By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Friday turned out to be a great day for the U.S. dollar. The greenback moved higher against all major currencies following Fed Chair Janet Yellen’s speech at Jackson Hole. Interestingly enough, it wasn’t her words that sent the dollar soaring. While Yellen said the rate-hike case strengthened in recent months, it was Fed Vice Chair Fischer’s comments that really sparked the rally in the greenback. He was explicit when he said Yellen’s comments were consistent with a possible September rate hike and that 2 rate hikes this year is possible. Throughout the past week, we heard consistently hawkish comments from U.S. policymakers who all seem to agree that the country is close to full employment and that inflation is on the rise. While some members like Fed President Powell still believe the central bank can afford to be patient, if next Friday’s nonfarm payrolls report is strong, the odds for a September hike will rise significantly.
Friday’s Fed comments served as a strong reminder to the market that no one is as hawkish as the Fed although Fed Fund futures are currently pricing in a 63% chance of a December rate hike, which is only slightly above even. But if jobs and wages surprise to the upside, those odds could shoot above 75%. Yellen and Fischer have done a great job of setting the bottom for the dollar and we anticipate further gains in the coming week. However Friday’s strong move took many major currency pairs to key technical levels -- 1.12 EUR/USD, 102 USD/JPY and 1.30 USD/CAD. Some of those levels have been broken while others have been tested, but either way, traders should look to buy the dollar on any shallow corrections. We expect USD/JPY to hit 104, EUR/USD to drop below 1.11 and GBP/USD to test 1.30.
After peaking at 1.1367 on August 18, the euro ended the week sharply lower against the U.S. dollar. The recovery in the dollar played a major role in the currency’s reversal, but softer Eurozone data also dragged the currency pair lower. Manufacturing- and service-sector activity in Germany slowed in August and while improvements in France compensated for Germany’s weakness, slower growth in the Eurozone’s largest economy raised red flags for anyone long the currency. German business confidence also declined with the IFO business climate index falling to its lowest level in 6 months. The irony of Brexit is that its single biggest impact may have been on German sentiment as highly export-driven German businesses became clearly concerned about the prospect of the UK leaving the EU. Yet the sharp fall in IFO may be more a result of fear rather than reality. Next week’s economic reports may give us better insight as German retail sales, unemployment change and consumer prices are scheduled for release. Any weakness and EUR/USD may find itself below 1.11.
Sterling was the only currency to end the week stronger versus the U.S. dollar but we believe there will be a deeper correction in the coming week. After Britain decided to leave the European Union, investors around the world braced for economic Armageddon in the U.K. Yet while the flash PMIs surprised to the downside, the rest of the data hasn’t been terrible. According to the British Bankers’ Association, consumer credit rose at its strongest pace in nearly 10 years as shoppers hit the stores and took advantage of low interest-rate loans. This shows that while Brexit may have hurt the housing market, it hasn’t had a major impact on consumption. Given how far sterling has fallen post-Brexit, this past week’s price action is mostly indicative of profit taking. In the coming week, U.K. manufacturing- and construction-sector PMIs are scheduled for release. While construction-sector activity may have slowed, the recent improvements reported by the Confederation of British Industry tell us that manufacturing activity remains healthy. With that in mind, sterling will continue to find resistance below 1.33. So far the economic impact of Brexit has been limited, but if there are more headlines about Prime Minister May invoking Article 50 early next year, GBP/USD could quickly extend its losses.
All three of the commodity currencies ended the week lower against the greenback. The Canadian dollar took its cue from oil but even though crude prices rose on Friday, USD/CAD could not shrug off the impact of a rising U.S. dollar. The only country with any fundamental developments over the past week was New Zealand where RBNZ Governor Wheeler said there was no need for rapid easing. That put a bid underneath NZD/USD, which rose to an 18-month high before Yellen’s testimony on Friday. The Fed Chair’s speech completely changed the technical picture for all 3 commodity currencies and now we are looking for deeper corrections. Fundamentally, there are no major economic reports scheduled for release from New Zealand, but Australia’s retail sales and PMI manufacturing are due along with Chinese PMIs. Canada has its current account, Q2 GDP and trade-balance figures on the calendar.