By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Fed fund futures are now pricing in a 93% chance of a rate hike in June. We continue to be astounded by these odds as Wednesday’s FOMC statement was not exceedingly hawkish. But as futures were only pricing in a 69% chance of a hike on Tuesday, we have to respect the power of dollar bulls. The Fed recognized the recent deterioration in data but felt that the slowdown in the first quarter should be “transitory,” and it completely ignored the surprisingly weak nonfarm payroll growth in March by saying the labor market continued to strengthen. The same was true for retail sales – it said fundamentals underlying consumption growth stayed solid even as retail sales fell in April. It is this blind optimism that is fueling bonds, Fed fund futures and the U.S. dollar. At this stage, the dollar will probably continue to March higher into Friday’s nonfarm payrolls report as investors position for the labor-market strength that the Fed is suggesting. USD/JPY will test and most likely break 113 as the dollar pressures other currencies lower.
The commodity currencies were hit the hardest by the rising dollar on declining in commodity prices. Wednesday's worst-performing currency was the Australian dollar, which dropped more than 1% intraday on the back of lower gold, iron ore and copper prices. Gold fell close to 1.5%, taking out support at 1,250. AUD/USD hit its lowest level in 3 months even though service activity accelerated in April. The New Zealand dollar also shrugged off a much stronger employment report that saw the unemployment rate sink to 4.9% from 5.2%. Employment increased by 1.2% in the first quarter as participation rose. The only downside to the report was earnings, which grew less than anticipated. Australia’s trade balance and China’s Caixin PMI Services were due Wednesday evening. Although manufacturing activity accelerated, Australia’s trade surplus more than doubled in February so a pullback is likely in March. The uptrend in USD/CAD could be nearing an end as the currency pair’s trading range starts to narrow. Oil prices ended the day unchanged, shrugging off post-inventory data losses. Canada’s trade balance is scheduled for release Thursday and a slightly larger deficit is anticipated.
Euro drifted lower but remains confined in its 1.0850-1.0950 trading range. While we believe that the currency pair will test the lower part of this range, Macron and Le Pen are holding their single debate before this weekend’s election and their performance could affect how EUR/USD trades. Eurozone data was mixed with German unemployment rolls falling more than expected in April. Producer prices, however, dropped -0.3% pushing the year-over-year rate down to 3.9% from 4.5%. Economists had anticipated weaker inflation but they did not expect such a steep decline. Normally this would be very negative for the euro but Wednesday’s report was countered by the hotter CPI numbers released last week. As for growth, the Eurozone economy expanded by 0.5% in the first quarter, which was right in line with expectations. Wednesday’s Eurozone PMI reports are not expected to have a big impact on the euro as they are only the revised figures.
Meanwhile, the British pound came under selling pressure after Prime Minister May admitted that some European officials don’t want Brexit negotiations to succeed. They have “issued threats,” a sign of the hardened stance that negotiators are adopting. According to our colleague Boris Schlossberg, EU negotiator Michel Barnier “issued several directives the EU will be seeking including the idea that EU citizens in UK and UK citizens in EU must enjoy same rights based on EU law after Brexit and that Britain must honour its share of all obligations undertaken as a member of the EU and should cover all its liabilities, contingent liabilities, and costs related to moving agencies out of the UK.” The rights of non-UK citizens and UK’s ultimate bill to the EU are the prime points of contention and the EC’s view on the Brexit bill is that “all we’re asking for is that accounts be cleared for the honoring commitments the U.K. has entered.” With that in mind, the losses in sterling were limited by better-than-expected data. Construction activity accelerated last month and investors are now looking for similar strength in Thursday’s service-sector PMI report. If we also see stronger service-sector activity, any immediate concerns about Brexit terms will fade as GBP/USD makes a move back above 1.29.