By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It was a crushing week for the U.S. dollar. The greenback sold off against most of the major currencies reaching multi-week lows versus the euro, British pound, Japanese yen, Swiss franc and Canadian dollar. On a percentage basis, the losses were capped at about 2% yet what made the dollar's downtrend so significant was its relentlessness. USD/JPY and USD/CAD did not experience one day of gains while EUR/USD marched higher without a correction until Friday. Although the U.S. economy is outperforming its peers and the Federal Reserve is the only major central bank not in easing mode, investors expected more. They had driven up the dollar last month after the recovery in nonfarm payrolls and on the back of hawkish Fed comments, which revived hope for a 2016 rate hike. But after the surprise stagnation in retail sales, investors grew skeptical of the central bank’s resolve so even though most of this past week’s economic reports were better than expected, all of them were viewed with skepticism. This includes FOMC voter Dudley’s comment that rates could still rise in September and the hawkish FOMC minutes.
In the week ahead, there’s not much in the way of market-moving U.S. data. New and existing home sales are scheduled for release along with Markit Economics’ PMI surveys, revision to Q2 GDP and the University of Michigan Consumer Sentiment Index. The main focus will be Janet Yellen’s speech at Jackson Hole on Friday. The selling pressure in the dollar is strong and for sentiment to change, we need Yellen to say that a rate hike is coming and we also need another unambiguously strong nonfarm payrolls report. Even then, there’s zero chance of a rate hike in September or November. December though is open for discussion, especially since it is a meeting where the Fed releases its latest economic projections and Janet Yellen delivers a press conference. If they're going to raise rates this year, it will happen then, days before Christmas when Americans are well into their holiday shopping.
Unfortunately there’s still 4 months before the December meeting and there’s zero chance the Fed will raise rates in September or November. So in order for the dollar to bottom, we need overwhelmingly positive data. Until then, USD will continue to fall, consolidate for the next week or experience shallow bounces. USD/JPY is still struggling around 100 and while a move to 101 is possible, the chance of a new August high above 103 is unlikely. Also, we could see numerous attempts below 100. At the end of the day, we believe the June low of 99 will hold, but USD/JPY has set a new lower range.
One of the biggest risks this year was Brexit and even though it continues to be a sore topic, one of the main things that we learned this week is that the damage so far to the U.K. economy has been limited. At the beginning of the week, many investors feared that the first set of post-Brexit data would be very weak and while they were right with regard to house prices, they were wrong every where else. U.K. consumer prices rose more than expected year over year, jobless claims declined, average hourly earnings increased and retail sales jumped 1.4% in July. The Brexit-induced weakness of the currency played a major role in boosting price pressures, attracting tourism and fueling spending. However at the end of the week, UK Prime Minister May said Article 50 would be invoked by April 2017, which sent GBP/USD tumbling. The U.K. calendar is light in the week ahead, meaning that headline could have a greater effect on the pound.
In contrast to the U.S. and U.K., there’s quite a bit of market-moving data from the Eurozone next week. This includes the August PMIs, German IFO report and revisions to second-quarter GDP. So far, data from the Eurozone has been relatively healthy and regional officials have expressed their optimistic view that the impact of Brexit will be limited. Considering that U.K. PMIs took a nosedive recently, investors will be watching the Eurozone PMIs carefully. EUR/USD enjoyed a very strong rally this week and there’s no major resistance until the pre-Brexit high of 1.1425. But if the currency pair finds itself back below 1.13, a deeper correction to 1.12 is likely.
After selling off for 9 days straight, USD/CAD finally rebounded Friday on the back of weaker-than-expected economic data. Retail sales dropped 0.1% in June while consumer prices fell 0.2% – both releases were significantly weaker than expected. We believe USD/CAD has bottomed but at the end of the day, CAD's fate is tied to oil. Now that the commodity is trading above $48 a barrel, the next stop could be $50. The recent reversal in oil is driven by the hope that the Saudis will convince their peers to cut production at next month’s informal OPEC meeting. Considering that there’s still weeks to go before that gathering, oil's rise is bound to lose momentum -- and when that happens, it will mark a near-term bottom for USD/CAD. There are no major economic reports scheduled for release from Canada next week.
Meanwhile, the worst-performing currency this week was the Australian dollar, which lost value against all of the major currencies -- including the U.S. dollar. The RBA minutes were uninspiring and their labor-market report ambiguous. The RBA expressed concerns about the elevated AUD and the issues it would cause for the transition from the mining book but added that low inflation should help growth. There were no hints on whether rates will fall again. In terms of the labor market, job growth was strong enough to push the unemployment rate lower but all of the work gained was part time with full-time jobs seeing the largest decline in 3 years. In contrast, New Zealand reported very healthy labor data and a sharp 12% rise in dairy prices. This divergence helped to drive AUD/NZD to its lowest level in nearly 3 weeks. Looking ahead, there are no major economic reports scheduled for release from Australia and only the July trade balance from New Zealand. Technically, both AUD/USD and NZD/USD are near a peak and with the greenback expected to move sideways before Yellen’s speech on Friday, we may not see much more upside momentum.