By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It has certainly been a busy week in the foreign-exchange market with the dollar rising against most of the major currencies. Sterling was the only currency to outperform the greenback and we’ll talk more about that later. USD/JPY was the primary focus with the currency pair finally ending the week above 110. Many economists expected the break of this key level to be driven by weak Japanese GDP numbers. But instead it was hawkish FOMC minutes that sent the dollar soaring. The shift in market expectations for Fed tightening and the confirmation from Fed Presidents is a significant development that has shifted the market’s appetite for dollars. We are not looking for the Fed to raise interest rates but we certainly anticipate hawkish comments from Yellen and an upbeat June FOMC statement. The dollar lost some of its momentum at the end of the week and with a relatively light U.S. calendar next week devoid of major market-moving economic releases, we could see choppy trading. Pullbacks can be bought, particularly versus the yen in anticipation of a move toward 112.00 ahead of next month’s monetary policy announcement. The G7 also meets in Japan and the prospect of more fiscal stimulus could keep pressure on the yen.
Meanwhile, the euro will finally get some love next week. Compared to many of other major currencies, the decline in EUR/USD was restrained this week by the lack of key economic data and comments from European policymakers. That changes completely next week with May PMIs (manufacturing, composite, services), ZEW, IFO and German first-quarter GDP numbers scheduled for release. The ECB is in wait-and-see mode and the PMIs will go a long way in telling us how quickly it will ease again. The currency pair found support at 1.12 this week and stronger numbers will confirm a bottom while a soft report could drive the pair to fresh 1-month lows.
Like USD/JPY, USD/CAD also broke out strongly this week but mixed data prevented a strong extension to the rally. Retail sales fell sharply in March but core consumer prices increased more than expected. CPI increased 0.3%, which was in line with expectations but core prices rose 0.2% against 0.1% forecast. On annualized basis, price pressure in Canada are rising, which is slightly at odds with the sharp drop reported by IVEY PMI. The Bank of Canada meets next week and Friday’s economic reports should leave its outlook unchanged because spending is weaker but prices are rising. The last time that we heard from the BoC, it left interest rates unchanged and upgraded its 2016 GDP forecasts. Although CAD traders shrugged off their positive assessment, this move reflected their optimism for the domestic economy. The main caveat this time around is the wildfires in Canada and how much it will impact Canadian GDP. Some economists believe that the impact is negligible but others think it could stall growth in Q2. We're sure the BoC has ts own views that it could share or allude to in its monetary policy statement.
The Australian dollar will also be in play. While there are no major Australian economic reports on the calendar, RBA Governor Glenn Stevens and Assistant Governor Debelle are scheduled to speak. Overnight, comments from RBA board member Edwards triggered a brief rally in AUD. He stated that any talk of a lower inflation target was “wildly premature” adding that RBA's 2%-3% range was always a flexible number. The market interpreted that to mean that the central bank has no immediate plans to ease again, which is consistent with the reluctance expressed in the RBA minutes. The New Zealand dollar appears to be moving in lockstep with AUD and with April trade data on the calendar next week, it should take direction from the market’s appetite for commodities and the greenback.
Finally, sterling was the only currency to outperform the greenback this week. Brexit polls continue to dominate trade with earlier polls showing more support for Remain, sending GBP sharply higher, while Friday’s TNS online poll showed more support for Leave, which drove the currency lower. With just over 1 month to go before the EU referendum at the end of June, these opinion surveys will continue to have a significant impact on the pound. If the gap grows in favor of remaining in the European Union, short sellers will start to cover their positions. But if the gap remains extremely close, we can expect more action in the British pound. While we ultimately believe that Britons will vote to stay, we are still looking for significant uncertainty ahead of the referendum with the risk for pound skewed to the downside. With that in mind, it's worth noting that this week’s economic reports provide a glimmer of hope for sterling bulls. Earnings are on the rise and consumer spending increased strongly in April. Public-sector finances and revisions to first-quarter GDP numbers are the only event risks on next week’s U.K. calendar, which means that politics will continue to be the primary driver of sterling trade.