By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The decline in U.S. rates drove investors out of U.S. dollars Thursday as the greenback moved lower against most of the major currencies including the euro and Japanese yen. EUR/USD in particular performed extremely well with gains extending as high as 1.13. The move was driven entirely by 10-year treasury yields, which fell to a one-month low intraday because U.S. data was generally better than expected. The Federal Reserve’s lack of transparency is torturing the dollar and while most economists believe liftoff will begin in 2015, investors fear that Federal Reserve Chair Janet Yellen will keep the market guessing. However when the central bank last met, we felt that Yellen made her preference for raising rates this year very clear. She went so far as to say that October is a live meeting and an impromptu press conference could be held if they decide to change monetary policy. Ahead of her Thursday evening speech in Massachusetts, we were not looking for any new comments. Still, any optimism or suggestion that rates could rise next month could turn the dollar around and a recovery in the dollar is exactly what we are looking for.
The U.S. economy continues to chug along according to the latest economic reports. New home sales rose 5.7% to its strongest level since early 2008. Jobless claims ticked higher but the increase was marginal compared to the previous week and less than anticipated. The only dark cloud were orders for durable goods, which fell 2% erasing the past month’s rise. core Excluding transportation orders demand was unchanged in August. While that report raises the risk of weaker growth in the third quarter, durable goods orders can be volatile month to month and manufacturing activity has not been a major cause of concern for the central bank. Nonetheless, the fact that Fed Fund futures is only pricing in a 38% chance of a rate increase in December and a 47% chance in January, indicates there is significant misalignment between market and economist expectations. When that happens, we can see larger-than-usual market moves. Revisions to second-quarter GDP and the University of Michigan Consumer Sentiment index are scheduled for release on Friday along with Markit Economics’ Composite and Services PMI reports. These reports should have a limited impact on the dollar.
A surprise increase in German business confidence helped the euro extend its recovery for the second day in a row. The expectations component of IFO report rose to 103.3 from 102.2 in September. After the recent decline in factory orders and drop in the PMI manufacturing index, economists had been looking for business sentiment to deteriorate. While German companies grew less optimistic about current conditions, they are hopeful that economic activity will improve in the coming months as low oil prices and rising incomes bolster demand. However this report was taken before the Volkswagen (XETRA:VOWG_p) scandal and the carmaker's troubles will hurt business confidence as the auto industry is the largest industrial sector in Germany. The latest recovery in the EUR/USD was driven by less-dovish comments from Mario Draghi. But between the crash in the DAX, the VW mess and the recent weakness in PMIs, we still view EUR/USD as a better sell than buy on the 1.13 handle (ideally between 1.1350 and 1.14).
Sterling finally stabilized against the U.S. dollar after falling for 4 straight trading days. But compared to the euro and yen, the move was modest as investors take stock of this week’s softer economic reports. Aside from the deterioration in public-sector finances and industrial orders, loans for house purchases increased less than anticipated in August. We have been seeing weaker U.K. data for some time now but that has not affected the more hawkish views of U.K. policymakers who are worried about wage growth. We won’t know more about wage growth for a few weeks, but PMIs are due next week.
Japanese markets re-opened Wednesday night. As expected, manufacturing activity slowed more than forecast in September. Consumer prices were scheduled for release Thursday evening and for the first time since April 2013, core CPI growth was expected to decline, signaling that deflation has not been beat.
The best-performing currency Thursday was the New Zealand dollar. Although the country’s trade deficit ballooned in August, rising to its highest level since April 2009, investors were relieved that exports and imports did not drop as much as anticipated. Fonterra, the world’s largest dairy exporter and New Zealand’s largest company, raised its payout for farmers and signaled that further increases are likely. The dairy industry has been the main source of pain for New Zealand’s economy over the past year and that decision takes some pressure off the country’s farmers and the Reserve Bank of New Zealand.
USD/CAD climbed to a fresh 11-year high on Thursday -- above 1.34 -- before settling back on the 1.33 handle. No economic data was released from Canada and it seems that the currency pair is moving on pure momentum. oil prices stabilized Thursday after falling sharply on Wednesday.
The Australian dollar also recovered it losses to end the day only slightly lower versus the U.S. dollar. During early North American trading session, AUD/USD spent some time firmly below 70 cents. The move was driven by a fresh forecast of rate cuts from local banks. ANZ believes that the RBA could lower rates by 50bp next year on the basis that high unemployment and slower Chinese growth will necessitate further easing. However for the time being, they are the lone doves with CBA, Westpac and NAB forecasting no change in rates next year.