By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
After a one day reprieve, investors returned to buying U.S. dollars. The greenback is on a tear, rising to fresh 1-year highs against euro, sterling, the Australian and New Zealand dollars. The commodity currencies extended even further with AUD/USD falling to its lowest level since January 2017 while NZD/USD to its lowest since February 2016. The gains in the greenback can’t be entirely attributed to risk aversion because U.S. stocks rose today and Treasury yields moved slightly higher. U.S. import and export prices were underwhelming and data from Europe was decent. The Turkish Lira is also off its lows, so the stress on emerging markets did not intensify, leading everyone to wonder what’s behind today’s move.
The answer is lies in the bigger story. Looking across the globe, there are no shortages of uncertainties that could easily jeopardize a currency – in Europe, we’ve seen no meaningful policy changes in Turkey, European banks are still at risk and the odds of a no-deal Brexit is growing. Even if the losses for banks are minimal, the hit to investor and business confidence could be significant. In Asia, Chinese consumer spending and industrial production is weakening, posing a greater risk to countries in the region. All of this explains why investors were reluctant to pick bottoms or take on risk. When no buyers could be found, the sellers stepped in ahead of Wednesday’s U.S. retail sales report. With wages on the rise and the labor market growing, consumer spending should be strong. Not only is the U.S. economy more stable but it is doing better than everyone else. Recent developments make it less likely for the other central banks to raise interest rates while the Fed needs a very good reason to pass on a rate hike next month.
The euro is the weakest currency today because investors are worried that Europe is ground zero for the next emerging market crisis. These concerns overshadowed improvements in Eurozone data. Second-quarter GDP growth in the Eurozone beat expectations, with the economy expanding 0.4% between the months of April and June. Unfortunately Germany was the only country where the pace of growth accelerated – all other Eurozone nations experienced steady to slightly weaker growth in Q2. Investor confidence improved significantly according to the ZEW survey but the data was taken before the Turkish Lira blew up. Between trade tensions, slower Chinese growth and Turkey’s economic crisis, the outlook for the euro is grim. If EUR/USD breaks 1.13 the next stop will be 1.12.
Sterling gave up earlier gains to end the day near its 1.2705 low. This is a big week for the U.K. but risk appetite, market sentiment and Brexit headlines continues to have a greater impact on the currency than data. Tuesday morning’s employment report should have been good enough to keep sterling supported but it didn’t. Although wage growth slowed slightly, the unemployment rate improved and jobless claims increased less than expected. Consumer prices are due for release Wednesday. Of all of this week’s reports, inflation has the greatest chance of helping the pound because price pressures was the main reason why the Bank of England raised interest rates this month. Yet with the selling pressure in GBP is so strong, external risks has and could prevent the currency from rallying. The sell-off in GBP gained momentum after the U.K.’s foreign secretary said the risk of a no-deal Brexit have been growing but GBP/USD collapsed on the back of the rising dollar and not UK factors.
The performance of the commodity currencies was less consistent. While the Australian dollar had been under pressure throughout the European and NY sessions, the New Zealand dollar turned later in the day. The Canadian dollar, on the other hand, outperformed the greenback. The loonie was the only currency that bested the buck. Its resilience was initially attributed to rising oil prices but when the dollar turned oil prices reversed as well but the loonie held strong. As for AUD and NZD, it is difficult for these currencies to do well with the Chinese economy slowing. China reported softer industrial production and retail sales data Monday night.