What Makes the Dollar’s Decline Durable

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What Makes the Dollar’s Decline Durable

Daily FX Market Roundup 01.15.18

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management

Holidays typically mean consolidations but today, less participation from the U.S. translated into exaggerated moves in currencies driven by low liquidity. It may be a new trading week but the theme of U.S. dollar weakness that we started the year with remains intact. Investors sold dollars across the board, driving EUR/USD to a fresh 3-year high and GBP/USD to a fresh 18 month high. The rest of the major currencies also benefitted from the dollar’s fall with JPY, CAD, AUD, NZD and CHF rising to new 3-month highs. U.S. stock and bond markets were closed for Martin Luther King Jr. Day, so no U.S. economic reports were released. In fact, with very little market moving U.S. data on the calendar this week, the forces that drove the greenback lower this month should continue to pressure the currency in the coming days. Namely investors are worried that there could be a big sell-off in U.S. bonds this year, sparked by worries about Chinese Treasury holdings and Japan’s QE taper. The Federal Reserve is expected to raise interest rates in March but we don’t expect much in the way of updated guidance this month as Janet Yellen prepares to hand over the baton to Jerome Powell.

What makes the dollar’s decline durable is that last week’s developments represent potentially significant changes in financial market conditions.
The ECB could change its guidance early this year if data continues to improve and even though we believe that the recent strength of the euro will raise red flags for the central bank especially in conjunction with rising German bond yields, until they actually express concern, there’s no reason for the euro to stop rising, particularly this week. The ECB has given investors a strong reason to add to their long trades but we expect profit taking closer to the central bank meeting on January 25th. In the meantime, EUR/USD could extend its gains another cent or more as the next major resistance level is at 1.24. This morning’s stronger Eurozone trade balance highlights the ongoing the strength in the economy. Meanwhile, German Chancellor Merkel is trying to hammer out a grand coalition with the Social Democratic Party but resistance is still a major concern as members of the SDP party in Saxony voted against the deal. With no major Eurozone or U.S. economic reports scheduled for release this week, the thematic trades that fueled currency moves so far this year will continue to drive FX flows.

Only 3 currencies could move on new fundamental information this week and those are sterling, the Canadian and Australian dollars – in that order.
This is an important week for pound with UK inflation and retail sales on the calendar. 2017 has been marked by recovery in the U.K. economy but with GBP/USD up 500 pips in the past month, any negative news flow and the traditionally volatile pound could succumb to profit taking. Consumer prices are scheduled for release tomorrow and economists are looking for price pressures to increase but according to the British Retail Consortium, shop prices declined towards the end of the year. If CPI misses, GBP/USD could sink lower quickly even as CPI remains well above the central bank’s 2% target. Although CPI and retail sales won’t change the big story of a Brexit deal this year, it could remind investors about the vulnerability of the U.K. economy and the reasons why the Bank of England will need to keep policy accommodative as the country leaves the European Union. However if CPI beats, it will add fuel to sterling’s rally and send GBP/USD towards its next major resistance level near 1.3975, the 38.2% Fibonacci retracement of the 2014 to 2016 decline.

The Bank of Canada meets on Wednesday and the loonie is soaring ahead of the monetary policy announcement.
The market thinks a rate hike is a done deal but we are skeptical because Canadian oil prices and housing activity weakened since the last policy meeting. There’s no question that the economy in general has improved with retail sales, GDP growth, CPI and employment activity improving significantly since early December but the BoC has more options than to raise interest rates immediately. We see 3 possibilities – 1) BoC hikes 25bp and downplays the move by suggesting future hikes are data dependent 2) BoC forgoes rate hike this month but acknowledges the improvements in the economy and signals plans to tighten in March 3) BoC raises rates by 25bp, suggest more to come. Scenario 1 and 2 are most likely and depending on which the Canadian choose, the reaction could be very different. If they hike but downplay the move and refrains from suggesting there’s more to come, USD/CAD will drop sharply and recover quickly. If they pass but prepare the market for a March hike, USDCAD will pop but should then resume its slide. Either way, we see the main USD/CAD trade as selling before the rate decision before squaring up and looking for opportunities after. Meanwhile the Australian and New Zealand dollars extended their gains on the back of U.S. dollar weakness. The uptrend remains intact for both currencies with the possibility of another cent rise. There are no major Australian economic reports scheduled for release tomorrow (employment numbers are due later this week) but there’s a dairy auction that will affect the New Zealand dollar. Two weeks ago, prices increased by the largest amount in at least 6 months. If the uptrend continues, NZD will extend its gains but if prices resume their slide, it could be the perfect excuse for profit taking.

Kathy Lien
Managing Director

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