Dollar Tanks after US Data – Is this a Pullback or Top?
Daily FX Market Roundup 05.12.17
There’s a serious misalignment between U.S. data, market expectations and Fed speak. Friday’s U.S. economic reports raise questions about the possibility of a rate hike in June. Consumer spending and inflation increased but less than anticipated so outside of the increase in job and wage growth, we haven’t seen significant strength in other parts of the economy. Yet the market still believes that the Federal Reserve will raise interest rates next month. Retail sales rose 0.4% in April, against expectations of 0.6%. Consumer prices increased 0.2% but the year over year rate slowed to 2.2%, which was more than the 2.3% forecast. Rate hike expectations dropped slightly after Friday’s reports but are still well above 90%. Every single one of the Federal Reserve Presidents who have spoken since the last jobs report believe that the economy is improving and further tightening is needed. Fed President Rosengren even said 3 more rate hikes could be needed but he is not a voting member of the FOMC this year. Nonetheless, it is clear that U.S. policymakers are happy with the progression of the economy and are therefore moving forward with policy normalization. Although the dollar did not extend its post payroll gains, the fact that the Fed is the only major central bank talking about rate hikes is positive for the dollar and should limit losses for the greenback. With that in mind, dollar bulls are clearly waiting for a catalyst to take the greenback higher and we’re not sure if next week’s economic reports are significant enough to take the dollar to new highs. The Empire and Philadelphia Fed manufacturing surveys are scheduled for release along with housing starts permits and the weekly jobless claims report. The levels to watch in USD/JPY are 115 on the upside and 113 on the downside. If 113 breaks the next stop should be 111.75.
Meanwhile even though EUR/USD popped on Friday, anyone trading the euro is still wondering if the 1.0730 April 24th gap will be filled. Like the U.S., Eurozone economic reports continue to surprise to the upside, a sign of ongoing improvements in the economy. Emmanuel Macron’s Presidential victory in France also removes a major uncertainty but rather than buy in relief, investors used it as an excuse to continue selling the single currency. There’s only one thing driving the currency and that is interest rate expectations. Despite all of the improvements in the economy, ECB President Draghi said it is too early to declare success for the economy because wages have not yet responded to the recovery so its not time to think about exiting QE. In effect, Draghi killed any expectation for tapering in the fall which contrasts with the Fed’s consistent message of tightening. Following Macron’s victory there was talk that the central bank could start reducing asset purchases as early as September and while that could still happen, the central bank is not ready to embrace the idea wholeheartedly because like many other central banks around the world they don’t believe that the recent uptick in inflation is durable especially given the steep slide in oil prices between April 11th and May 4th. Looking ahead, Eurozone consumer prices, trade balance, GDP and German ZEW survey are scheduled for release. Given Macron’s victory we expect sentiment to improve but that may not be enough to deter the bears from filling the gap at 1.0730 but before that happens support at 1.0825/30 needs to be broken.
For GBP/USD 1.30 has become an extremely important resistance level and we finally saw some decent selling that signals a potential top below this key rate. The bulls were reluctant to take sterling above this level before the Bank of England’s monetary policy announcement and now that we know U.K. policymakers are skeptical about the rise in inflation, this level is looking more and more like a top. Going into the rate decision, many investors believed that the central bank would upgrade its growth and inflation forecasts with Carney recognizing the improvements in the economy. Some even hoped there would be 2 dissents in favor of higher rates but instead, the Bank of England lowered its 2017 GDP forecast and attributed the entire recent pickup in inflation to the weak currency. In his speech, Carney focused on the weakness of household spending and GDP and emphasized that domestic costs and wages remain subdued. However the central bank’s outlook was not entirely sanguine and for this reason, sterling fell but did not crash. The central bank still expects wage growth to strengthen and the output gap to close on time. They also said the U.K. may need tighter policy than the yield curve implies as more upside news would push others to support a hike. With that in mind, the central bank’s forecasts are based on a rate increase by the fourth quarter of 2019 and not 2017 or 2018. So while the central bank sees the improvements in the economy, they don’t want to sound overly optimistic because everything hinges on a smooth Brexit – something few have confidence in. Sterling remains in focus in the coming week with inflation, employment and retail sales scheduled for release. We expect most of these reports to surprise to the upside, particularly the labor data as the PMIs report some of the strongest conditions in the labor market this year. Whether that drives GBP/USD back towards 1.30 or not depends on what the market gives more weight to – BoE guidance or economic data.
The Australian and New Zealand dollars ended the week lower against the greenback as USD/CAD decides whether it wants to fade or break 1.38. Although commodity prices stabilized they have yet to rise and this exerted additional pressure on commodity currencies. Weaker export demand from China and a surprise decline in retail sales along with the sharp drop in building approvals drove AUD/USD to a fresh 4 month low. Although the currency bounced towards the end of the week, it still faces significant pressure. Next week’s employment report is not expected to help as a retracement is anticipated after last month’s unexpectedly large rise in full time job growth. So even if AUD continues to bounce, rallies towards 75 cents will most likely invite sellers. The same is true for the New Zealand dollar, which did not sell off further after an initial drop following the Reserve Bank of New Zealand’s monetary policy announcement. Investors had high hopes going into RBNZ. They expected the central bank to turn hawkish but instead, they ignored all of the recent improvements in the New Zealand economy and warned that “uncertainties remain and policy may need to adjust.” Like the BoE and the ECB, the RBNZ doesn’t believe that the recent pickup in inflation is durable as there is no evidence of accelerating wage growth according to RBNZ Governor Wheeler. There’s less capacity pressure in the economy and as a result, policy will remain accommodative for a considerable period. Rate hikes are off the table until “inflation expectations rise” and there’s no sign of that at this time. With that in mind, we still feel that NZD will underperform with but the greater weakness may be against the AUD and CHF. New Zealand’s PMI services, retail sales and producer price reports are scheduled for release in the coming week.
Lastly, there’s been higher than usual intraday volatility in USD/CAD. This had nothing to do with data as the calendar was relatively light. Only housing market reports were released and all of the numbers showed a slowdown in housing market activity. This is not a big concern as the Toronto housing market has been running very hot and the Bank of Canada will be pleased with the latest developments. Instead, USD/CAD traders struggled with short and long term fundamentals. In the short term, the rebound in oil prices should help the Canadian dollar recovery and we see rallies towards 1.38 being sold. However in the long term, Canada faces many threats with the renegotiation of NAFTA and the consequences of the April decline in oil. This past week, rating agency Moody’s also downgraded 6 of Canada’s largest banks, sending the currency tumbling lower but given record short exposure according to the latest CFTC report, there aren’t many sellers left in the markets and those who are on the sidelines are waiting for a fresh catalyst. That could be in the form of weaker retail sales or inflation – 2 reports that are due for release on Friday. For the time being there appears to be rock solid resistance at 1.38 but USD/CAD needs to hold below this month’s low of 1.3640 to confirm a top. Otherwise a move back up to 1.40 remains a possibility.