The Chicago Futures Market data also shows that an outstanding number of short or sell CAD futures contracts has increased in the recent weeks, suggesting that the current 3-year decline in CAD could continue deep into this year.

In addition to the BOC meeting and decision on Wednesday, the December Consumer Price and Retail Sales data will be released on Friday.  Stay tuned.

AUD shows some strength

The Australian dollar had a good week last week and managed to rally against most currencies.  The rally started after the release of an employment report which showed 37,400 new jobs were created and the unemployment rate tumbled to 6.1 percent in December.  A firmer tone in copper and other commodity prices also helped to rally the Australian dollar.

Additional temporary support for the Australian dollar this week will be provided by the ongoing turmoil in Europe over the Swiss National Bank abandoning its currency floor commitment to the euro last week, and the European Central Bank decision on Thursday.

However, the Australian dollar value is inexorably tied to economic fundamentals in China, which is the largest customer of Australian exports.  With China continuing to slow, the Australian dollar’s recent gain is expected to erode and resume its decline that began two years ago.

This week, the January Consumer Inflation report will be released on Thursday and is not expected to have a major impact on the market.

Have a great week.