Dollar Pulls Back But Don’t Buy Yet

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Daily FX Market Roundup 01.14.15

Dollar Pulls Back, Don’t Buy Yet
AUD: Beware of the Big Moves in Copper, Employment Next
NZD: Hit by Lower Commodity Prices
CAD: Oil Prices Bounce Off 16 Year Trendline
EUR/GBP Falls to 6 Year Lows

Dollar Pulls Back, Don’t Buy Yet

An unexpectedly large decline in retail sales drove the U.S. dollar lower against most of the major currencies. Consumer spending fell 0.9% in the month of December, the largest drop in 11 months. Lower gas prices were widely expected to drive down receipts at the pump but excluding autos and gas, spending still fell 0.3%. While the miss came as a surprise to the market, our readers should have anticipated the move as we argued that spending could be weak given lower wage growth and cheaper gas prices. We have been looking for USD/JPY to pullback towards the 116.75 to 117.50 range and today’s decline surpassed our target. However, USD/JPY recovered a large part of its losses almost just as quickly as it incurred them. The currency pair ended the day in negative territory but the initial reversal was so swift that USD/JPY spent very little time below 116.50. This price action shows that investors still believe in the long dollar trade as they viewed the decline as opportunity to buy at lower levels. The Beige Book report reinforced our view that the Fed remains on track to tighten. Despite the sharp slide in spending, the central bank saw modest retail sales gains with advances in most areas along with modest to moderate growth in most districts. So with USD/JPY trading below 118 and the central bank maintaining an optimistic tone, other investors may be wondering if it is time buy especially after the strong bounce off 116. As you may know our long-term view is for further gains in USD/JPY and an eventual move above the 121.85 December high. However our call for a pullback hinged on our outlook for 2 pieces of data – weaker retail sales and lower consumer prices. The first piece of data has been released but not the second so we do not rule out another dip below 117.00 before a move back above 120. Jobless claims, producer prices, Empire state and Philadelphia Fed manufacturing surveys are scheduled for release on Thursday.

AUD: Beware of the Big Moves in Copper Prices

Big moves in commodities continued to drive the flows in currencies and equities. The 5% rebound in crude brought some relief to the Canadian dollar, which was hurt the decline in oil prices over the past few months. Fundamentally, the oil story hasn’t changed, the market share war is well underway and supply outstrips demand but after a 40% decline in 2 months, oil is deeply oversold and prime for a recovery. By now everyone is calling for $20 oil and when sentiment reaches such extreme levels, it oftentimes marks a short and possibly long-term bottom. In the past year, the price of oil has fallen faster and more aggressively than any analyst predicted. At some point enough is enough and the current speed and magnitude of losses is just not sustainable especially in such a crowded trade. At $45 a barrel, some OPEC nations could start reconsidering their positions on production cuts – all it takes is one announcement to turn everything around. The rebound today is happening right at a major 16-year trend line that marked a bottom for oil in 2009. Although USD/CAD barely reacted today, we are looking for a pullback to 1.18. Copper prices are also on the move. The price of copper dropped to a 5 year low on concerns of slowing demand from China and excess supply. While this story is not new, copper is often seen as a barometer for growth and its recent decline raised concerns about global growth prospects and explains the decline in U.S. equities today. Australian employment numbers are scheduled for release this evening. After a strong November, slower job growth is expected in December.

Slow Grind Lower for Euro

The euro continued to hit fresh 9 year lows in what we expect to be a slow grind lower for the currency pair. The European Central Bank’s monetary policy meeting is a week away and we expect one or two more days of new lows before a potential short squeeze. This morning, the European Court of Justice found the ECB’s OMT program to be within their mandate. While this is a non-binding decision that can be dismissed, it is unlikely and supports the central bank’s plans for Quantitative Easing. More specifically, the European Court of Justice noted that the “the objectives of the programme are in principle legitimate and consonant with monetary policy. ” Furthermore the court added that,” the OMT programme decided upon by the ECB, as it results from the technical features described in the press release, does not infringe the principle of proportionality and may be considered lawful, provided that, in the event of the programme being implemented, the obligation to state reasons and the requirements deriving from the principle of proportionality are strictly complied with.” In other words, this decision smoothens the path to QE, which could be announced as early as next week. However with the amount of uncertainty surrounding the decision and the extensiveness of short EUR/USD positioning, we do not rule out a profit taking driven bounce for the currency pair 48 hours ahead of the ECB announcement. After that, the euro’s move will hinge on the ECB’s decision.

EUR/GBP Falls to 6 Year Lows

Sterling traded sharply higher against the U.S. dollar today and this strength drove EUR/GBP to 6 year lows. While no U.K. economic reports were released today, BoE Governor Carney supported the ECB’s plans to increase stimulus due to “persistently low inflation.” What is interesting is that U.K. inflation is also very low, dropping to an annualized rate of 0.5% in December and yet he doesn’t seem to be worried as he chose instead to say that the drop in oil prices is positive for the U.K. economy. Admittedly, the inflation environment in the Eurozone is very different from the U.K. On an annualized basis, Eurozone CPI dropped 0.2% compared to a rise of 0.5% in the U.K. Comparing core prices, the last yoy print from the Eurozone showed 0.8% growth compared to 1.3% in the U.K. So the Brits have less to worry about with regards to price pressure but prices should have fallen further in January. In the near term with the ECB poised to ease, EUR/GBP is vulnerable to additional losses.

Kathy Lien
Managing Director

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