By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
September has been a challenging month for the U.S. dollar. The greenback lost value against most of the major currencies with AUD/USD and USD/JPY leading the slide. In the early part of the month the dollar’s decline was slow and steady driven by disappointing non-farm payrolls but this week the selling gained momentum after the Federal Reserve left interest rates unchanged. Only a handful of investors expected tightening but many anticipated unambitiously hawkish comments from Janet Yellen who told us at Jackson Hole that the case for a rate hike has strengthened. This language made it into the FOMC statement but probably only as a conciliatory move for the 3 members who voted for an immediate rate hike. More importantly, Yellen maintained a cautious tone throughout her press conference, suggesting that she is a reluctant bull. Yellen is a dove at heart so the latest slowdown in job growth, wages, manufacturing and service sector activity makes her worried. She fears that raising interest rates prematurely could make it difficult to reverse that trend. As a result, the next 3 non-farm payroll reports will be extremely important and from now until October 7th when September’s figures are released, we expect consolidative trading in the dollar with shallow rallies and retracements. As for data, the U.S. economic calendar is mostly filled with second tier U.S. releases such as new home sales, consumer confidence, durable goods, GDP revisions, personal income and spending. So the focus should be on the 8 U.S. policymakers speaking, four of whom are FOMC voters including Yellen and George who voted in favor of an immediate rate hike. Chances are Yellen’s peers will be more enthusiastic about the recovery, which should prevent the dollar from experiencing a steep decline at the end of the month/quarter. At the same time, since U.S. stocks performed very well in Q3, we could see some dollar selling so the chance of a massive rally end of quarter is slim.
Meanwhile the Bank of Japan made only modest changes to monetary policy this past week. They relaxed the framework for bond purchases by dropping their average maturity target and altered the mix of equity purchases to include more TOPIX. They also maintained their 2% inflation target and left interest rates unchanged, which was widely expected. While the yen initially declined sending USD/JPY to a high of 102.79, the rally fizzled quickly as investors saw the announcement as a big disappointment. There was nothing surprising let alone impressive in the decision and it will be difficult for the central bank to reach its inflation target without additional easing. More rate cuts are likely but there was nothing in monetary policy statement suggesting that it would happen soon. Instead Japanese officials could be waiting for the Fed to do the heavy lifting because rising U.S. rates will take USD/JPY higher, easing pressure on the Japan’s export sector and the central bank. Until USD/JPY closes above 101.50, another run down to 100 remains possible.
Even after all of the big events last week, EUR/USD failed to break out of its multi-week trading range. For most of September the currency pair was confined between a narrow 1.1120 to 1.1285 range, barring a one day pop above 1.13. Friday’s Eurozone PMI reports were the only pieces of European data released this past week and economic activity was mixed. While the service sector slowed, manufacturing activity in Germany and the Eurozone as a whole accelerated but that did not stop the composite index from moving lower. The OECD and central banks around the world have been worried about slower global growth and part of that centers around the troubles in Europe. Technically, 1.12 is holding as support for EUR/USD for the time being. Aside from the PMIs, we’ve seen weakness in Eurozone industrial production, factory orders and investor confidence. Germany’s IFO report is scheduled for release next week and we may not see much improvement in sentiment.
There were no major U.K. economic reports released this past week and the calendar remains light next week with only revisions to second quarter GDP numbers on the calendar. GBP/USD broke below 1.30 on the back of Brexit fears shrugging off Bank of England monetary policy committee member Forbes’ optimism. At a speech in London she said the initial Brexit impact was less than expected and she’s not yet convinced that more loosening will be needed. Forbes believes the BoE may be overcounting Brexit-uncertainty effect and with faster inflation, current data may lead to upgraded forecasts. However judging from the way sterling reacted to Boris Johnson’s comment on Friday that Article 50 will be invoked early next year, investors and most likely Governor Carney don’t share her positive views. In the coming weeks we expect more Brexit headlines that will stifle sterling’s rally.
All three of the commodity currencies ended the week stronger against the U.S. dollar but the gains varied greatly. The best performing currency was AUD, which received support from the neutral RBA minutes. The RBA did not see any serious need to ease and noted that their main reason for leaving interest rates on hold in September was because it sees current monetary policy as being accommodative to its inflation goals. In the coming week, there were no major Australian economic reports so AUD driven flows should be at a minimum. The worst performing currency was the New Zealand dollar, which was hit hard by the Reserve Bank’s dovish monetary bias. They made it very clear that “further policy easing will be required” because the New Zealand dollar is too strong. This bias should keep lead to further underperformance for NZD especially against AUD and CAD. New Zealand trade numbers are scheduled for release at the beginning of the coming week but the impact on NZD should be limited.
The Canadian dollar traded strongly this past week thanks to the sell-off in the U.S. dollar and corresponding rise in oil prices. There were no Canadian economic reports released until Friday so the currency took its cue from oil, which found below $43 a barrel. However the rally in the CAD was quickly halted by softer Canadian data. Retail sales and consumer prices declined in the month of August. Consumer spending has fallen for the second month in a row and more importantly we have not seen an increase in 4 months. CPI stagnated causing the year over year rate to slow to 1.8% from 2.1%. Canadian GDP numbers are scheduled for release next week and the drop in spending signals the possibility of lower growth. We think these figures should enough to take USD/CAD above 1.32.