By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Fed Chair Janet Yellen spared the U.S. dollar Thursday by avoiding any talk about her discomfort with the recent surge in U.S. yields. Going into her joint testimony on the economy and monetary policy, many investors expected the Fed Chair to confirm that rates are rising in December and manage lower the expectations for further tightening next year. However she made no mention of what happens beyond December and none of the members of Congress raised questions about this during the Q&A session. Instead, Yellen’s testimony ended positively with the main takeaways being her confidence in the economy and the progress the Fed is making toward its inflation and employment goals. She indicated that waiting too long could mean the need to tighten faster later, which could spur excessive risk taking -- comments that are consistent with a hawkish bias. While she also felt that the state of the economy warrants only gradual rate increases, she did not suggest they would hike in December and then pause in early 2017 as her colleague Fed President Bullard indicated. Investors were worried about less-dovish future guidance and when the risk was lifted, USD/JPY charged toward 110 and EUR/USD broke 1.0950.
While we continue to believe that the December FOMC statement will be less hawkish, the Fed chair clearly did not want to detract from their plans for tightening next month -- even if it means that it could alleviate the rise in the U.S. dollar and yields. Another way to look at this is that she gave investors the green light to send the dollar to new highs. The latest U.S. economic reports helped to support her view with housing starts and building permits rising strongly. Consumer prices also increased in October, which contrasts with the flat reading in PPI. Jobless claims dropped to 235K from 254K to its lowest level in 40 years. The only miss was the Philadelphia Fed manufacturing index, which dropped slightly more than expected. With no major U.S. economic reports due on Friday, we expect the dollar to remain bid with shallow retracements attracting additional buying interest.
It should be no surprise that EUR/USD broke 1.06, making 1.0525 -- last November’s low -- the next target for the pair. Between weaker EZ data, stronger U.S. data and dovish ECB minutes, the path of least resistance for the currency pair throughout the day was lower. Economists were looking for inflation to slow to 0.3% in October but instead it slumped to 0.2%. According to the ECB minutes, core inflation still lacks a convincing upward trend as wage-growth dynamics have surprised to the downside. The minutes revealed that the bank is in a “wait-and-see” mode and will wait for December to better formulate views and actions moving forward. The Eurozone’s current account balance and German producer price reports are scheduled for release Friday but those numbers will take a back seat to political concerns and the market’s appetite for U.S dollars.
Of all the major currencies, sterling continued to hold up best versus the U.S. dollar. Significantly stronger-than-expected consumer spending in October drove the currency pair above 1.25 but the gains failed to last as the U.S. dollar took control of all major currencies. With that in mind, however, the 1.9% increase in retail sales was nearly 4 times greater than forecast and excluding autos and gas, demand was even more robust rising 2% against a 0.4% forecast. The chilly weather spurred a shopping spree for cold-weather clothes and shoes with internet sales rising 27%, the largest increase in 6 years. These numbers will go a long way in boosting fourth-quarter GDP growth and keeping sterling bid versus the euro. While most of this week’s U.K. economic reports were mixed, the attractiveness of sterling stems primarily from the unattractiveness of the euro. EUR/GBP hit a 7-week low and so far the losses have been shallow. However we believe that a steeper decline is likely, especially with the currency pair rejecting the 100-day SMA.
All three of the commodity currencies traded lower against the U.S. dollar Thursday with the Australian dollar experiencing the sharpest decline. Wednesday night’s labor-market report was better than expected but investors were not impressed and the currency came under heavy selling throughout the North American trading session. Job growth increased by 9.8K, which was better than the previous month but less than forecast. The unemployment rate held steady at 5.6% and more than 41k full-time jobs were created, offsetting the 31.7k drop in part-time work. Unfortunately, the participation rate was revised down to 64.4%. The problem is that even though full-time jobs increased strongly, they failed to sufficiently offset the massive 74.3K drop in September. AUD may continue to fall but, we expect a bounce in AUD/NZD soon. There was no data from New Zealand with the country’s retail sales and PPI reports postponed. USD/CAD broke through 1.35 and ended the day right around that level. Oil prices fell slightly on news that OPEC is close to reaching a consensus on a 6-month output deal. There were also reports that Qatar was in talks with Iran and Iraq to freeze oil output at its current levels. The Canadian dollar remains in focus Friday with the release of CPI data.