By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
With the year drawing to a close, FX traders are finally enjoying the risk-on rally that equity traders coasted on throughout the month. It took a while for Treasury yields and the dollar to catch up to the move in stocks and what is particularly interesting about Tuesday’s price action is that both the dollar and yields powered higher, even though equities retreated. Stronger-than-expected U.S. data combined with the prospect of a House and Senate vote on the tax bill in the next 24 to 48 hours took USD/JPY above 113.00. Economists expected housing starts to decline after rising strongly in October but instead, starts rose by another 3.3%. Granted, the data is not overwhelmingly positive as the previous figures were revised lower but they were good enough for dollar bulls. Building permits fell -1.4%, which was a smaller decline than forecast. The current account deficit also shrank to -$100.6B in the third quarter from -$124.4. While none of these reports was overwhelmingly impressive, they still reinforce the positive trajectory of the U.S. economy. Still, Tuesday's best–performing currencies were the yen crosses with the resilience of euro allowing EUR/JPY to lead the gains.
Euro was the only currency that withstood the dollar’s decline, spending most of the day trading above 1.18. Tuesday morning’s Eurozone economic reports were mixed with the Ifo Business Climate Index index slipping down to 117.2 from 117.6 and the expectations component falling to 109.5 from 111. The current assessment portion of the report however ticked up to 125.4 from 124.5. This tells us that while investors see stronger economic activity, they are nervous about the year ahead. EUR/USD dipped on the back of the report but recovered all its losses to end the day in positive territory as investors still see the German IFO confirming the underlying strength of the Eurozone’s largest economy. Let's not forget that the ECB upgraded its GDP forecasts last week and between its brighter outlook for the Eurozone and the Fed’s positive view on the economy, it's no surprise that EUR/JPY was the day’s best-performing currency. The EUR/USD itself is stuck in a 1.1720 to 1.1860 range but the charts show the potential for a move up to 1.19.
In contrast, sterling was the weakest currency on Tuesday, having rejected 1.34 at the start of the European trading session. No U.K. economic reports were released but Brexit concerns continue to weigh on the currency. According to the latest reports, the EU will not allow U.K. financial firms the same passport arrangement it currently has to provide services to other EU members. Brussels continues to take a tough stance on Brexit and as long as they push back on U.K. wishes, sterling could have a tough time rallying.
All 3 commodity currencies traded lower Tuesday with the New Zealand dollar the most vulnerable to additional losses. Having traded sharply higher this month on nothing more than short covering, Tuesday’s -3.9% decline in dairy prices could take NZD/USD much lower. Earlier this month, NZD/USD traders and dairy farmers hoped that the small uptick in prices marked a bottom for the sector but instead of slowly trending higher, dairy prices fell by the largest amount this year, taking the GDT index to its lowest level since October 2016. None of this bodes well for New Zealand’s economy and even though the trade deficit is expected to shrink in November, we are bearish on Q3 GDP and growth in the fourth quarter. The 0.7050 level should hold as resistance for NZD/USD with the pair eyeing a stronger decline toward 0.6930. USD/CAD also tested to the top of its 6-week range. Despite a sharp rise in Canadian bond yields and higher oil prices, the pair traded above 1.2900 before settling the day just underneath that level. If USD/CAD trades above 1.2920, it should squeeze to 1.2950 and that will be the main level to watch. Like the New Zealand dollar, the Australian dollar traded lower on the back of the U.S. dollar’s strength. Monday night’s RBA minutes did not have a significant impact on the currency as the central bank’s confidence in wage and job growth was offset by its concerns about household consumption.