3 Reasons Why the Dollar’s Incredible Rally Can Last
Daily FX Market Roundup 10.03.18
By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
It was a great day to be long U.S. dollars. The greenback traded higher against all of the major currencies in a move that took USD/JPY to its strongest level in 11 months. The Australian dollar was hit the hardest by the dollar’s rise while sterling was the most resilient. Today’s move was driven by the classic story of economic dominance. The largest economy in the world is growing the fastest. While economic reports from around the world surprised to the downside, U.S. data is consistently beating expectations and reinforcing the positive momentum. According to the latest reports, service sector activity expanded at its fastest pace in more than 20 years. The details of the ISM non-manufacturing report showed broad based improvements in prices, new orders, backlogs and employment. In response, 10 year US Treasury yields jumped to their highest level in 7 years and this move played an important role in driving the US dollar higher.
Looking ahead, there are a few reasons why we think the dollar’s rally is durable –
1. The US economy is strong and non-farm payrolls will confirm that – The employment component of the non-manufacturing ISM report rose for the third consecutive month and this uptick suggests that payroll growth could exceed 200K in September
2. Hawkish Fed comments – A number of Fed officials spoke today and many of them seem see significant upside risk to inflation. Fed Chair Powell in particular believes that the expansion can continue for quite some time. Prices in the service sector increased and there’s a good chance that PPI and CPI will rise as well.
3. There’s no resistance for 10 year yields until 3.5% and that is consistent with USD/JPY rising to at least 115. USD/JPY is trading above the 200-week SMA for the first time since early January and a move like this usually coincides with a 300-400 pip rally from the SMA at 113.00
4. Data abroad hasn’t been great – While the US prints better than expected numbers, the latest Eurozone, UK, Australia and New Zealand were weaker expected. Until this changes, diverging economic performance is a big reason why the dollar’s rally can last.
Prime Minister May’s Tory Conference speech was a major disappointment. Not only did she fail to provide any meaningful updates on Brexit but sterling barely moved despite her pledge to accept no deal rather than a bad one. UK data was also worse than expected with the PMI services index falling to 53.9 from 54.3. Although some investors may have found comfort in UK Brexit negotiator Raab’s comment that they hope to have deal by November, speculative positioning is the main reason for sterling’s resilience. Traders are still heavily short the pound and unless there’s major negative news they may need some convincing to add to their positions. If leaving the door open to no deal or weaker UK PMIs can’t do the trick, then a reversal would have to be driven by a much better than expected US jobs report.
Not only did EUR/USD decline for the sixth consecutive trading day but it came very close to breaking 1.15. The downward revision to Eurozone PMIs and weaker retail sales contributed to the move but the primary reason for the euro’s decline was U.S. dollar strength. German bond yields increased significantly today which should have been positive for the single currency especially as Italian yields declined but the market’s demand for U.S. dollars was just too strong. With that in mind, Italian Economy Minister Tria’s pledge to reduce debt in line with what is agreed with the EU helped to alleviate some of the selling pressure on Italian bonds. 1.1500 is the level to watch in EUR/USD. If it breaks, the next stop should be 1.14.
The worst performing currencies today were the Australian and New Zealand dollars. An unexpectedly steep decline in building approvals in Australia triggered the initial slide that gained momentum on the back of the rising U.S. dollar. Of the major economies, Australia and New Zealand are the most vulnerable to the U.S.’ trade conflict with China. The deterioration in local data reinforces the market’s concern that slower Chinese growth will dampen the recovery in Australia and New Zealand’s economy. While Australia reported softer housing data, New Zealand saw job ads and commodity prices faall. The Canadian dollar also declined against the greenback despite a strong increase in bond yields and the more than 1% rise in oil prices. This only goes to show the power of the U.S. dollar today. The IVEY PMI report is due for release from Canada tomorrow. If the Bank of Canada is to raise interest rates, stronger manufacturing activity is needed. Since the index descended from a multi-year high in April, we haven’t seen much improvement.