By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Wednesday an incredibly active day in the foreign-exchange market with many major currencies experiencing big moves. The focus was on the British pound, Japanese yen and Canadian dollar as there was zero consistency in the performance of the greenback. The U.S. dollar strengthened versus the GBP, AUD and NZD but weakened against JPY, CAD and CHF. The latest economic reports show the U.S. recovery losing momentum but there are more pressing problems abroad. New Home Sales may have fallen more than expected as service-sector activity contracted for the first time in 28 months according to Markit Economics but the impact on the dollar was limited by the data’s influence on Fed policy. According to the latest comments from U.S. policymakers, the Fed is far more worried about market volatility than the direction of the economy. Most Fed Presidents still feel confident that the recovery will gain momentum, but market developments tightened financial conditions making it increasingly difficult for the Fed to justify raising interest rates next month. For the Fed to move forward with tightening, it's not data but the markets that need to stabilize. So don’t expect much reaction to Thursday’s jobless claims and durable goods reports.
The British pound dropped to its weakest level in nearly 7 years Wednesday against the U.S. dollar. EUR/GBP climbed to a 1-year high while GBP/JPY dropped to a 2-year low. Growing concerns about Brexit pressed sterling lower for the third consecutive trading day. Although the latest polls still point to marginally more people in favor of staying in the European Union, U.K. corporates and investors are planning for the worst by hedging the downside in sterling through spot, forwards and options -- especially now that 1.40 has been broken. When it comes to panic selling around an event with significant impact on U.K. businesses, the economy and the country’s legacy, the currency could fall more quickly and aggressively than most of us could imagine. With GBP/USD trading below 1.40, the next support level is not until the March 2009 low of 1.3656, which is almost 2% below current levels. There’s no major resistance in EUR/GBP until 80 cents. Revisions to fourth-quarter GDP is scheduled for release on Thursday but no changes are expected.
USD/JPY also extended its slide Wednesday coming within 6 pips of its 15-month low. Anywhere between 111 and 111.50 is intervention territory for the Bank of Japan. They may not opt for verbal over physical intervention at the onset, but some attempt to stop the yen from rising will be made if the pair remains below 112. Many Japanese corporations are hedged for the year at 115 USD/JPY, which means they are already underwater on their positions. A slide toward the 110 level would be catastrophic for profits. We’ve already seen the Japanese government check rates between 111 and 111.60 and we think that’s the line in the sand. As an export-dependent nation, the Japanese need a weak yen to survive. The 2-year U.S.-Japanese bond-yield spread continues to point to a stronger USD/JPY while speculative positioning shows the largest short USD/JPY positions since June 2012 -- a position that attracts BoJ intervention. In other words, unlike sterling where we expect further losses, we believe Wednesday’s 111 low in USD/JPY is not far from the bottom. We fully anticipate an active Asian trading session with a flurry of comments from Japanese officials attempting to halt the rise in the currency and perhaps even more.
Meanwhile, oil remains the primary driver of USD/CAD. At the start of the North American trading session, oil prices were down 3% and USD/CAD was trading closer to 1.3850. By the end of the day, oil closed up 1% and USD/CAD dropped toward 1.3700. Oil's reversal was sparked by the weekly oil inventory report, which showed an increase in refined products. Although crude-oil stockpiles hit a fresh record high this week, supplies of refined products fell, catching investors by surprise because they had anticipated the increase in inventories. Either way, the outlook for oil hasn’t changed and we continue to look for oil to make another move below $30 a barrel and for USD/CAD to rally. Bank of Canada member Schembri spoke Wednesday and while he did not touch on monetary policy, he said Canada’s risks are generally much lower than other countries. These comments contributed to CAD's bounce.
The 1.10 level has proven to be extremely magnetic for EUR/USD. After falling to a low of 1.0957 before the NY open, the currency pair ended the day right around this key level. Wednesday’s sell-off was driven almost entirely by Brexit concerns because Britain’s exit from the European Union would undoubtedly cause uncertainty for the Eurozone economy and volatility for European markets. However Brexit is not the only reason why euro should remain under pressure in the coming weeks. Bundesbank President Weidmann -- who has often resisted more stimulus from the ECB -- said Wednesday morning that “it is clear developments warrant stimulus review,” adding “ECB policy must be powerful and effective.” While he warned that any measures mustn’t be counterproductive, it is becoming increasingly clear that one of Europe’s most influential monetary official is open to the idea of more easing.
Finally, the New Zealand and Australian dollars ended the day unchanged against the greenback. Both currencies bounced off their lows as U.S. stocks turned positive. Australian skilled vacancies and wage prices were released overnight with no major surprises. On Thursday evening, New Zealand trade numbers are scheduled for release and given the rise in the manufacturing PMI index, an upside surprise is possible.