FX Outlook: Is This All According To The BOJ's Plan?

by: Sean Bellamy McNulty

This past week saw a number of volatile moves in the currency market. Compounding the danger of this volatility was the price actions largely unexpected directions. The CAD (NYSEARCA:FXC) rallied on the best job numbers since 2002, the AUD (NYSEARCA:FXA) fell on disappointing GDP numbers despite being at multiyear lows and the JPY (NYSEARCA:FXY) rallied after a speech from Prime Minster Abe fell short of expectations.

When trading currencies in times like these, it is important to remember that return of capital is more important than return on capital.

Summary of Last Week's Action

The European Markit Manufacturing PMIs were a rare piece of good news from the Euro region. All the major economies' PMIs increased, handily beating expectations:

The U.S. ISM Manufacturing PMI disappointed in an interesting role reversal for the U.S. and Europe, with the reading missing expectations and falling into the sub 50 zone, meaning more manufacturing managers were stating that business conditions worsened rather than improved.

The Market Services PMI told a different story, with services PMIs falling in Italy and Germany, while the Euro region collectively fell to 47.7. The Euro PMI number was in line with expectations, dampening any potential negative impact from the lower reading.

The positive Manufacturing PMIs corresponded with a rise in the EURUSD (NYSEARCA:FXE), which closed the week above 1.32. This is similar price action to May 23rd, the last big release of Markit PMI readings which also beat expectations.

But the biggest news, especially compared to forecasts, was the Canadian job numbers beat. As mentioned previously, the 95k new jobs created was the most since 2002 and puts in jeopardy the "short Canada" investment thesis being pitched by a number of hedge funds. To put this in perspective, Canada is 10% of the population of the U.S., therefore a job number of 95k is the equivalent to a U.S. job number of 950k. Imagine what that would do to the S&P 500 (NYSEARCA:SPY).

The CAD rallied on the news, but interestingly the Canadian equity markets did not.

Things are not looking good for Vijai Mohan's thesis on the macro level, but oddly enough if he is shorting Canada via the equity market he is making cash.

Sunday June 9th

Two big numbers out of Japan Sunday, the Current Account and GDP, with GDP being especially crucial. One of the side effects of the massive BOJ interventions has been rising bond yields raising the cost of borrowing for the Japanese Government, and given that Japan has the largest government debt in the world, a high cost of borrowing could be debilitating. This is where GDP comes in, as nominal GDP growth will increase tax receipts that will enable Japan to pay its debts.

Of course, since Japan has a printing press, it can always pay its debts, the question is the value of what the bond holders receive in exchange.

Japan's Current Account is expected to worsen and GDP is expected to climb to 3.5%.

In terms of the JPY, I'd be selling at these levels but using very little leverage to take into account the volatility. There still may be room for appreciation, especially if there is a broader "rush to safety", as the JPY still functions as a safe haven currency despite the new monetary regime, much like the USD (NYSEARCA:UUP) still does despite a similarly radical monetary regime by historical standards.

Monday June 10th

More Japanese news Monday, this time the Bank of Japan (BOJ) Monetary Policy Statement and Interest Rate Decision. The Interest Rate Decision is a moot point, but the Monetary Policy Decision will be one to read. The key is the reaction from the BOJ to the JPY and Nikkei Stock Index (NYSEARCA:NKY) rise and fall. I expect reiteration of the 2% inflation or bust strategy and reiteration that the BOJ is above concerning itself with short-term market fluctuations. Both are being released at 20:00 PT.

Canada's Housing Starts Numbers on the back of the huge employment beat will be one to watch. In May's labor force survey, 43k of the 95k jobs were in construction, offsetting the 14k jobs lost in manufacturing. A large component of construction will be housing construction, so look for housing starts to beat expectations and the CAD to rally.

Below is the table from the Canadian Labor Force Survey with the construction jobs highlighted.

Tuesday June 11th

Tuesday's data to watch is Germany's Consumer Price Index. This reading has severe implications for the Euro region as it is a barometer on the monetary policy options available to the ECB. If Germany begins to experience deflation, given that they hold the purse strings in the EU, you can be sure that looser monetary policy will be soon to follow. Conversely, German CPI moving back to the 2% range ensures more bickering between the EU and Germany with regards to the appropriate monetary policy regime.

The worst case scenario has been emerging, with Germany employment numbers deteriorating in the face of rising inflation. The last German CPI data point was a reversal in a longer term trend down.

If German CPI continues to improve, I'd expect the EUR to continue to appreciate reflecting diminished expectations of aggressive monetary easing.

Wednesday June 12th

More impactful news on the EUR coming out of Germany Wednesday with the German Constitutional Court ruling on ECB bond buying at 03:00 PT. If it is deemed that bond buying by the ECB is allowed, this again opens the door for monetary policy at the ECB and a lower EURUSD exchange rate.

Back out to Asia, the Reserve Bank of New Zealand (RBNZ) has an Interest Rate Decision and Policy Statement being released at 14:00 PT. Interest rates are expected to stay flat at 2.5%, meaning that the action will be in the policy statement. Much like the Reserve Bank of Australia policy statement last week, it'll be worth taking note if the RBNZ makes any comment on the depreciating New Zealand Dollar.

Speaking of Australia, the employment numbers are published at 18:30. The last print was a very strong 50k in jobs created and expectations are for this to revert to 10k jobs lost. The weakness out of China is a driver of these low expectations, but with the large short position already in the AUD, there may be an opportunity for a swing to the upside in the AUDUSD if this number beats expectations.

Last up is Japan's Foreign Bond Investment and Foreign Investment in Japanese Stocks numbers. Both of these will be informative as to how other segments of Japan's capital markets are digesting the new monetary policy regime. Recently Japanese bonds and stocks have been seeing outflows from foreigners, and given the massive volatility as of late, I suspect outflows will have increased.

Thursday June 13th

U.S. job and retails sales numbers are the highlights for Thursday. Of these, the retail sales numbers have the largest potential for an upside surprise due to housing values climbing. Retail sales and housing have historically been correlated:

Source: Paper Money Blog

An upside surprise in the retail sales should cause the S&P 500 to rally, which as of late also means a USD rally.

Friday June 14th

On the heels of German CPI and the German Constitutional Court Ruling on ECB bond purchases is the EU Consumer Price Index reading. As with the last German CPI reading, this also saw an uptick as of late reversing a downtrend. With the other releases early in the week, this will be an important piece to the EU region's monetary policy puzzle.

The week wraps up with the University of Michigan's Consumer Sentiment Index. It has been on a tear as of late, rallying from a low of 54 in 2011 to 84 at the last reading. Below is a short-term and long-term chart of the index.

It is important to note that despite the recent rise in the index, it is still well short of historical levels during stock market rallies, for instance, the dot-com bubble in the late 90s. There is plenty of room for this indicator to continue to rise.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am actively trading FOREX and CFDs and may either be long or short the instruments discussed at the time of this article's publication. To see a complete list of my open trades in real time, visit mcnultycapitalmanagement.com.