Dollar Rings in New Year with Losses, No Help from NFP
Daily FX Market Roundup 01.05.18
By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
The U.S. dollar rang in the New Year with fresh 3-month lows against the euro, sterling and Canadian dollars. Coming on the heels of the worst year for the greenback in more than a decade, this lack of relief has many forex traders wondering if 2018 will be another crushing one for greenback. Commodity currencies continue to be the best performers with the Australian dollar rising 4 out of the last 4 trading days. In fact since early December, there was only one material down day in over 20 for AUD/USD, which is a testament to the phenomenal strength of the currency. The Canadian and New Zealand dollars also performed very well but these currencies are recovering from weakness whereas euro and sterling are extending their strength. Despite less significant gains in the first week of the New Year, EUR/USD is hovering near its 2 year high and sterling is trading near its 18 month high.
The one currency pair that hasn’t budged much is USD/JPY. While the dollar may be weakening against most of the major currencies, it is rising against the Japanese Yen and risk appetite is the reason for this divergence. U.S. stocks rang in the New Year with fresh record highs and despite the overall weakness of the greenback, 10 year Treasury yields are closing in on 2.5% as the 10 year U.S. – Japanese Yield spread hit its highest level in 9 years. U.S. data was mixed with manufacturing activity accelerating and service sector activity slowing. Job growth fell short of expectations in December with non-farm payrolls rising only 148K compared to a forecast of 190K, but the unemployment rate held steady at 4.1% and average hourly earnings growth rose to 0.3%. Given that the details of the labor market remain strong, the outlook for the Federal Reserve remains unchanged. Under Jerome Powell, the Federal Reserve is widely expected to raise interest rates 2 to 4 times this year and for this reason we think the dollar will recover in 2018 as ultra-low unemployment, tax cuts, consumer and business confidence leads to faster growth. The Fed will also be the most hawkish central bank and we could start to get a sense of that with some of the speeches from U.S. policymakers this week. However we also need to be realistic – it will be some time before the Federal Reserve raises rates again (the next hike isn’t expected until late March) and between now and then, investors will be focused on the changes at the Fed and fading memory of the GOP’s tax reform victory. There’s no question that the weakness of the dollar in 2017 carried over to 2018 and with no major U.S. economic reports on the calendar until Friday, when CPI and retail sales are due for release, the first 2 months of trading this year could be challenging for the dollar as it waits for the market to shift its focus to the prospect of a March hike
In the meantime, the euro continues to be propelled higher by solid Eurozone growth. 2017 was a great year for the single currency, which saw double-digit gains against the U.S. dollar. The upward revision in the Eurozone PMI composite index, rise in German retail sales and drop in unemployment claims served as a reminder that the growth in the region continues to expand and accelerate. EUR/USD spent the entire first week of the year trading above 1.20 and with a flurry of Eurozone economic reports scheduled for release in the week ahead, we expect to see EUR/USD break 1.21 and potentially extend as high as 1.22. Gains beyond that level will hinge upon whether the European Central Bank see recent economic strength as a reason to commence taper operations early or that the latest gains in the euro are a concern. With the December inflation estimate falling to 1.4%, we believe Mario Draghi will talk down the currency before mentioning taper possibilities. The ECB made it very clear that they have no plans to tighten until October and with the currency having appreciated 13% over the past 12 months, further gains could rile up policymakers as the stronger currency poses a threat to the region’s continued recovery. But until Draghi officially expresses his discomfort, the hope for a less dovish central bank and the positive momentum should continue to carry EUR/USD higher.
Sterling on the other hand could enjoy a more sustained rally this year as U.K. politicians continue to work towards a Brexit deal. This past week, Chancellor Hammond said he would not rule out a customs union with the EU as they would be guided by what brings the greatest economic advantage to the U.K. This is another sign of the government aiming for a soft Brexit and 2018 is the year that a Brexit deal will be done. As the market has completely discounted the Brexit mess, breakthroughs and progress will be positive for sterling and its greatest gains will be against the euro. As for the economy, it continues to chug along. While manufacturing and construction activity slowed towards the end of the year, service sector activity accelerated and house prices increased. Industrial production and the trade balance are due for release next week but the impact on the currency should be limited. All eyes will be on the parliamentary debate January 16 and 17. Until then, the market’s appetite for risk will drive sterling’s moves. Technically, it appears poised for more gains versus the euro and U.S. dollar.
The Australian dollar is starting the year strong, hitting a high of .7875. This marks a nearly 4-cent rally for AUD/USD in less than a month. What’s interesting about the recovery is that it has been driven less by data and more by risk appetite. This past week, we saw that manufacturing and trade activity slowed while service sector activity accelerated. Gold prices moved higher while copper prices declined. Iron ore prices were flat. Unlike other currencies, the outlook for the Australian dollar in 2018 is less promising. China is widely expected to experience slower growth this year and while Australia has done a good job of rotating from a mining to non-mining based economy, sluggish wage growth is a persistent problem. This week’s retail sales report could shine a light on this issue as the sales component of the PSI report shows weaker demand. For this reason, we see the rally in AUD/USD losing momentum between 79 and 80 cents. There were no New Zealand economic reports released over the past week except for dairy prices which rose by 2.2%, the largest increase in at least 6 months. The hope for a recovery in dairy prices this coming year propelled NZD/USD well above 71 cents. Unfortunately the lack of New Zealand data next week means that the currency will be driven by the market’s appetite for risk and the U.S. dollar.
The Canadian labor market is on fire and this strength has taken the loonie to fresh 3 month highs. After creating nearly 80K jobs in December, Canada added another 78.6K jobs. Not only was this significantly stronger than the market’s 2K forecast but the combination of solid full and part time job growth drove the unemployment rate to its lowest level in 4 decades. It should be no surprise then that rate hike expectations also shifted dramatically with the odds of a hike this month soaring to 70% from 40%. While we don’t expect the Bank of Canada to start the year with a hike especially with trade and manufacturing activity slowing, there’s no doubt that they will be talking about one in 2 weeks. 2018 should be a good year for the Canadian dollar. The economy is growing, consumers are spending and the labor market is strong. We see anywhere between 2 to 3 rate hikes this year from the BoC. The prospect of stronger global growth in 2018 should also drive oil prices higher which would fuel additional gains for the loonie. The greatest risk for CAD is NAFTA re-negotiations but what this past year has shown is that the economy is more resilient to the U.S.’ rumbles than ever before. As such, we see USD/CAD trading back to 1.20 in the coming year.