By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The Federal Reserve minutes failed to inspire additional gains in the U.S. dollar on Tuesday, which isn’t surprising as we were only looking for dollar strength going into the release. Although most Fed officials saw tightening likely to be appropriate as soon as consumer spending rebounds, a few policymakers were worried that progress on inflation has slowed. As such, they felt that it was prudent to wait for evidence that the slowdown is transitory before taking action. They also said their balance-sheet plan would raise roll-off caps every 3 months as part of their process to unwind stimulus. On the face of it, the minutes were positive but investors expected more, especially in front of 112 resistance in USD/JPY. They sold dollars because they didn’t like the comment on inflation and we are certain this is a view other central banks share (ECB). Tuesday morning’s U.S. housing market reports were also mixed with existing home sales falling more than expected. But that was offset by rising mortgage applications and higher house prices, according to the Federal Housing Finance Agency. Jobless claims and the April trade balance are scheduled for release and we believe the deficit may have grown due to weakness in export orders. Looking ahead, 112.15 is the level to watch for USD/JPY. If it fails to break this level, then a move back below 111 before next month’s FOMC meeting becomes likely.
Wednesday's best-performing currency was the Canadian dollar, which traded sharply higher after the Bank of Canada’s monetary policy announcement. Even though the BoC described growth and inflation as subdued, warning about excess capacity and the uncertainties surrounding their April outlook, investors interpreted the statement as hawkish because the central bank saw recent data as “encouraging.” In other words, while they felt that present stimulus is appropriate, the BoC recognizes the improvements in the economy, which makes them slightly less dovish. This was enough for CAD bulls, who sent USD/CAD tumbling lower. The mild decline in oil prices on the back of mixed inventories did not have much impact on the currency. However crude will drive CAD on Thursday with the OPEC meeting underway. There are 4 possible scenarios – no extension, which would be extremely negative for oil and CAD, a 6-month extension, which would be mildly negative, 9-month extension, which would be positive and anything more than 9 months would drive crude and CAD sharply higher. The market is hoping for a 9-month extension to production cuts and anything less would be a disappointment.
Meanwhile, the New Zealand and Australian dollars moved in completely opposite directions. While the Australian dollar was hit by Moody’s downgrade of China and lower leading indicators, the New Zealand dollar was supported by a trade surplus that was nearly 2x greater than forecast. Thanks to the strongest rise in exports in 2 years, New Zealand posted a trade surplus of 578M, up from 267M. This is the largest surplus since March 2015. What’s so positive about this report is that the gains were not just in dairy – although dairy exports rose 35%, log and wine demand also increased. These improvements should ease the central bank’s concerns and pave the way for the currency’s outperformance. No economic data is due for release from Australia, but in the next 24 hours, the finance minister will deliver the budget and NZ’s milk coop will set initial prices for the coming fiscal year. We believe both of these events will promote further gains in the currency.
The euro, on the other hand, failed to recapture Tuesday’s losses despite an uptick in German consumer confidence and relatively optimistic comments from ECB President Draghi. Speaking in Madrid, the central bank President described the macroeconomic environment as improving and warned that QE may have more side effects than negative rates. Although the region is witnessing an increasingly solid recovery, he saw no reason to deviate from the current policy guidance because underlying inflation pressures remain subdued. Other policymakers such as Constancio and Praet were equally cautious about inflation while at the same time recognizing the improving economy. With EUR/USD up approximately 6% since early April, the ECB is clearly not in a rush to talk tapering because a stronger currency puts greater pressure on inflation. We would not be surprised if EUR/USD dropped to 1.11, possibly even as low as 1.10.
Sterling extended its losses against the greenback after the UK raised its terror threat to 'critical.' There were numerous headlines about suspicious packages across the country, all of which were unfounded (thankfully). Lower highs and lower lows signal a potential top for GBP/USD and we think it won’t be long before the currency pair drops back down to 1.28. Revisions to first-quarter GDP and the British Bankers’ Association’s Loans for House Purchase are due for release Thursday and softer housing data is expected.