By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar came under heavy selling pressure this past week with the greenback breaking key support levels against the Japanese yen, euro, British pound and other currencies. Although softer economic reports played a key role in the dollar’s decline, President Trump’s political trouble is the real reason for its aggressive slide. The investigation into ties between Trump’s presidential campaign and Russian influence sparked talk of impeachment. While this may be wishful thinking for some, the real implication will be on the president’s ability to push through his pro-growth policies — and that’s where the political trade becomes an economic one.
The U.S. dollar ran up sharply mid April to mid May on the prospect of a June Federal Reserve rate hike but the central bank’s hawkish views rely on Trump following through with his tax cut and spending plans. If the optimism fades and doubt grows, the Fed may need forgo raising interest rates next month and that’s when the long dollar trade completely unwinds. We’re not saying that the Fed will stand pat next month, in fact they are quite hawkish. But this is a serious risk for the dollar. Even if the Fed tightens next month, if it casts doubt about future moves, the dollar could suffer. Therefore, when it comes to U.S. politics or economics — it’s really the same trade because the ongoing recovery in the economy and, in turn, future rate hikes hinge on pro-growth policies that are now at risk from Trump uncertainty. He could also “save” the dollar by going over Congress and pre-announcing policy plans — its unprecedented but so are many of this president’s actions. The FOMC minutes, revisions to second-quarter GDP, housing data and the trade balance are the main U.S. economic reports on the calendar next week. The minutes are likely to be hawkish along with comments from the 5 Federal Reserve presidents, so USD/JPY could rise above 112.
The euro rose to its strongest level in 6 months on the back of U.S. dollar weakness. Although it pulled back slightly toward the end of the week, the breakout/uptrend remains intact as long as the currency pair holds above 1.10. It has been nearly 4 weeks since EUR/USD gapped up from 1.0730 to 1.0880 and the longer the pair holds above these levels, the more durable the gap. Fundamentals are also on the euro’s side as the political risk in France and Germany fade with the CDU party’s victory in rival territory. Data this past week has been good — German investor confidence rose strongly in May, the Eurozone’s trade surplus hit a 3-month high and there were no revisions to the Eurozone’s Q1 GDP and French CPI reports. Even ECB President Draghi had to acknowledge the euro-area recovery as resilient and increasingly broad based. The euro also received help from the German – U.S. yield spread, which moved sharply higher this week. In the week ahead, the euro will remain in focus with the German IFO report and May PMIs due for release. Of all the major economies, the Eurozone is one of 2 with big events on the calendar so expect EUR/USD to be on the move. We are still looking for a firm break of 1.12 but if EUR/USD dips below 1.10, a deeper correction becomes likely.
As for sterling, GBP/USD has broken above 1.30, a psychologically and technically significant level. The break still needs to extend beyond 1.3050 to convince the bears that the next move will be 1.32. Although the Bank of England ruled out any rate hikes in the foreseeable future, data has been very good, easing the market’s concerns. Consumer spending jumped 2.3% in April, which was more than double the market’s 1.1% estimate. On an annualized basis, spending rose 4%, which happened to be the strongest pace of growth in 5 months. Excluding autos and gas consumption was also very strong as the warm weather drew shoppers to the stores. Wages increased, inflation is on the rise and the number of people claiming jobless benefits was less in April than May. So while the BoE may not be ready to raise rates, its dovishness will gradually fade from the minds of investors if data continues to improve. There are no major U.K. economic reports scheduled for release next week outside of GDP revisions but U.K. GDP is generally not revised. Given the lack of U.K. data, a sharp fall in U.S. yields may be needed to take the pair back to 1.32.
The commodity currencies also ended the week higher against the greenback. The Canadian dollar was the best performer while the New Zealand dollar lagged on mixed data. Dairy prices increased but less than the previous auction. Softer service-sector activity was offset by stronger consumer spending. In Australia, Over 37K jobs were created in April, which was lower than March but significantly better than expected. Full-time job losses were limited and most importantly, the unemployment rate dropped to 5.7% from 5.9%. Although the Reserve Bank has expressed concern about labor activity, its worries should be eased by this latest report. There are no major Australian economic reports scheduled for release next week but Reserve Bank of Australia Deputy Governor Debelle speaks a few times and New Zealand releases its trade-balance report. The trend is still down for AUD and NZD, especially if the U.S. dollar recovers.
USD/CAD came off its recent highs as oil recovered, leading many investors to believe that it peaked despite mixed Canadian data. CPI increased but less than anticipated, causing the year-over-year rate to hold steady at 1.6%. Retail sales shot up in March but all of the increase was caused by auto sales as spending ex autos dropped -0.2%. There are 2 major events on Canada’s calendar next week — the Bank of Canada monetary policy announcement and the OPEC meeting. At the last meeting, the central bank raised its growth forecast and brought forward its forecast for closing the output gap to the first half of 2018, sending the loonie sharply higher. Investors interpreted the announcement as the central bank moving away from its easing bias. Since the last meeting there have been both improvements and deterioration in Canada’s economy. Retail sales, inflation, housing and trade activity softened while employment and manufacturing activity increased. We don’t think there are enough changes to alter the central bank’s views and put the CAD recovery at risk. OPEC nations are widely expected to extend the production cuts they agreed to earlier this year. There shouldn’t be a shock-and-awe announcement but a mere extension in production should still be enough to trigger a brief rally in oil and gains in the Canadian dollar.