By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
With the violence in Charlottesville redirecting the Trump Administration’s attention on Monday, the lack of fresh antagonism toward North Korea encouraged short covering in the U.S. dollar. The greenback rebounded Monday as the silence gave investors the perfect excuse to take profits ahead of Tuesday’s retail sales report. Unfortunately the silence does not mean that conditions have improved. Over the next 2 weeks, there are some crucial days when the tensions between the U.S. and North Korea could be inflamed. The first is “mid-August,” which is anytime from August 15th – the timeframe that North Korea plans to shoot four missiles near the US territory of Guam. When that happens, we expect USD/JPY to crash as investors eye President Trump’s response. If the dramatic rhetoric returns, or worse, Trump views this as an act of war and initiates military action, USD/JPY will fall quickly and aggressively as risk aversion hits the market. On August 21 and August 31, the U.S. and South Korea plan to hold joint military exercises and we will be watching North Korea’s response. Both nations have the option to ignore the other’s display of force, but chances are Donald Trump and Kim Jong-un won’t miss the opportunity to fire back verbally or physically. The threat has not diffused and if anything, Trump’s warning of potential military action in Venezuela and his plan to investigate China’s trade practices only worsens U.S. global relations.
With this in mind, Tuesday’s U.S. retail sales report could extend the dollar’s recovery. Investors are desperate for some good news and even if deep down they know that a mild uptick in consumer spending won’t affect the odds of a year-end rate hike, they could drive the dollar higher on the back of a positive report. Consumer spending should have rebounded in July based on stronger average hourly earnings, record-breaking levels in U.S. stocks and the uptick in gas prices. However the Fed is worried about inflation and until price growth accelerates, it will be less eager to raise interest rates. Aside from retail sales, the minutes from the last FOMC meeting is also scheduled for release this week and inflation concerns should be front and center. So between ongoing geopolitical tensions and the less hawkish rhetoric from U.S. policymakers, there’s still significant downside risk for the dollar – even though it started the week stronger thanks to short covering and positive comments from Fed President and FOMC voter Dudley who said the record highs in stocks are consistent with the economy’s performance and a balance-sheet announcement should be made relatively soon.
Both euro and sterling traded lower against the greenback with the former pressured by a larger-than-anticipated contraction in Eurozone industrial production. No data was released from the U.K. but Tuesday kicks off a busy week for sterling starting with the consumer price report. When the Bank of England released its last Quarterly Inflation report, it lowered its GDP and wage-growth forecasts but left its inflation projections unchanged. Although normally this would lead us to believe that price growth held steady in July at 0%, there’s nothing impressive about zero growth. With shop prices falling according to the British Retail Consortium and the price components of manufacturing and service PMIs declining, the risk is to the downside. For the past 6 trading days, GBP/USD has trading in a narrow 1.2940-1.3060 range. But that should change this week with inflation, employment and consumer spending numbers scheduled for release. Most of these reports should confirm the slowdown in the economy and if that’s true, GBP/USD will break 1.29 rather than 1.31.
All 3 of the commodity currencies traded sharply lower against the greenback on Monday. Between the unrest in Venezuela and NAFTA talks, crude went from strong gains to sharp losses. USD/CAD responded in kind, rebounding from a low of 1.2975 to end the day near its highs above 1.2700. With no major data scheduled for release until Friday, geopolitical risks and the market’s appetite for U.S. dollars will determine how the loonie trades for most of the week. Canada has a long list of goals for the NAFTA talks, which could be tough with Finance Minister Freeland suggesting that they could walk away if the U.S. pushes to scrap the dispute settlement mechanism. Although losses for all 3 currencies were modest, the Australian dollar led the slide ahead of the RBA minutes. At the last meeting the central bank lowered its GDP forecasts, said the strong currency dampened growth and warned that a continued rise could depress prices and limit employment. For these reasons, we are looking forward to less-hawkish RBA minutes, which should put pressure on the Australian dollar. No economic reports were released from New Zealand but softer Chinese industrial production and retail sales numbers sent AUD and NZD lower. New Zealand’s dairy auction is scheduled for Tuesday but even if prices rise, it will be difficult for investors to forget about last week’s RBNZ intervention talk.