For the past few weeks, anti-dollar flows have been the driving force for currencies. The sell-off in the U.S. dollar drove euro, sterling, Swiss Franc, Australian, New Zealand and Canadian dollars to multi-year highs. While the greenback continued to fall on Monday against most currencies, we’re also beginning to see more two-way action as investors look to take year-end profits on short dollar positions.
There’s very little on the U.S. calendar this week with the exception of inflation data. Prices are expected to rise, in part, due to the higher cost of fuel, but inflation in the U.S. is very low, so an uptick will have zero bearing on Fed policy. With that said, investors could find a stronger number a good excuse for U.S. dollar short covering. Instead, we have our eye on stocks. The Dow Jones Industrial Average pulled back after climbing to record highs last week, but the Nasdaq extended its gains. If stocks suffer a deeper correction, the greenback could catch a safe-haven bid.
The focus will be in Europe this week. UK Prime Minister Boris Johnson and European Commission President Ursula von der Leyen held the highest levels of Brexit talks today and, unfortunately, no agreement was reached. According to Ireland’s Foreign Minister Simon Coveney, no actual progress was made in the last two days. Sterling sold off sharply in response but rebounded from its lows as investors hope that a physical meeting between Johnson and Von der Leyen over the next few days will yield positive results. The UK government also offered to withdraw parts of its internal market bill that counteracts the withdrawal agreement if a trade deal is reached this week. This olive branch gave Brexit deal optimists hope. Yet, both sides have been stubbornly unwavering on three key issues – fishing rights, enforcement of governance of the agreement and a level playing field. So it remains unclear if a deal is really within reach. Regardless, expect some serious volatility in sterling this week.
The euro will also be a big mover with the European Central Bank gearing up to ease monetary policy. While stronger-than-expected German data keeps EUR/USD near 2.5-year highs, we are still looking for profit-taking ahead of the monetary policy announcement. The ECB made its intentions very clear, giving investors plenty of time to discount its move. However, they won’t be happy with the 3% rise in EUR/USD since November and the surge in virus cases abroad. A vaccine is here, but dissemination won’t be quick enough to avoid more deaths. Germany responded by closing retail shops for a few weeks after Christmas. Countries like Denmark are reinstating partial lockdown measures, which confirms that the pandemic continues to take a toll on the region’s economy. The ECB is expected to ease but it is also likely to leave the door wide open for additional measures.
The Australian and New Zealand dollars extended their gains on the back of stronger manufacturing data from Australia and trade data from China. Of all the major currencies, we think AUD is the most vulnerable to a correction. Data has been good and they’ve beaten a second COVID-19 wave, but tensions with China continue to grow. China suspended imports of more Australian beef. This follows as much as 200% tariffs on Australian wine, blocked imports of Australian lobsters and delays on coal imports. These are some of Australia’s most important exports to China. The Canadian dollar also lost ground on the back of softer manufacturing growth. The IVEY PMI index dropped to 52.7 from 54.4. Economists had been looking for an improvement to 54.7. The most worrisome part of the report was the employment component, which fell to 48.1 from 50.3, suggesting that job growth in December will be much weaker.