US Dollar, Japanese Yen Face Downside Risks as US Stress Test Results Benefit Carry Trades

The US dollar and Japanese yen spent much of Thursday under pressure as volatile price action in currencies like the euro and British pound drove much of the FX market’s direction. These moves are likely to continue overnight following the release of the official results of the US government’s stress test of the 19 largest financial institutions. Results were largely in line with expectations, as 10 of the 19 will require additional capital amounting to $76.4 billion, including: Regions Financial ($2.5 billion), GMAC ($11.5 billion), Suntrust ($2.2 billion), Keycorp ($1.8 billion), Bank of America ($33.9 billion), Citigroup ($5.5 billion), Fifth Third ($1.1 billion), Morgan Stanley ($1.8 billion), PNC ($0.6 billion), and Wells Fargo ($13.7 billion). Banks determined to meet capital requirements include: Goldman Sachs, JPMorgan Chase, Metlife, American Express, State Street, BNY Mellon, BB&T, Capital One, and US Bancorp.

The US dollar is likely to see choppy price action yet again on Friday. Based on both a Bloomberg News poll of economists and a variety of leading indicators, the 8:30 ET release of US non-farm payrolls (NFPs) is likely to show job losses for the sixteenth straight month in April, but the rate of decline is anticipated to slow. At the time of writing, Bloomberg News was calling for NFPs to plunge by 600,000, but looking at the range of estimates, economists are anticipating that NFPs could fall anywhere between 360,000 and 750,000. Based on the improvements we’ve seen in leading indicators like initial jobless claims, consumer confidence, and the employment components of ISM non-manufacturing and ISM manufacturing, we expect that NFPs may drop somewhere in the range of 500,000 to 600,000.

That said, the steady accumulation of job losses does not bode well for economic growth going forward and indicates that the unemployment rate will continue to climb. In fact, for the April reading of the rate is projected to rise to 8.9 percent, the highest since September 1983, from 8.5 percent. At the same time, initial estimates of Q1 GDP for the US showed a 2.2 percent jump in personal consumption, after spending contracted for the previous two quarters, suggesting that aggressive discounting by retailers has been able to counter the impact of falling incomes, to a certain degree. In coming months, it will be important to get a sense if the rising optimism amongst consumers – which has been focused more on the economic outlook than current conditions – can remain robust even if growth doesn’t bounce back in the second half of the year.

From a technical perspective, the daily charts of the US dollar index shows that the currency is going to face major support at the confluence of the 200 SMA and a rising trendline at 83.13. As a result, it will be important to watch how the US dollar responds to this pivotal level, as a breakdown in the greenback would signal a significant bearish turn in the currency across the majors. On the other hand, a failure and subsequent retracement could indicate that the US dollar is due for a broad rebound. Likewise, the Japanese yen crosses face hefty hurdles in the near term, with EUR/JPY facing immediate resistance at the 200 SMA (132.84) and GBP/JPY facing the psychologically important 150.00 mark.

British Pound Tumbles as the Bank of England Expands Quantitative Easing Program

The British pound fell across the majors on Thursday after the Bank of England left rates unchanged at 0.50 percent and surprisingly announced an expansion of their quantitative easing (QE) program. Indeed, the Monetary Policy Committee agreed to increase its purchases of government and corporate debt by 50 billion pounds to a total of125 billion pounds, suggesting the BOE believes that the economic outlook has worsened as the world economy remains in “deep recession.” The MPC’s policy statement also noted that the economic outlook was “dominated by two countervailing forces,” as growth takes a hit from the inside and out due to a rise in private saving and weak global demand. This moves leaves downside risks open for the British pound, as the QE program should bring down broad interest rates. That said, the currency is often treated as a “risky” currency, and a surge in investor confidence that lifts carry trades and equities has the potential to push the British pound higher as well. Looking to GBP/JPY, the pair backed off from resistance at 150.00 today, which may signal an intermediate top, but a break above that point may mark a buying opportunity.

Euro Gains Despite ECB Rate Cut, Credit Easing Announcement - Why?

The euro actually held its own against many of the majors on Thursday after the European Central Bank cut rates by 25 basis points to 1.00 percent. However, this wasn’t even the most important part of their latest meeting. Instead, ECB President Jean-Claude Trichet’s announcement that the central bank will buy 60 billion euros worth of covered bonds indicated a major turning point in policy, especially after ECB Governing Council member Axel Weber said on April 15 that “direct interventions, such as the purchase of corporate debt, shouldn’t take priority.” Trichet also refused to say that 1.00 percent marked any sort of floor for interest rates, as the ECB anticipates that “price developments will continue to be dampened by the substantial past fall in commodity prices and the marked weakening of economic activity in the euro area and globally.” The ECB cited no risk for deflation, but did say that they expect that headline inflation rates will fall further and temporarily remain negative “for some months around mid-year.” We had generally expected that a credit easing announcement would have bearish repercussions for the euro, which did not happen to be the case, as closer details won’t even be released until June 4. That said, resistance for EUR/USD looms above at the 200 SMA at 1.3486, not to mention the psychologically important 1.3500 level.

Canadian Dollar Slips Ahead of Canadian Employment Report on Friday

The Canadian dollar was generally weak on Thursday, which helped keep USD/CAD above Fibonacci support at 1.1660, and the pair is likely to see choppy price action on Friday morning as well. At 7:00 ET, the Canadian net employment change is forecasted to have fallen by 50,000 during April, marking the sixth straight month of job losses. Furthermore, the unemployment rate is anticipated to have risen to match July 1998 high of 8.3 percent from 8.0 percent. Since the employment change tends to be a very volatile release, this should have the greater impact on the Canadian dollar, with a sharper than expected drop likely to propel USD/CAD up for a test of the 200 SMA at 1.1864, while a surprisingly strong result may weigh USD/CAD toward Thursday’s lows of 1.1627. That said, speculative sentiment works very much in favor of USD/CAD weakness.

Terri Belkas is a Currency Strategist at FXCM.