By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Political jockeying and trade-war threats rocked the foreign-exchange market Wednesday as the NY session kicked off with a steep slide in the U.S. dollar. The meltdown in the greenback was triggered by reports that China is looking to slow or halt its purchases of U.S. Treasuries. The Bloomberg story claims that “people familiar with the matter” say Beijing officials are reviewing the country’s foreign portfolios and suggesting that the world’s largest holder of U.S. Treasuries start looking elsewhere for opportunities. China has sold Treasuries and reduced its purchases in the past (2016 in particular) but this is the strongest headline we’ve seen on the issue to date.
While these comments do not come from Beijing officially, the fact that they weren’t denied is a sign of the government’s endorsement. Trade tensions are also a motivation. China’s appetite for U.S. Treasuries has long been both a political and economic issue so there’s never a coincidence in the timing of these announcements. With the Commerce Department expected to recommend whether a steel and aluminum import tariff should be implemented – a move directed at China – this could be a politically charged decision. As the U.S. Treasury is poised to boost its debt supply significantly in 2018, if China stops buying T-bills, the bull market in bonds is officially over. Treasury prices will collapse, yields will skyrocket and the dollar will fall. As we saw on Wednesday, USD/JPY will be hit the hardest and we could easily see the pair trade down to 109, especially as short yen traders cover their positions. For the time being, however, the next stop for USD/JPY should be 111, with the move possibly extending down to the November low of 110.85.
The Canadian dollar fell 100 pips against the U.S. dollar in a matter of minutes on the back of a Reuters report that Canadian government officials believe that President Trump will pull the U.S. out of NAFTA in the very near future. Minutes later, the White House denied these claims, saying Trump has not changed his position. Also, after the initial release, Politico was told by a Canadian government official that “it is inaccurate to say that the Government of Canada is convinced that the U.S. will soon pull out of NAFTA” as progress “was made during previous rounds and the December intersessional and we expect more progress to be made in January.” You can never tell who to believe but the swift WH denial suggests that Trump is in no rush to make a decision. The next round of NAFTA talks begins on January 23. For this reason, we believe that the rally in USD/CAD should be faded, especially with crude oil at 2-year highs, the U.S. dollar weakening and the Canadian economy roaring. Technically, USD/CAD has significant resistance above current levels with the 100-day SMA capping gains below 1.2600 and the 200-week SMA hovering below this same level. So USD/CAD either holds below 1.2595 or soars up to 1.27.
In contrast, the Australian and New Zealand dollars performed well thanks to U.S. dollar weakness with NZD/USD hitting a fresh 3-month high. Australian retail sales were due Wednesday evening and the weakness in wage growth along with the softer sales reading in the PSI point to a downside surprise for the report. Economists are looking for sales growth to slow to 0.4% from 0.5% in November but we believe that the change could be more substantial.
Meanwhile, euro ended the day up against the dollar, but well off its highs while sterling traded lower. The ECB publishes the minutes from its December meeting on Thursday and we think the report will highlight the improvements in the Eurozone economy. Sterling traded lower on mixed data – industrial production numbers were stronger, the trade balance was weaker.