By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The biggest story in Tuesday's FX market was the euro, which fell to fresh 6-month lows against the U.S. dollar. After a one-day pause, investors returned to selling the pair in anticipation of easing from the ECB. No major U.S. or Eurozone economic reports were released so the decline cannot be attributed to data or ECB speak. Both ECB members Weidmann and Liikanen appear to be in no rush to ease. Instead, the head of Germany’s central bank warned about the risk of keeping monetary policy easy for too long while Liikanen said no decision has been made on interest rates. Considering that recent weakness in the Eurozone economy has been driven primarily by the slowdown in Germany, we are surprised by the Bundesbank’s resistance to more stimulus. But when the time comes, Weidmann should support Draghi’s decision to ease because their economy needs it. The latest decline in the EUR/USD tells us that investors are shrugging off Weidmann’s comments and preparing for dovishness from ECB President Draghi on Wednesday. If he doesn’t waver from his recent comments, we could see the EUR/USD drop below April's spike-lows near 1.0660 and make its way toward 1.05.
Aside from the sell-off in the euro, we have not seen any other big moves in the forex market, which is not surprising considering that no major U.S. economic reports were released on Tuesday. For the most part the greenback is still feeling the rush from the Nonfarm Payrolls report and comments from Fed President Evans who said he wouldn’t necessarily dissent on a December rate hike even though he would prefer to wait. Based on the performance of equities and Treasuries, stock and bond traders have continued to price in tightening and it should only be a matter of time before the FX market does as well. Dollar bulls only need a small push that could come from Friday’s Retail Sales report, which we believe will be strong, reinforcing the case for December lift off. In the meantime, it's show time for sterling.
If you're looking for action in the forex market over the next 24 hours, you should be trading GBP. The labor-market report is one of the most important pieces of data a country releases and in the case of the U.K., wage growth is a central focus for monetary policy. Last month, wages growth missed expectations and if it continues to slow, it would be the perfect excuse for FX traders to send GBP/USD to 1.50 because the data would reinforce the central bank’s dovishness. However there have been more upside than downside surprises in U.K. data and according to the PMIs, employment conditions improved in the manufacturing, service and construction sectors last month. So there is a greater chance that the data will be strong than weak but don’t expect much pre-positioning ahead of the report because traders will still be wondering if labor data motivated the Bank of England’s recent decision to lower its GDP forecast. In terms of trading GBP/USD, if the data prints lower, the pair will make a run for 1.50. If it's strong, the currency pair will rally -- but we view that as an opportunity to sell GBP/USD at a higher level. The best trades are the ones where we go with the central banks and not against them. In that case, both the BoE and Fed policy are signaling a lower GBP/USD and the small but serious risk of a Brexit gives investors another reason to be short pounds.
China’s economic reports could also trigger some action in AUD. According to Monday night’s consumer and producer price reports, deflation is still a problem for the People’s Bank of China. Consumer price growth slowed for the 44th straight month and the situation hasn’t improved after China’s massive stimulus. Between the deterioration in export/import activity -- coupled with the inflation numbers -- more stimulus is necessary if they are to keep their pledge of no tolerance of a sharp slowdown. More easing by China is positive for countries like Australia and New Zealand, which rely heavily on demand from the world’s second-largest economy. The Australian dollar traded lower Tuesday on the back of U.S. dollar strength and weaker data. The NAB Business Confidence index dropped from 5 to 2 in October and while home-loan growth accelerated, investment lending and the value of loans slowed significantly. Australian consumer-confidence numbers were scheduled for release Tuesday evening along with New Zealand’s business PMI index.
After racing to a high of 1.3317 last week, USD/CAD is beginning to roll over. It is far too early to call this a near-term top for the currency pair but technically, the right shoulder of a head-and-shoulders pattern could be forming on the daily chart. This reversal pattern signals a steeper decline toward 1.31 for USD/CAD. On a fundamental basis, however, we have strong reasons to believe that USD/CAD will extend its gains. Aside from weaker Canadian data, the greenback’s expected strength deals a double blow to the Canadian dollar by driving USD/CAD higher and oil prices lower. No data is scheduled for Canada Wednesday so consolidation is more likely for the pair.