By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar is on a tear but its gains may not last. Tuesday’s dramatic USD recovery left many investors confused because the move was fueled by minimally antagonistic comments from President Trump on North Korea and the hope of a major tax announcement. However as we saw on Wednesday, Trump was back on twitter: “The U.S. has been talking to North Korea and paying them extortion money for 25 years. Talking is not the answer.” He also talked tax reform in Missouri but aside from repeating his desire to see changes in the tax code and corporate-tax rates lowered, there was very little detail on “how” this would be accomplished. In other words, no real progress has been made on tax reform. So that leaves North Korea tensions, the debt ceiling debacle, the pace of Fed tightening, Friday’s nonfarm payrolls and the general trajectory of the U.S. economy as the main drivers for the dollar. Most of these pose serious threats to the greenback if they boil over and that’s where the question mark lies. Right now, investors are riding high after better-than-expected U.S. data. ADP reported the largest private payroll growth in 5 months. Economists expected U.S. companies to add fewer jobs in August but instead they added 237K, which was much stronger than the market’s 185K forecast. Second-quarter GDP was also revised up more than expected to 3% from 2.6% on the back of healthier personal consumption. How the dollar trades now rests on Friday’s nonfarm payrolls but before we get to that, we have personal income, personal spending, jobless claims, the Chicago PMI and pending home sales scheduled for release. In the near term, 110.50 is the level to watch because if USD/JPY trades above that level, the next stop will be 111.15.
Euro broke below 1.19 on the back of the rising dollar. Buyers are looking at Wednesday’s stronger Eurozone economic confidence and German inflation data as reasons for why the European Central Bank will announce plans to taper next week. Consumer price growth in Germany accelerated to 1.8% from 1.5% in August, a sign that the central bank is making substantial progress in boosting price pressures. There’s some talk that the ECB could opt for a dovish taper next week to avoid driving the euro higher and while that may be true, if the U.S. jobs report disappoints on Friday, we could see EUR/USD back above 1.20 pre-ECB. For the time being, euro is still vulnerable to additional losses, especially with the PMIs signaling weaker labor-market activity in August. The next level of support for EUR/USD is at 1.1850 and more importantly, 1.1810.
Unlike euro, sterling held up well in the face of U.S. dollar strength and this resilience triggered a massive reversal in EUR/GBP. Brexit may be on everyone’s minds but data from the U.K. was healthy with shop prices falling at a more moderate pace in August and mortgage approvals rising by the largest amount since March 2016. With that in mind, U.K. consumer credit grew at its slowest pace since April 2016, which is a sign of weakness. The most important event risk for the U.K. this week comes on Friday when the manufacturing PMI report is due. The sharp rise in the CBI index reflects stronger manufacturing activity and if the PMI report confirms that, we could see EUR/GBP back down at 91 cents.
All three of the commodity currencies traded sharply lower on Wednesday, which allowed USD/CAD to clock in as the day’s best-performing currency pair. Although Canada reported a better-than-expected current account balance, the continued decline in oil prices plus USD's rise provided USD/CAD traders with the perfect excuse to take profits on the strong move. In the last 4 months, USD/CAD dropped from a high of 1.38 down to 1.24 and the speed of that move invites short covering and profit taking. Wednesday’s rally has taken USD/CAD to the 20-day SMA but given how quickly the pair has declined, we can see the move extending as high as 1.2700 before USD/CAD meets serious resistance. Thursday’s Canadian GDP report could be the perfect catalyst to take USD/CAD above its 20-day SMA as weaker retail sales and trade balance points to a softer release. The only wrinkle is that expectations are already very low with economists looking for only 0.1% growth in June versus 0.6% in May.
Wednesday's second-worst-performing currency was the New Zealand dollar, which nose-dived on the back of dovish comments from the Reserve Bank. Central-bank governor Wheeler said “a lower New Zealand dollar is needed to increase tradables inflation and help deliver more balanced growth.” Data wasn’t terrible with building permits falling at a more moderate pace in July. The same was true in Australia where building approvals fell less than anticipated. However both currencies appear poised for further losses with AUD/USD eyeing the August low near 0.7845 and NZD/USD aiming for 0.7130. There’s also a major head-and-shoulders pattern that could be at the cusp of breaking. The neckline is at 72 cents so if NZD/USD selling accelerates, we could see a much stronger move that could take the pair as low as 70 cents.