By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The rally in the U.S. dollar unwound quickly Wednesday after President Trump disbanded his two business councils. The CEOs of Merck (NYSE:MRK), Intel (NASDAQ:INTC), Under Armour (NYSE:UA), American Axle & Manufacturing (NYSE:AXL), Campbell Soup (NYSE:CPB), 3M (NYSE:MMM) and Johnson & Johnson (NYSE:JNJ) have left the group following Trump’s response to the violence in Charlottesville. More would have probably followed if the whole panel wasn’t shut down to avoid further embarrassment. The president is losing his coveted support from business leaders in what is yet another blow to a weakening administration that has been too busy deescalating the tension created by Trump’s controversial remarks to focus on policy. Recent developments could also cost him the support of key GOP leaders. Regardless of where you stand on this, there’s no doubt that all the geopolitical uncertainty and domestic division recently created will distract from and slow the administration’s progress on fiscal stimulus, a critical element to continued growth. The sell-off in the dollar also gained traction after the FOMC minutes were released. While most policymakers back a balance-sheet move at an upcoming meeting, their view that inflation will remain below 2% for longer than expected suggests that the central bank may wait until 2019 to raise interest rates again. That’s certainly what Fed fund futures show with the odds of a rate hike falling to 33.6% from 43.8% on Tuesday. While USD/JPY did not break below 110, this level could come under attack again as good data is quickly overshadowed by Trump’s twitter tantrums.
The sell-off in the U.S. dollar proved to be particularly positive for high-yielding currencies like the Australian and New Zealand dollars. AUD and NZD erased all of this past week’s losses to end the day up approximately 1% versus the greenback in what was the strongest one-day rise for both currencies over the past 3 weeks. No economic reports were released from either country but base metal prices rebounded. Australian labor-market numbers were due for release Wednesday evening and stronger numbers could take AUD/USD well above the 20-day SMA near 0.7930. According to the PMI reports, major employment gains were seen in the manufacturing, service and construction sectors, so there’s a very good chance that we’ll see another strong labor-market report. New Zealand, on other hand, will probably report softer producer prices after the unexpected slowdown in CPI growth.
It was also a good day for the Canadian dollar, which soared against the greenback. USD/CAD’s 1% decline was the strongest one-day decline in 2 months. Despite lower oil prices and Canadian bond yields, the loonie benefitted significantly from U.S. dollar weakness. These 2 factors should have driven CAD lower but at the end of the day, the Bank of Canada has been more eager to raise interest rates than the Fed thanks to consistent improvements in Canadian data. CPI is scheduled for release on Friday and given the rise in the price component of IVEY PMI and the central bank’s hawkishness, inflation should have recovered. Technically, strong days like the one we saw Wednesday in USD/CAD tend to have continuation. At minimum, we are looking for a move down to 1.26 with the possibility of a stronger slide down to 1.25. USD/CAD has also closed below the first standard deviation Bollinger® band, which is a strong sign of reversal.
While EUR/USD ended the day in positive territory, it spent most of the NY trading session under water. It wasn’t until the dollar began to sell off that the euro climbed back above the 20-day SMA. There were early reports that ECB President Draghi will not make a major policy announcement at Jackson Hole next week and the thought is that he will reserve the big decisions for his home turf. If true, then the delay should lead to a deeper near-term correction in the euro as it means that balance-sheet changes won’t be announced until the September ECB meeting. The rally in sterling, on the other hand, is fully justified. As we wrote in yesterday’s note, U.K. PMIs pointed to stronger labor-market conditions and that was exactly what we saw in Wednesday’s report. Jobless claims fell the first time in 5 months and more importantly, wage growth accelerated. But before getting too excited, retail sales are due for release Thursday and the decline in shop prices along with the drop in the BRC retail sales monitor means that sterling’s rally could be sapped by a softer report.