By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Investors continued to sell the U.S. dollar Wednesday and that weakness drove the commodity currencies to fresh 2016 lows. The best performer was the New Zealand dollar, which reached its strongest level since June of last year. The Canadian and Australian dollars also hit multi-month lows but unlike NZD, both currencies pared their gains to end the day within 2016 ranges. What's remarkable about the move in the New Zealand dollar is the lack of significant data and the central bank's easing bias. The Reserve Bank of New Zealand is one of the few policy-making bodies still talking about more cuts. After lowering interest rates in March, the RBNZ signaled plans to ease again with the market looking for the move in June. While part of Wednesday's gains can be attributed to the big jump in building permits, U.S. dollar weakness and the generous yield offered by New Zealand are the primary reasons for the currency's out-performance.
The U.S. dollar is falling because the Federal Reserve signaled significantly more tightening than it intends to deliver this year. Investors are adjusting their positions in response and have turned to the New Zealand dollar as it offers some of the highest yield with the greatest geopolitical/political stability. Australia's yield premium also benefitted the currency but to a lesser degree because of the drag from lower gold prices.
USD/CAD fell to its lowest level since October after the EIA reported a decline in oil production. Crude almost hit $40 a barrel on the back of the news but eventually settled unchanged when investors realized the importance of the inventory build. While the hope that OPEC will freeze production mid April is keeping oil prices from tumbling lower, we continue to believe that we've seen the peak in oil. USD/CAD dropped to a low of 1.2913 and ended the day above 1.2950. Canadian GDP numbers are scheduled for release Thursday and there's a speech from BoC Deputy Governor Patteron. Picking a bottom in USD/CAD has been a loser's game and we don't see support for the pair for at least another 100 pips (the October low) and possibly even another 300 pips (38.2% Fib of the 2011 to 2015 rally).
The big question is will the gains in commodity currencies last -- investors are seeing the spike highs and the natural inclination is to think of exhaustion. However we believe that the U.S. dollar has further room to fall because of the significance of Yellen's comments. Data from Canada and Australia is also expected to show improvement this week, encouraging further gains in the commodity currencies. However all 3 commodity currencies face one serious risk that could quickly put an end to the rallies and that is central-bank discomfort with the rise in the currency. AUD is up 5% this year and CAD is up nearly 7% -- if the RBA or BoC say the currency is overvalued or that they would like to see it much lower, the gains could evaporate quickly. Australia and Canada are both export-dependent countries and a strong currency poses a big problem for their economies. With that in mind, however, USD/CAD is still 3500 pips off its 5-year lows and AUD/USD is 3500 off its highs so there's plenty of room for the commodity currencies to rise as the central banks have dealt with much stronger currencies.
Sterling is in focus on Thursday with Bank of England Governor Carney scheduled to speak. If he expresses any concerns about the economy or emphasizes the risks posed by Brexit, sterling could come tumbling lower. We've seen how volatile GBP can be in recent weeks and the rollercoaster ride will continue as the EU referendum nears. Consumer confidence, mortgage approvals and GDP revisions are also scheduled for release on Thursday but these reports will most likely take a back seat to Carney's comments because there tends to be very little revision to the U.K.'s GDP number. For the most part, we continue to view sterling as a sell on rally.
Thanks to better-than-expected economic data and a weaker dollar, euro came within a few pips of its 2016 high. Eurozone business and industrial confidence improved in March but most importantly consumer prices rose 0.8% this month in Germany, which was double the previous month and higher than expected. Prices are beginning to rise, a sign that the ECB's efforts could finally be paying off. Whether new year-to-date highs are made will now hinge on Thursday's German retail sales and unemployment report. Data will take on increased importance for the rest of the week. There's a cup-and-handle pattern forming in the EUR/USD, and this bullish pattern would be in play if the currency pair breaks above its year-to-date high of 1.1376, opening the door for a move to 1.1500.
Meanwhile Wednesday morning's U.S. ADP report showed stronger-than-expected job growth but not much change from the previous month. More importantly, there seems to be growing opposition within the Fed as many policymakers share diverging views from Yellen. On Wednesday morning we heard from Evans who expressed confidence in the U.S. economy saying he's not seriously concerned about Chinese hard landing and indicated that more than 2 rate hikes could occur this year if data is strong.