By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Tips on Trading the Dollar Post Yellen & Pre-NFP
This week, Federal Reserve Chair Janet Yellen breathed new life into the dollar after laying out her strongest case for raising interest rates this year. We were surprised by the market’s dovish reaction to this month’s FOMC meeting and advised our readers to buy the dollar on dips. However since the greenback powered higher, many investors are wondering if there will be an opportunity to buy it lower. We’ve seen strong trends emerge quickly in the forex market. But even in a currency pair like GBP/USD -- which can fall 600 pips without blinking -- reversals will occur. Yet traders can’t expect to be initiating positions at pre-rally or meltdown levels. Entries have to be set higher on uptrends and lower on downtrends.
Between next week’s Chinese PMIs, Fed speak and Friday’s nonfarm payrolls report, we should have the opportunity to buy the dollar lower than where it settled on Friday. Yellen said there would likely be an initial increase in the federal funds rate this year but “if the economy surprises us, our judgments about monetary policy will change.” The Federal Reserve’s number-one concern is the labor market; so while economists are looking for a pickup in job growth, the larger-than-anticipated increase in average hourly earnings in August signals the risk of slower growth in September. There are a lot of question marks surrounding next week’s NFP and because of that, we could see profit taking in the dollar ahead of that key release. If job growth is strong and average hourly earnings rise at a satisfactory pace, investors will immediately start pricing in October tightening. However if any part of the report falls short, the dip in the dollar will be a great buying opportunity.
Before Nonfarm Payrolls we could still get an opportunity to buy USD/JPY near 120.50 and sell EUR/USD closer to 1.12. But as you can see from these levels, we're only anticipating a shallow pullback that could be driven by weaker Chinese data or Fed speak. Six members of the FOMC are scheduled to speak next week and 5 of them are voters. They include Yellen, Evans, Williams, Brainard and Bullard. Each one of these policymakers -- with the exception of Bullard who is a nonvoter -- is considered a dove. But as we saw in Yellen’s speech this week, even the doves are calling for a rate rise this year.
USD/JPY was also lifted Friday by softer Japanese data. Core consumer prices dropped for the first time since the launch of BoJ stimulus. With the effects of Abenomics fading and commodity prices falling, Japan is struggling to beat deflation. As such, the Cabinet revised down its assessment of the economy by saying that “slowness can be seen in some areas.” The Quarterly Tankan survey is scheduled for release next week.
The euro extended its losses on Friday but managed to close above its monthly low of 1.1087. While less-dovish comments from Mario Draghi this week and a stronger German IFO report lent support to the currency, higher U.S. rates will cause U.S. stocks to fall and European equities to follow. That would tighten conditions in Europe, which could lead to renewed dovishness from the ECB. The most important economic report on the Eurozone’s calendar next week is German unemployment. Eurozone confidence will also be important but less market moving. Data from the region’s largest economy has been mixed but according to the PMIs, job growth in Germany accelerated this month.
The British pound moved lower against the U.S. dollar for the sixth consecutive trading day Friday. We have not seen a green day for GBP/USD since the day after the Fed meeting. As there were no U.K. economic reports released, demand for U.S. dollars and market momentum drove the move. Revisions to Q3 GDP and the PMI manufacturing report are scheduled for release next week. Given how deeply oversold GBP/USD has become, only marginally positive numbers are needed to turn the currency pair around.
China’s official PMI numbers are also scheduled for release on Wednesday. The meltdown in the commodity currencies this week was driven by the surprise decline in Caixin’s PMI manufacturing report. This private-sector survey is seen as the most reliable measure of Chinese manufacturing activity. Given the continued weakness of Chinese stocks, we don’t think the government will release a terrible manufacturing report that could renew the decline in the markets. Nonetheless, the report is worth watching as it generally impacts the Australian and New Zealand dollars.
Both AUD and NZD rebounded slightly on Friday. It ws a tough week for both currencies, especially the Australian dollar. NZD performed better than AUD thanks to better-than-expected export data and Fonterra’s increased dairy payout. Aside from Chinese PMI, the only market-moving data for either country is Australia’s retail sales report. That means the performance of AUD and NZD will be largely driven by the market’s appetite for U.S. dollars.
After this week’s strong gains that took USD/CAD to 11-year highs, the currency pair ended Friday unchanged thanks in part to the rebound in oil prices. How USD/CAD trades next week will depend primarily on oil prices and the market’s demand for U.S. dollars. Canada’s July GDP report is scheduled for release but we believe the impact on USD/CAD will be short-lived. Fed tightening is not necessarily positive for USD/CAD. In the lead up to the start of tapering in December 2013, USD/JPY rose strongly while USD/CAD traded in a very tight range. And when USD/JPY fell sharply in the beginning of 2014, USD/CAD rallied. That divergent price action is driven by the perception that what’s positive for the U.S. is good for Canada as well.