By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
After a tough week, the U.S. dollar rebounded against all of the major currencies, extending gains that started when U.S. markets were closed for President's Day on Monday. USD/JPY traded as high as 113.78 before settling the day just under those levels. The dollar’s dominance was seen despite softer U.S. data and a retreat in U.S. yields. Manufacturing and service-sector activity slowed in February according to Markit Economics, which pushed its Composite index down to 54.3 from 55.8 in February. The 10-year Treasury yield rose over 4bp before retreating from its highs. yet none of that mattered as investors focused on last week’s important data surprises and optimism from Fed Chair Janet Yellen. This week’s relatively light U.S. calendar leaves the focus on Fed speak. Fed President and FOMC voter Harker said he sees 3 rate hikes this year, Williams said historically low rates will persist (he is not a voting member of the FOMC) while Kashkari refrained from making specific comments on the economy and monetary policy. Nonetheless, there’s no doubt that the Federal Reserve is confident about the economy, so much so that a March hike is on the table. With no major U.S. economic reports on the calendar this week, the main question before us is whether Wednesday’s FOMC minutes will give the dollar the kick it needs to propel higher. We know that the Fed plans to raise interest rates, but the tone of the last FOMC statement was more cautious than Janet Yellen’s semi-annual testimony so the minutes could provide a nudge but not necessarily the swift kick up that the bulls are waiting for.
Meanwhile, Tuesday's worst-performing currency was the euro, which is pressured by election uncertainty. French Presidential Candidate Marine Le Pen is leading in some polls and Dutch candidate Wilders’ is also making strong inroads ahead of elections in April and March. Investors are nervous about the anti-EU sentiment of these candidates and with the Dutch elections fast approaching next month and new opinion polls showing Le Pen ahead, everyone is worried that a Le Pen victory would mean that France would start talking about leaving the European Union. The fear is that Europe will become even more fractured in the coming years, as anti EU, populist sentiment spreads across the region. However for the time being the weaker euro is still supporting the economy according to the latest PMI reports. Manufacturing and service-sector activity is up in the region led by gains in Germany. These improvements bode well for Wenesday’s German IFO business confidence report. Even if the report is firmer, political concerns and U.S. dollar strength should cap gains in the currency.
Sterling was the only currency that outperformed the greenback Tuesday and its strength can be mostly attributed to EUR/GBP selling because data was weak. The country’s public finances fell sharply, declining by 26.5b in January, a far cry from the 36.3b the previous month. Central Government NCR also saw similar deterioration with figures showing a drop of 27.8b vs. 19.3b the previous month. Public sector net borrowing fell -9.8b but was better than the -14.5 number forecasted. On top of that, Governor Carney failed to provide any encouragement in his speech on Tuesday. The central-bank head said rates may rise faster OR slower than market expects and attributed the entire CPI overshoot to a weaker currency. A similar view was shared by BoE member Haldane, suggesting that policymakers are very comfortable with keeping monetary policy steady for the time being. Revisions to fourth-quarter GDP numbers are scheduled for release Wednesday.
All 3 of Tuesday's commodity currencies traded lower against the greenback. AUD held up the best while NZD and CAD tumbled about the same amount. RBA Governor Lowe spoke Tuesday evening and sounded relatively upbeat, noting that households are coping reasonably well with high debt levels. He also expressed satisfaction with the direction of the labor market and the current inflation target. This tone is consistent with the cautiously optimistic central-bank minutes. According to the report, the unexpected pullback in GDP was mostly attributed to seasonal factors. Household consumption has been subdued to due lack of income growth but retail sales volumes continue to show improvement. GDP forecasts remain consistent at 3% for 2017. Employment for the region has also improved with more full-time employment than the previous period. However, the labor market still has room to fill, with “spare capacity” seen for Australia according to the minutes. The New Zealand dollar was hit hard by a 3.2% drop in dairy prices -- although losses were limited by the stronger service PMI and producer price reports released on Sunday evening. NZD has fallen hard over the past month and appears to have found some support above 71 cents. The Canadian dollar shrugged off a rise in oil prices to end the day lower. Oil prices rose on reports that OPEC secretary general Barkindo said that participation in agreed production cuts among the cartel has been above 90%. Barkindo hopes for even more compliance in the future and confirmed that cartel members remain firm in their stance on continued production limits. Canada is the only commodity-producing country releasing market-moving data Wednesday, with retail sales on tap.