By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The Federal Reserve did exactly what the market anticipated but unfortunately that was not enough. The U.S. dollar sold off aggressively in the hour after the monetary-policy announcement with USD/JPY dropping 100 pips, EUR/USD hitting a 2-year high, GBP/USD breaking 1.31, AUD/USD hitting 80 cents and NZD/USD breaking above 0.7500. Multi-year highs were reached in many major currency pairs with more gains likely to follow in the days ahead. The FOMC statement did not disappoint – the Fed left interest rates unchanged, acknowledged that inflation declined and is running below 2%. It also set the stage for reducing asset purchases in September by saying balance-sheet normalization will be “relatively soon.” These tweaks were all anticipated but clearly investors expected more. So between lofty expectations, a sharp reversal in Treasury yields and the break of key technical levels, we have at least 3 reasons why the dollar got dumped post FOMC. We had been saying that the greenback would be a sell on rally but with the reversal happening sooner than we anticipated, the next stop for USD/JPY should be 110.50.
Meanwhile, EUR/USD is headed for 1.18. Aside from the market’s negative reaction to FOMC, there’s nothing on the Eurozone calendar to threaten the greenback’s rally. No Eurozone economic reports were released Wednesday and nothing significant is on the calendar for Thursday. This should allow the euro to extend its gains as the market’s reaction to this week’s Eurozone economic reports shows underlying demand for the currency. Traders completely shrugged off weaker PMIs and found relief in stronger business confidence. The shallow declines in the euro tells us that investors are bullish as they believe the European Central Bank is close to tapering asset purchases. While this may be true, the Eurozone is also much more sensitive to exchange rates than the U.S., which means if the euro continues to rise, the positive trend of data surprises could give way to data misses. Friday’s Eurozone confidence and German consumer-price reports will be particularly important in settling the score on whether the uptick in business confidence or the slowdown in service and manufacturing activity is more indicative of the general trend of the region’s economy.
Stronger second-quarter GDP growth kept GBP/USD in positive territory throughout the North American trading session. According to the latest report, the U.K. economy expanded by 0.3% between April and June. Although this was faster than the 0.2% growth experienced in Q1, it was not strong enough to maintain the annualized pace of growth, which slowed to 1.7% from 2%. Despite Wednesday’s rally in sterling, there’s no doubt that U.K. growth is slowing with the details of the GDP report showing weakness in the manufacturing and construction sectors. Growth is expected to ease further in the coming months as BREXIT gets underway and for this reason, we still see sterling as a sell on rallies, particularly versus the euro. It is also worth mentioning that Wednesday's worst-performing currency was the Swiss franc, which fell hard following Swiss National Bank President Jordan’s comment that the currency is still significantly overvalued. However the reversal in the greenback helped CHF recover all of its earlier losses.
Wednesday's best-performing currencies were the Australian and New Zealand dollars, which blew past key technical levels, triggering stops that took AUD/USD and NZD/USD to their highest level in 2 years. Forget about softer data, the only things that matter to comm-dollar traders right now are commodity prices and carry. With that in mind, inflation is still slowing in Australia as consumer-price growth grew only 0.2% in the second quarter, less than half of the previous 0.5% rate and the market’s 0.4% forecast. Instead of accelerating, the year-over-year rate also slowed to 1.9% from 2.1%. This along with comments from Reserve Bank Governor Lowe confirms our view that the RBA is not thinking about raising interest rates. As they did not ease as much as other central banks, Lowe said “we don’t need to move in lockstep with global peers” especially with slow wage growth. He expects wages to remain subdued for some time, making it difficult to generate 2.5% CPI. Prices will probably accelerate in the third quarter as power costs rise but Lowe believes that will increase business costs. On the currency, his comments were relatively benign, which may be the reason why the Australian dollar did not extend its losses after CPI. Instead of aggressively talking down the currency, he simply said it would be better if A$ is a bit lower. The next major resistance level for AUD/USD is 0.8070 but the pair could still reject 80 cents if the 200-week SMA holds. Stronger-than-expected New Zealand trade data helped NZD/USD rise more than 1% on Wednesday. Despite lower dairy prices, a strong currency and a weaker business PMI index, the country’s trade surplus jumped from 74M to 242M in June. But before you get too excited, it is important to note that the improvement was driven by weaker exports AND imports.
Last but certainly not least, USD/CAD dropped to fresh multi-year lows. Thanks to the persistent rise in oil prices, rallies have been sold. The real test for the Canadian dollar this week is Friday’s GDP report. If growth accelerates, we could see a move down to 1.2375, but if it eases we could finally see a bottom. Either way, there’s no doubt that the downtrend is reaching exhaustion and traders will be looking for any excuse to take profits after the 10% rally over the past 10 weeks.