By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- What it Takes to Drive USD/JPY to 125
- AUD Jumps More than 2% on RBA
- NZD Shrugs Off 9% Drop in Dairy Prices
- CAD: Supported by Rebound in Oil
- GBP: Looking Ahead to PMI Services
- Euro Shrugs Off Major Losses for Greek Stocks
What it Takes to Drive USD/JPY to 125
It is no secret that most investors are bullish dollars but in the last 2 weeks, the greenback has struggled to extend its gains. After failing to close above 124.50 on Thursday, investors are wondering if 125 will mark the top for USD/JPY. This week’s economic reports have been mixed with factory orders growing strongly (1.8%) and investor confidence slipping according to IBD. On Monday, we learned that manufacturing, construction activity and personal spending growth slowed while income growth was slightly higher, though only after a downward revision in May. At the same time, Prime Minister Abe Advisor Honda said overnight that there is no need for further easing from the Bank of Japan. These forces have limited the rise in USD/JPY and given how quickly and aggressively the dollar appreciated since the beginning of the year, a sharp rise in Wednesday’s ISM non-manufacturing index and Friday’s labor-market report is needed to not only drive USD/JPY above 125, but to keep it there. Unfortunately, the chance of a downside surprise is just as high as an upside surprise. We are still waiting for a number of important leading indicators for non-farm payrolls to be released in the next 48 hours but the drop in confidence and dip in manufacturing activity is worrisome.
To be clear, job growth in July will be strong but the main question is whether it -- along with average hourly earnings growth -- will be strong enough to drive investors to buy dollars. A resounding 'yes' is needed on both fronts for USD/JPY to break and hold above 125. The importance of the non-farm payrolls reports has been heightened by the Federal Reserve’s focus. At the last meeting, the central bank signaled that rates would only rise in September if some additional improvement were seen in the next two labor-market reports. Thankfully, jobless claims have been very low and as long as they did not spike sharply last week, it would be consistent with a continued improvement in the labor market. The dollar was unchanged-to-weaker against most of the major currencies Tuesday as investors brace for Wednesday ISM non-manufacturing and ADP reports.
AUD Jumps More than 2% on RBA
Tuesday's best-performing currency was the Australian dollar, which rose more than 2% against the greenback on an intraday basis. That was the strongest one-day rally for the pair in more than 2 months and the breakout opens the door for a test of 75 cents. The market was completely caught off guard because given the weakness in the Chinese economy and the decline in commodity prices, everyone thought that not only would Australian data be weak but the Reserve Bank would grow increasingly dovish. Instead, both the trade balance and retail sales surprised to the upside. In fact consumer spending rose 0.7% in June. However it was the RBA statement that really drove the Australian dollar higher. According to our colleague Boris Schlossberg, “Rather than repeating the phrase “Further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices,” the RBA instead noted that “The Australian dollar is adjusting to the significant declines in key commodity prices.” The shift in posture to a much less aggressive stance vis a vis currency devaluation convinced the market that the RBA may consider current levels to be fair value for the currency right now.” Tuesday’s rally in AUD/USD was driven primarily by short covering. According to last week’s CFTC data, speculators held the largest amount of short sterling contracts since March 10 while leveraged funds had the largest net AUD short positions in 8 months. The Canadian and New Zealand dollars also increased in value as oil prices stabilized and the decline in dairy prices eased. However we are skeptical of the strength of NZD because even though dairy prices fell by 9.3% Tuesday versus 10.7% at the last auction, it was still the second-largest drop in prices since April. NZD should be trading lower as these declines negatively impact the economy. The only explanation for the currency’s resilience is the possibility of stronger labor-market numbers Tuesday evening. Aside from NZ employment, Australian and Chinese Service sector PMIs are scheduled for release along with Canada’s trade balance.
GBP: Looking Ahead to PMI Services
Sterling continued to consolidate against the U.S. dollar as the hawkish monetary policy biases of both the BoE and Fed kept GBP/USD trapped in a range. Tuesday morning’s softer construction sector PMI report failed to have a significant impact on the currency due in part to the uptick in house prices. For the U.K., service sector activity is the most important and while economists are looking for slower growth, the stronger PMI manufacturing index signals the potential for an upside surprise. Given the significance of this week’s event risks, especially on “Super Thursday,” there’s a very good chance that the 1.5467 to 1.5690 trading range will break. We are looking for an upside break but expect sterling to see its strongest gains against non-dollar currencies.
Euro Shrugs Off Major Losses for Greek Stocks
So far this week, the focus has not been on the euro. The currency has been trading in a relatively tight range and with Greek stocks falling only 1.6% Tuesday, the country’s debt crisis has been more of an afterthought for investors this week. Eurozone producer prices also failed to hurt the euro, which ended the North American trading session unchanged against the greenback. PPI declined 0.1% in June, which was consistent with the drop in German PPI. Although Eurozone retail sales are scheduled for release Wednesday along with revisions to service sector PMIs, how EUR/USD trades will largely be dictated by U.S. data. For the most part we expect the currency pair to drift between its 1.08 to 1.1050 trading range.