By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
After falling for 4 straight days, the Australian and Canadian dollars finally rebounded against the greenback. Unfortunately, the gains have been shallow so it is far too early to draw the conclusion that commodity currencies have bottomed. On a technical basis, AUD/USD and NZD/USD broke below major technical levels and appear poised for further losses. As long as AUD/USD remains below 73 cents and NZD/USD below 70, the downtrend remains firmly intact. USD/CAD is not as strong and would probably be one of the first to recover. However on a fundamental basis, the prospect of a stronger U.S. dollar in 2017 means commodity prices and commodity currencies could fall further. Data from these countries have been mixed. The Canadian dollar is supported by the rebound in oil prices, rise in Canadian yields and better-than-expected data. Wholesale sales rose 1.1% against a forecast for 0.5% rise and this bodes well for Friday’s broader retail sales report. The Australian dollar on the other hand is vulnerable to Chinese-U.S. tensions and the impact of a weak Chinese currency. The RBA minutes were not as benign as the monetary policy statement with the central bank emphasizing the high levels of household debt as a reason why we’ve probably seen the bottom in Australian rates. With that in mind, they are also in no rush to raise interest rates as “there was expected to be excess capacity in the labour market for some time, which was consistent with further indications of subdued labour cost pressures”. New Zealand dairy prices dropped for the first time in 2 months and while the trade deficit narrowed, it shrank less than anticipated, which is in line with the lower business PMI index reported earlier this month. New Zealand GDP numbers are scheduled for release Wednesday and between the trade deficit and weaker consumer spending, the risk is to the downside for the third-quarter report.
Meanwhile, there was very little consistency in Tuesday's performance of the U.S. dollar. The greenback traded higher versus the euro, British pound and Japanese yen but lost value against the commodity currencies. With no U.S. economic reports on the calendar, the dollar took its cue from U.S. rates, which rebounded after Monday’s decline. U.S. stocks also climbed to record highs, attracting renewed demand for the greenback. However even with Tuesday’s gains, the U.S. dollar has not escaped the risk of year-end profit taking, especially with the greenback ending the day near its lows as U.S. yields gave up most of their earlier gains. The Bank of Japan rate decision hurt the Japanese yen after Governor Kuroda said it is not appropriate to reduce ETF purchases at this time. There was some hope that recent yen weakness would spark talk of tapering but policymakers wanted to wait until their next outlook report to debate the effects, which means they either want to see if yen weakness will last or simply deal with the issue in the New Year. U.S. existing home sales report is scheduled for release Wednesday and a pullback is expected after last month’s decline. While interesting, this release won’t have a major impact on the dollar. Instead, traders should keep their eyes on U.S. rates as we are still looking for another drop to the 116-handle before a push to 120 in 2017.
EUR/USD on the other hand found support above 1.0350 but it was the retreat in the dollar and not Eurozone data that supported the currency. With that in mind, we continue to see evidence of the positive impact of euro weakness. Producer prices are on the rise and the Eurozone’s current account surplus increased in October. These upside surprises should continue in January as the sharp slide in the currency this month lends additional support to the economy. However for the euro, politics and terrorism could overshadow economics in the coming year. Monday’s horrific terror attacks in Germany, Turkey and Switzerland reflect growing populism and anti-immigration sentiment. Saddled with billions of bad loans, Italy’s banking sector is also in focus -- Italian bank stocks performed extremely well Tuesday after the government took steps to seek permission from Parliament to borrow as much as 20 billion euros to rescue the sector in case it fails to raise sufficient funding. With elections in France and Germany next year, politics, Europe’s banking troubles and terrorism will continue to affect the currency in 2017.
Sterling also remained under pressure on the back of Brexit worries and mixed comments from BoE member McCafferty. Brexit negotiations will begin next year and Prime Minister May said the goal is to “forge a brand new relationship with the European Union….it isn’t about trying to replicate bits of membership.” While this past year was about whether Brexit would happen, next year’s focus will be on the terms of Brexit and the possibility of a hard vs. soft exit. There are also concerns that negotiations with the U.S. will be for a hard Brexit. With that in mind, CBI retailing reported sales that shattered expectations with a reading of 35, far above economist’s forecasts of 20. Total distribution reported sales also managed to show improvement with a 42 reading, beating the 34 reading the previous period. These numbers tell us that consumers are spending, which bodes well for next month’s broader retail sales report. Comments from Bank of England member McCafferty were mixed -- while he said CPI is expected to rise sharply and stay above the BoE’s two percent target beyond 2019, he also said that “the economy is likely to weaken over the period, pushing up on unemployment and widening the output gap.” For the first time in 3 weeks, GBP/USD spent the entire day below the 50-day SMA and unless it breaks back above this moving average -- which is at 1.2420 -- the currency is at risk of a deeper slide toward 1.22.