By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
To the frustration of anyone who believes that USD/JPY should be the purest pro-dollar-anti-dollar trade, the greenback moved lower against all of the major currencies Monday except for the Japanese yen. U.S. data continues to be unimpressive as manufacturing activity in the NY region declined for the first time in 7 months. This follows the softer-than-expected consumer spending and inflation reports released on Friday and while builder confidence is up, these reports are far more important and have a greater impact on monetary policy. Just a week ago investors were convinced that the Federal Reserve will raise interest rates next month but in light of recent reports, they are growing skeptical of the central bank’s resolve. Yet we are still seeing investors sell dollars — just not against the yen. There are a few reasons for USD/JPY’s resilience. The first and probably most important is U.S. rates, which rebounded after falling sharply on Friday. USD/JPY takes its cue from yields spread and unlike EUR/USD or GBP/USD, whose yield spreads moved in favor of euro and sterling, Japanese yields were flat and U.S. yields increased, encouraging the rise in USD/JPY. Also, technically USD/JPY has a lot of support at 113 as buyers swooped above that level. Traders are now looking for the currency pair to break below 113 and more specifically the 100-day SMA near 112.95 before selling. Lastly, as indicated by Fed fund futures, the market still expects the Federal Reserve to raise interest rates and for this reason, investors may be reluctant to sell U.S. dollars. 114.37 is the main resistance level for USD/JPY and with no major U.S. data on the calendar this week, we would be surprised if USD/JPY took out this level easily.
The euro, on the other hand, is closing in on 1.10. German yields rose strongly Monday after the Christian Democratic Union’s victory in North Rhine-Westphalia this weekend. Not only is this is the largest German state, but it's also the rival’s heartland and the win by Chancellor Merkel’s party pretty much guarantees her reelection in September. There were no major Eurozone economic reports released Monday and nothing significant on the calendar Tuesday. Our readers may find it interesting that Bloomberg conducted a poll of 50 economists and the majority of them expect Euro-area inflation to remain below the central bank’s target throughout 2018. Yet with that in mind, they also expect German growth and inflation to move higher this year. Aside from the political favor, EUR/USD moved higher as the increase in German yields exceeded the rise in U.S. rates.
This is a big week for the British pound and the action starts Tuesday with the country’s April inflation reports. We know from the Bank of England meeting that inflation has been on the rise but the increase was driven “entirely” by the weak currency, so if the data is strong, investors could still fade an initial pop. With that in mind, the employment and consumer spending reports later this week could have a more lasting impact on the currency. 1.3000 is the level to watch — if that breaks, we should see a stronger move to 1.32. Otherwise, we expect to see GBP/USD drift down to 1.2350 and possibly even 1.2775.
Monday's best-performing currency was the Canadian dollar, which extended its losses versus the greenback. As our colleague Boris Schlossberg noted Monday morning, oil prices, and in turn CAD, rose following a new agreement between OPEC and Non-OPEC nations to curtail production all the way to March of 2018. Crude jumped to $49/bbl on news that Russia and OPEC decided to maintain curbs for another nine months. Regardless of whether this is a real solution for oil, USD/CAD has fallen hard. If it breaks 1.36, we should see a swift slide down to 1.35. However selling USD/CAD could still be tough with the oil recovery stalling underneath $50. Canadian data also provided no help with existing home sales falling -1.7% in April. The Australian and New Zealand dollars joined in on the comm-dollar rally despite mixed data. In Australia, home loans declined but the decrease was offset by higher investment lending. In New Zealand, softer service-sector activity was offset by stronger consumer spending. Chinese data was mostly softer with retail sales and industrial production growth slowing. The minutes from the most recent RBA meeting were due Monday evening.