By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Two main themes dominated FX trade this week – U.S. dollar weakness and lower commodity prices. These do not normally come hand in hand as dollar weakness generally drives commodity prices higher. But nothing seems to matter more this week than position adjustments. There have been no major European and U.S. economic reports released so far this week and yet we’ve seen big moves in EUR/USD and USD/JPY. Year end is quickly approaching and investors who have been short euros, long dollars for most of the year are looking at their positions and wondering whether they should go flat and preserve whatever profits they may have. A month of gains has already been wiped out and the chance of the Federal Reserve doing or saying something that could take the greenback to its highs before the end of the year is extraordinarily slim.
We think Friday’s U.S. retail sales report will surprise to the upside because wages are on the rise, payroll growth last month was strong and gas prices are low. While this would help the dollar, it won’t save the rally. Consumer spending is the backbone of the U.S. economy and for most of this year spending levels have been low. One good report would not be enough to change the Fed’s mind about the pace of tightening. A weak report on the other hand would be disastrous in that it would encourage more investors to bail out of the dollar pre-FOMC. The only person that could save the dollar is Janet Yellen and we won’t hear from her until next week.
Although EUR/USD found its way back below 1.10, the only person that could end the short squeeze is Mario Draghi and right now there are no schedule speeches for the central-bank President. In the short span of a week, the single currency has risen nearly 5%, which in of itself is bad news for the Eurozone economy. But with a 10% rise in oil prices during this same period, some ECB officials may have wished that they eased more aggressively. The bright side however is that they left themselves with room to maneuver and one easy way to stop the pain would be to talk the currency down. ECB President Draghi attempted to do just that a few days ago and on Thursday morning ECB member Mersch said they could always add QE. But investors clearly want to hear more.
Investors sold the British pound after the Bank of England’s monetary policy announcement but GBP/USD ended the day off its lows. While the decision to leave interest rates unchanged was the same as the previous month with 8 members voting for and 1 against the move, the central bank expressed concerns about wage growth and fiscal constraints. The decline in oil should keep inflation under pressure and the Bank of England from raising interest rates anytime soon.
The Swiss National Bank left monetary policy unchanged. SNB head Jordan said he did not see risk of a deflationary spiral but warned that they still have firepower.
Surprisingly strong Australian employment numbers drove the Australian dollar sharply higher against all of the major currencies. Economists were looking for a loss of 10k jobs but instead added 71,400 -- the largest one-month increase in 15 years. On top of that, the unemployment rate declined while the participation rate increased. Weekly hours worked fell slightly but between the other improvements and the balance of full-time and part-time jobs, this was an extremely healthy report that reinforces the RBA’s optimism. Some analysts argue that the data may not be accurate given that the ABS is using new sampling techniques that may overstate the numbers. However even if job growth were 50% less, it would still be a strong report.
The New Zealand dollar extended higher post RBNZ. While the gains were small, they reflect the market’s assessment of the central bank’s rate announcement. The Reserve Bank cut interest rates 4 times this year and they could lower them further if the economy weakens. But for now they feel that they’ve done enough.
USD/CAD climbed to fresh 11-year highs with oil prices moving lower. 1.35 remains the key support level for the currency pair and an area that we view as attractive buy levels for a move to 1.40.