By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Now that the holidays in Asia and North America are behind us, currencies are once again on the move. The relief rally in USD/JPY was short-lived with the greenback resuming its slide ahead of the FOMC minutes. The big story last week was the meltdown in global equities and the diminishing chance of a Fed rate hike in March. In fact investors are no longer pricing in another round of tightening in 2016 according to Fed fund futures. This week, we expect the FOMC minutes to remind investors that a rate hike next month is extremely unlikely, which could be just the excuse that FX traders need to sell the dollar again. Despite the uptick in consumer spending, the recovery in the U.S. economy is losing momentum with the strong dollar hurting manufacturing activity and corporate profitability. The Empire State manufacturing Index came in much weaker than expected, printing at -16.64 versus a -10 forecast. Wednesday’s economic reports are only expected to show small improvements. As for the FOMC minutes, it's important to remember that every single change the Federal Reserve made to last month’s monetary-policy statement was negative for the dollar. They described growth as slowing late last year, pointed to weakness in inflation and warned that they are closely monitoring global economic and financial-market developments.
Meanwhile, OPEC’s decision to freeze production tells us that oil has finally reached cringe-worthy levels. Tuesday’s announcement should have been positive for a commodity that has fallen more than 50% over the past 3 months, but investors expected more after the UAE’s comments last week. The energy minister of the United Arab Emirates sparked hopes of a production cut when he said OPEC nations are willing to talk about reducing output. But Tuesday’s announcement indicates that no one is willing to give up market share. In other words, the decision to freeze output eliminates any near-term chance of the market getting what it really wants – a coordinated reduction in output that could finally cement a bottom in oil. While we believe that a bottom is already in place at $26 a barrel, there could be another dip in before a slow recovery. For currencies, this means that USD/CAD could trade through to 1.3900 before making another run lower.
The euro continues to be incredibly resilient in the face of ECB dovishness and weaker data. On Monday, ECB President Draghi took the opportunity to remind us that they are prepared to ease if market turmoil weakens price stability. On Tuesday morning, we learned that investor confidence dropped to its lowest level since October 2014. Both the current and expectations component of the ZEW survey fell sharply in February. Of course this should come as no surprise because the stronger euro, market volatility and meltdown in European equities will have most certainly weighed on sentiment. However EUR/USD continues to hold above its former 1.1050 resistance level. The demand for euros comes primarily from short-covering flows as euro continues to behave as a funding currency.
Sterling also experienced steep losses Tuesday on the back of weaker inflation data. U.K. consumer prices dropped -0.8% in January, which was worse than expected and significantly weaker than the previous month. On an annualized basis, CPI growth accelerated to 0.3% from 0.2% (far short of the central bank’s 2% target). But core CPI yoy growth rates slowed to 1.2% from 1.4%. Lower price pressures add to the market’s concerns about a Brexit. Mr Cameron is headed to Brussels again for EU membership discussions and investors have sold sterling in anticipation of negative headlines.
While calmer Chinese markets helped prevent steeper losses in currencies and equities, we are still in risk-off mode in the forex markets with the New Zealand dollar experiencing the second-sharpest decline behind USD/JPY. Aside from weaker service-sector activity and retail-sales growth, we learned Tuesday morning that dairy prices fell another 2.8% -- the fourth time in a row that prices settled lower. The New Zealand dollar did not react to the last decline but it may be difficult for the currency to ignore this one -- especially after the recent disappointments in data.
At the same time, the Australian dollar held up comparatively well after the Reserve Bank of Australia meeting minutes offered nothing new. While the central bank was concerned about low inflation, it also pointed to improvements in the domestic economy. Everything we have heard from the RBA in recent weeks indicates that it's in no rush to ease monetary policy, which helps the currency, as does the People’s Bank of China’s pledge that it will use various tools to maintain adequate liquidity.