By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Since the beginning of the month we’ve seen broad-based gains in the U.S. dollar, but as the greenback continued to fall and investors adjusted expectations for Fed tightening, currency traders have been yearning for a turn -- and that’s exactly what we saw on Thursday. U.S. stocks eased off year-to-date highs and the dollar rebounded against most of the major currencies. The only currency that continued to rise against the USD was the New Zealand dollar. The smaller-than-expected increase in U.S. jobless claims helped but it has been a while since this report had any meaningful impact on the greenback. So the question now is whether Thursday’s reversals will turn into a top for high-beta currencies and a bottom for the dollar.
Unfortunately, we don’t think that we’ve seen the bottom in the U.S. dollar because Treasury yields continued to fall with 10-year rates hitting their lowest level since February. The Federal Reserve meets next week and the Fed fund futures, which are pricing in 0% chance of tightening in June and only an 18% chance of tightening in July, are telling us that investors expect cautiousness and hesitancy from the FOMC statement and Janet Yellen. Based on the tone of her speech this week, there’s a reasonable chance that Yellen will disappoint dollar bulls. Even if she ends up being more hawkish than expected, the dollar should fall in the lead-up to the monetary policy announcement as the chance of a summer rate hike fades with each passing day. The University of Michigan’s Consumer Sentiment index is scheduled for release Friday and between this month’s terrible nonfarm payrolls report, the rise in gas prices and the drop in confidence reported by IBD/TIPP, U.S. consumers have very little to be optimistic about.
The euro rejected the 1.1400 level overnight, trading as low as 1.1304 during the North American trading session. Eurozone data was better than expected with Germany’s trade surplus dropping to 25.6B instead of 21.3B expected. Exports were flat instead of falling and imports declined. The current account surplus also narrowed less than expected. ECB President Draghi didn’t have anything particularly insightful to say -- he simply expressed his desire to see other policies (namely fiscal policy) be aligned with monetary policy. Other ECB officials including Villeroy have been stressing the central bank’s easy policy and warning that “as long as inflation is too low we must take action.” However despite the euro’s weakness, there have been buyers at 1.1300, where we have the 50-day SMA.
Sterling also ignored economic fundamentals with the currency falling despite a healthier trade-balance report. At this stage, none of our readers should be surprised by the currency’s disregard for data. The 1.43 to 1.48 trading range and Brexit is all that matters. With exactly 2 weeks to go before the E.U. referendum, the polls are still too close to call, which worries a lot of GBP traders who understand that the greatest risk is if the U.K. votes to leave the Union. However many banks and forex dealers are raising their margins on GBP and other related currencies ahead of the referendum, which means we could also see a short squeeze in GBP/USD ahead of the June 23 vote.
Thursday's best-performing currency was the New Zealand dollar, which soared against all major currencies. The move was a direct result of the RBNZ’s decision Wednesday night to keep interest rates unchanged and Central Bank Governor Wheeler’s concerns about house price inflation. Wheeler said, “at this stage we don’t need further monetary stimulus for the economy,” because they want to see house prices slow significantly. This is a direct response to the REINZ and QZ reports of double-digit house price growth in April and until prices start to moderate, the RBNZ will be reluctant to lower interest rates again. To be more specific, the RBNZ is done easing for the time being making the stability of NZ interest rates an attractive carry play.
The Australian dollar failed to participate in the rally, rejecting 75 cents for the second day in a row. We still believe AUD is a buy on dip for the same reason that NZD is attractive. But AUD/NZD selling coupled with the recovery in the dollar could take the currency pair briefly below 74 cents.
USD/CAD is in play Friday with Canadian employment numbers scheduled for release. No one should be surprised that CAD traded lower Thursday with the greenback climbing against many major currencies because the rise in the dollar also drove oil prices lower. Crude traders are now watching oil prices closely to see if the $50 resistance-turned-support level holds. The latest economic reports from Canada were better than expected with the capacity utilization rate and new housing price index moving higher. However the most important release for Canada this week will be Friday’s employment report. According to IVEY PMI, more jobs were lost in the manufacturing sector but last month’s report was already very weak so a downside surprise would mean two months of negative job growth and an increase in the unemployment rate -- a situation that will definitely set a near-term top in the Canadian dollar and renew expectations for Bank of Canada easing.