Will Yellen Help or Hurt the Dollar?
Daily FX Market Roundup 02.10.17
After nearly a month of losses, the U.S. dollar ended the week steady to higher against all of the major currencies. U.S. data was mostly better with the trade balance narrowing slightly, jobless claims falling and import prices rising. Consumer sentiment however soured in the month of February with the University of Michigan index dropping to 95.7 from 98.5. The dollar was actually pressure for most of the week but recovered strongly after President Trump said he will announce “something phenomenal on taxes in 1-2 weeks.” These were the very same promises that drove the dollar sharply higher after the election so it is no surprise that investors were excited about their prospect. Does this remove the risk of a deeper correction in the U.S. dollar? No but it is a welcome distraction from the President’s attempts to talk down the currency. While we can’t forget that one of President Trump’s main policy goals is to strong arm other countries into strengthening their currencies, the market has found an excuse to revisit the Trump trade and this sentiment could last through the new trading week.
With that in mind, the dollar will remain in control of currency market flows in the coming week with Janet Yellen delivering her first semi-annual testimony on the economy and monetary policy since Donald Trump became President of the United States. As the most important event risk on the calendar, investors will be listening in closely for her views on the economy and plans for tightening. We know from the last Federal Reserve meeting that U.S. policymakers are optimistic about the labor market, consumer spending and sentiment. However they also believed that inflation is low and business investment soft. At the end of the year, Yellen seemed to support the idea of 3 rate hikes in 2017 but Fed fund futures are only penciling in 2 rounds of tightening. Data has been mixed giving us very little guidance on which way the Fed chair will swing. If she is unambiguously positive and expresses her commitment to raising interest rates a few times this year, dollar bulls will take the greenback higher, driving USD/JPY through 114.00. However if there’s even a hint of greater caution in her voice and she over weights the uncertainty of fiscal policy, USD/JPY could slip back down to 112. Of course USD/JPY wont be the only currency affected as the greenback is likely to move strongly in one direction against all major currencies. While Yellen’s views will have the most significant impact on the dollar, consumer prices, retail sales, the Philadelphia Fed manufacturing index, housing starts and building permits are also scheduled for release. Consumer spending was very strong in the month of December but the data was far from stellar because excluding autos and gas purchases, retail sales was flat – we’ll need to a see a pickup on this front to support the case for March tightening.
The euro was confined in a relatively tight trading range against the U.S. dollar over the past week. It tested but failed to break above 1.08 and sank as low as 1.0607. There were no major Eurozone economic reports on the calendar but the ones that we saw including Germany’s industrial production, trade and current account balances were worse than expected, a sign that the benefits of a weaker euro were fading. ECB President Draghi also spoke but he spent a large part of his speech firing back at Trump and his accusations that the euro was being manipulated. However he did mention that the Eurozone economy wasn’t strong enough for the central bank to reduce stimulus even though there have been recent signs up improvement and pick up in inflation. We expect EUR/USD to remain under pressure in the coming week and for 1.08 to hold as resistance. Eurozone and German fourth quarter GDP numbers are scheduled for release along with Eurozone trade and current account numbers as well as the German ZEW survey and consumer price reports.
In contrast to euro, sterling held up extremely well versus the U.S. dollar. The only major economic reports were Friday’s trade balance and industrial production numbers – both were better than expected. The strength of sterling had more to do with easing concerns about Brexit and hawkish comments from the Bank of England. According to monetary policy committee Kristin Forbes, based on the current trend of the UK inflation, she might consider voting for a rate increase. Citing resilient employment and output statistics for the region, even in light of Brexit concerns, Forbes expressed concern for the central bank’s tolerance of overshooting inflation targets. Although she is widely viewed as one of the most hawkish members of the central bank and her views diverge with Governor Carney’s cautious outlook, they were enough to turn the pound around, driving sterling sharply higher against all of the major currencies. Next week will be a busy one for the pound with U.K. inflation, employment and retail sales numbers scheduled for release. We expect these reports to influence sterling flows and shape expectations for the central bank’s outlook. Taking a look at how the economy has been performing recently, we believe that the risk is to the downside for these reports, which would be negative for GBP/USD.
The commodity currencies on the other hand had vastly differing performance. The Canadian dollar ended the week higher against the greenback thanks to better than expected data. Job growth was very strong in the month of January, nearly matching the healthy increase in December. Both full time and part time work increased, helping to drive the unemployment rate down to 6.8%. Canada’s trade surplus also narrowed less than expected and these developments should ease the concerns of the central bank and potentially drive USD/CAD back to 1.3000.
The Australian dollar also held up better than the New Zealand dollar. Not only did the Reserve Bank of Australia maintain a relatively upbeat tone, the central bank noted that conditions in the global economy improved in recent months. RBA Governor Lowe also said it is hard to say if the Australian dollar is too strong given the reasonable growth outlook. According to the RBA “the Bank’s central scenario remains for economic growth to be around 3 per cent over the next couple of years. Growth will be boosted by further increases in resource exports and by the period of declining mining investment coming to an end. Consumption growth is expected to pick up from recent outcomes, but to remain moderate. Some further pick-up in non-mining business investment is also expected.” This positive tone should help AUD maintain its gains against many of the major currencies (although AUD/USD could retreat on U.S. dollar demand). The New Zealand dollar on the other hand was hit hard by less enthusiastic comments from the Reserve Bank of New Zealand. Although the RBNZ left interest rates unchanged and Governor Wheeler said their easing bias has been removed describing current policy as “very neutral”, traders latched onto the central bank’s call for a lower currency. They said the New Zealand dollar remains higher than sustainable for balanced growth and that a decline in the exchange rate is needed. Assistant Governor and Head of Economics McDermott also said the central bank wants to make sure inflation will hit 2% before tightening because the strong currency will continue to press down tradables inflation. These comments were aimed at squashing any expectations for RBNZ tightening and should keep NZD under pressure. There are no major Canadian economic reports scheduled for release in the coming week but employment numbers are due from Australia and retail sales from New Zealand.