By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
In quiet summer months, less liquidity can often mean greater volatility for the foreign-exchange market. We saw a classic example of that in Tuesday’s movements with the euro enjoying its strongest day in more than a year. The gains were broad-based with EUR/USD rising to its highest level in 9 months. EUR/JPY also reached an 11-month high while EUR/GBP came within 5 pips of making a new 7-month high. Janet Yellen’s speech in London was suppose to be the focus of the day but ECB President Draghi stole the show early on when he said they may change policy to keep stance unchanged. In other words, he’s suggesting that the ECB could soon move from their current accommodative stance to a neutral one. German and French yields leaped higher in response, taking EUR/USD up with it. In light of positive Eurozone data, few can question Draghi’s optimism and for this reason, the move in EUR/USD could extend as high as 1.15. With that in mind, it is also important to realize that a large part of the rally can be attributed to short covering and that flow will start to ease as sellers turn into buyers. Wednesday’s pending home sales and trade balance reports are not expected to have a significant impact on the dollar.
The U.S. dollar raced above 112 ahead of the Janet Yellen’s talk in London but came off its highs as the Fed Chair failed to strongly reinforce her hawkish bias. Yellen simply said she's made it clear rates will rise very gradually and that a gradual rate-hike pace is well anticipated by the markets. These carefully worded comments combined with a delayed health-care vote prevented USD/JPY from extending higher but as the greenback eased back against other currencies, its losses versus the yen were limited by the hawkish comments made by Fed officials earlier in the day. More specifically, Fed Vice Chair Fischer lamented about the risks of high asset prices and noted the uptick in risk appetites. This suggests that he supports raising interest rates again to bring equity P/E ratios off their highs, as he feels they are near the top of historical levels. It is now becoming clear that all 3 members of the Fed’ leadership (Yellen, Fischer and Dudley see merit to raising rates again in 2017). Fed Presidents Harker (voter) and Williams (non-voter) also share their view as the Harker said point-blank that he still backs another rate increase in 2017 and Williams noted that the U.S. has regained, even surpassed, full employment. So while the IMF has chosen to cut its growth forecasts for the U.S. this year and next, U.S. policymakers reinforced their optimistic views for the economy, which is why we believe a pullback in USD/JPY should be limited to 111.50.
The moves in sterling were less uniform. While the currency rose strongly against the Japanese yen, U.S., Australian and New Zealand dollars, it lost value versus the euro and Swiss franc. The Bank of England increased its capital requirements for banks Tuesday by 0.5% with another 0.5% hike scheduled for November. The move was aimed at ensuring stability in the financial sector as the U.K. moves to leave the European Union. Carney still views Brexit as a major risk for the financial sector and the economy. It will be interesting to see if this move satisfies the hawks who have been calling for an immediate rate hike since it takes money out of the banking sector. Sterling also benefitted from the fact that Carney did not say anything dovish and from the stronger CBI Distributive Trades Survey, which showed sales rising in June. Carney speaks again on Friday along with ECB President Draghi, Bank of Canada Governor Poloz and Bank of Japan Governor Kuroda.
BoC Governor Poloz’s speech will be the most interesting since Draghi and Carney just spoke. The Canadian dollar rose to its strongest level in nearly 3 months versus the greenback in anticipation of hawkish comments. Oil prices also rose 2%, supporting the move in the loonie. On a technical basis, USD/CAD has broken through many support levels and appears poised for a move to 1.30. However given how far it has fallen in the past month and a half, even a hint of caution from Poloz and the USD/CAD could U-turn back to 1.33. The Australian and New Zealand ended the day unchanged versus the buck but NZD underperformed AUD as the country’s trade surplus shrank to 103 million from 536 million in May. Although disappointing, the drop came entirely from a rise in imports as exports also increased.