Don’t be Fooled by the Dollar

Daily FX Market Roundup 11.28.16

Don’t be fooled by the performance of the U.S. dollar today because the uptrend remains intact. The dollar may have declined versus the Japanese Yen and commodity currencies but it remains strong against the euro, Swiss Franc and British pound. Most importantly, today’s rebound in U.S. bonds was modest with yields pulling back only marginally. For today’s reversal in the dollar to become a more significant top, we would need to see 10-year Treasury yields drop 6bp or more in a single day. Outside of profit taking after last week’s strong moves, there was nothing to explain the sell-off in the dollar. Traders were able to push the greenback sharply higher in a low liquidity environment on Thursday and Friday and now that U.S. traders have returned from their holidays, they brought USD/JPY down from the stratosphere. With that in mind, the only piece of U.S. data released today was the Dallas Fed manufacturing index, which turned positive for the first time in nearly two years and rose to its highest level since July 2014. This report confirms that the U.S. economy is performing well and able to withstand a rate hike from the Federal Reserve. Revisions to second quarter GDP are scheduled for release on Tuesday along with S&P CaseShiller House prices and consumer confidence. None of these reports are expected to hurt the dollar and could instead help it particularly the Conference Board’s consumer confidence release, which should follow the University of Michigan and Investors Business Daily indices higher.

While Friday’s non-farm payrolls report is the primary focus for the dollar this week, there are a number of Federal Reserve officials scheduled to speak and their comments could have a significant impact on how the dollar trades ahead of the jobs number. The market has fully discounted a rate hike in December so unless job growth slowed in November compared to October, these expectations are unlikely to change. The question now is what happens in 2017. Will the Fed slow down or will they continue to hike in the months to follow? Investors will be looking for answers to these questions from Fed Presidents Dudley, Powell, Kaplan, Brainard and Tarullo all of whom are scheduled to speak this week. Fed Chair Janet Yellen provided zero forward guidance beyond December and if her peers follow in her lead this week, we’ll see only see a cautious dollar rally. However if they suggest a long pause after rates are hiked in December, the dollar will fall while expectations for further tightening will boost the dollar. Chances are they’ll reinforce the market’s expectations for tightening in December but keep their views beyond that close to their chest, which should still be enough to prevent the dollar from falling much further as investors hope that their hawkish guidance will extend into the New Year.

After racing to a high of 1.0685 intraday, the EUR/USD spent most of the North American trading session below 1.06 – ending the day only slightly above this key rate. Euro received some support from Francois Fillion’s victory over Alain Juppe. As the new Republican candidate he will most likely challenge Marine Le Pen in 2017 with the latest polls showing him winning by a comfortable majority. That of course can and will change as next year’s election nears. In the meantime, we still expect euro to trade heavy asItaly’s referendum poses the greatest risk for currencies over the next 7 days. Depending on how the vote goes, we will either see a big short squeeze in the EUR/USD next week or a major collapse. Given the binary risk of Italy’s referendum, global investors will most likely pare EUR/USD positions ahead of the event. The focus right now is on Italian banks because a “no vote” could lead to Prime Minister Renzi’s resignation, which would usher in a new period of political uncertainty that will make foreign investors less likely to bailout Italian banks. A no vote would create a crisis of confidence in Italy and flight of capital out of the Eurozone’s third largest economy.

Meanwhile sterling came under selling pressure versus the euro and U.S. dollar. Part of the move was attributed to end of the month EUR/GBP flows but the OECD also issued a bleak forecast for the U.K. economy. According to the OECD, the UK economy is estimated to grow 1.2% in 2017 and 1% in 2018. This is consistent with the central bank’s forecast for faster growth in 2016 and slower growth in 2017 and 2018. The U.K. Supreme Court begins its hearings on Article 50 this coming weekend so Brexit headlines could affect how the currency trades. With that in mind, a decision is not expected until the New Year. U.K. mortgage approvals are scheduled for release on Tuesday. While interesting the impact on sterling should be limited. We continue to look for GBP to outperform EUR but underperform the USD.

All 3 of the commodity dollars traded higher versus the greenback today. The OPEC meeting is the central focus at the front of week and so far, there’s no additional clarity on whether a deal will be reached. Early in the day oil prices fell on comments from Saudi Arabia who said OPEC would not need to reduce output because increasing demand would even out the supply glut by 2017. It then reversed higher after Iraq’s oil minister Jabbar al-Luaibi pledged to reach a deal that would be suitable for all. However by the end of the day, they seemed to be no closer to a deal with Iran and Iraq refusing to resolve their issues. Iran’a oil minister even noted that OPEC would be successful if it were not managed by political rivals. At the end of the day, a deal could still be reached but chances are any deal would be a watered down one. Bank of Canada Governor Poloz also spoke this afternoon and his comments provided further support to the loonie. He said he expects inflation to return to target by mid-2017 and a significant departure from that outlook would be needed to cut rates. For the time being, until OPEC makes its final announcement on Wednesday, oil prices and the Canadian dollar will key off OPEC headlines. As for the Australian and New Zealand dollars, they extended their gains on the back of U.S. dollar weakness. There were no major economic reports from either country.

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