By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Tuesday's biggest forex story was the euro's strong rally. The single currency broke above 1.10 and came within a few pips of 1.11. Stronger-than-expected Eurozone data contributed to the move but the 1.10 break occurred well before the first releases. Euro is still coasting on Emmanuel Macron’s victory and the strong possibility that Angela Merkel will be reelected as Chancellor in the fall. Despite the ECB’s dovishness, data 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. The euro also received help from the German–U.S. yield spread, which moved sharply higher in the past week. As our colleague Boris Schlossberg pointed out, political risk drove EUR/USD lower in April and now that this risk has been removed, we could see stronger gains in the currency, especially since the CFTC data last week showed speculators turning bullish for the first time since 2014. And that means there’s room to the upside and on a technical basis, we see no major resistance for EUR/USD until 1.12.
The U.S. dollar is losing serious momentum and all it took was a little patience to see USD/JPY join the selling. An unexpected decline in housing starts and building permits in April triggered the initial wave of selling, which gained momentum after options expired at 10am NY Time. But not all of Tuesday's U.S. economic reports were weak, as industrial production increased, and at some point, the general trend of downside surprises would be too much for the dollar and Tuesay was the day that the bulls decided to liquidate. USD/JPY dropped below 113 as 10-year yields declined. But the fact that USD/JPY did NOT close below 113 in a meaningful way is significant and suggests that for now, the uptrend remains intact. The bulls still don’t want to give up control but as more data disappoints, their conviction will weaken. We need to see USD/JPY move well below the 100-day SMA at 112.90 to open the way for further selling down to 111.95. There are no major U.S. economic reports scheduled for release Wednesday, so USD/JPY traders will need to take their cue from yields. But the current momentum suggests that the path of least resistance is lower.
Sterling also traded higher against the greenback but it took a lot of convincing to bring the buyers in because Tuesday morning’s inflation numbers failed to do the trick. Consumer prices rose 0.5% in April, which was slightly firmer than economists had anticipated. This drove the year-over-year rate to 2.7% from 2.3%, the highest level since September 2013. Core prices also rose 2.4%, up from 1.8% the previous month. GBP/USD popped to 1.2958 on the back of the report but quickly sank back below 1.29 as investors recalled the central bank’s comment that the increase in inflation won’t last because it is caused entirely by sterling's weakness. However as the dollar sold off, sterling was driven higher and by the end of the North American trading session, GBP/USD closed well above 1.29. U.K. labor data is scheduled for release on Wednesday and this is another report that could spur demand for the currency. Unlike inflation, which the market can discount, employment is sticky. According to the PMIs, manufacturing, service and construction saw very strong job growth in April. Average weekly earnings are also expected to rise significantly but excluding bonuses, wage growth is expected to slow. In many ways, earnings will be more important than the absolute amount of job growth. If the data is good as we expect, we could see another move toward 1.30. But if it's soft, it will sink back down to 1.2850.
The Canadian and Australian dollars extended their gains against the greenback while the New Zealand dollar consolidated near its recent lows. All eyes are on USD/CAD, which is forming a top. There’s no specific catalyst outside of U.S. dollar weakness and a mild recovery in oil. Crude prices actually fell Tuesday, confirming the rejection of $50. Canadian yields ticked lower and yet the oversold loonie was bought by speculators looking to unwind their long USD/CAD positions as the currency pair broke through important support levels. A move to 1.35 now appears likely though it would be driven more by positioning than fundamentals. The minutes from the last Reserve Bank of Australia meeting had very little impact on AUD. The RBA is cautious but the Australian dollar was driven higher by a weaker U.S. dollar. The New Zealand dollar lagged, despite another rise in dairy prices. Producer prices were due Tuesday evening and an increase is expected after the sharp rise in CPI.