By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Dollar - Fed Minutes Confirm 2015 Liftoff
- Double Top in Euro
- Sterling Soars on M&A Flow
- USD/CAD Bounces as Oil Drops 6%
- AUD, NZD Extend Gains
Dollar - Fed Minutes Confirm 2015 Liftoff
The U.S. dollar did not end Wednesday higher against all of the major currencies but it turned positive or recovered part of its losses after the FOMC minutes. According to the notes from the last Federal Reserve meeting, central bank officials favored raising rates later this year because of falling oil prices and a strong dollar. Normally a delayed rate hike could be perceived as dollar bearish but the minutes confirmed that the central bank plans to tighten this year with the policy committee "split" on raising rates in June, which would have been a very aggressive move. We have long believed that the Fed will hike this year, driving the dollar to fresh highs. Slowly but surely, sentiment is finally shifting our way again and we continue to look for further gains in the dollar. There were no additional U.S. economic reports released Wednesday but we did hear from 2 voting members of the FOMC -- Powell and Dudley. As a centrist, Powell said he supports a rate hike later this year with June a potential date for the rate rise. He argued for a gradual increase in rates because the "unemployment rate probably understates the amount of slack remaining in the labor market." He also sees greater risk of damaging the economy with a premature rate increase, but nonetheless he supports a hike in the coming months. Dudley, on the other hand, is one of the most dovish members of the FOMC and even he believes that it is reasonable to expect a rate increase this year. In fact he said he could imagine scenarios in which a hike in June would be necessary. With that in mind, Dudley felt that there is reason to err on the side of raising rates later. He noted the recent disappointments in U.S. data and said that if growth slows further, liftoff might be delayed. We are looking for a hike in September. One interesting point that Dudley made is that investors should not make much of the weak March payrolls report. And that says a lot because if one of the most cautious members of the central bank is not worried about last week's jobs number, we shouldn't worry either. This clear and consistent message from the Fed should keep the dollar's uptrend intact.
Double Top in Euro
Investors have been cautious about buying euros despite the broad based pullback in the U.S. dollar. Their apprehension was caused partially by Wednesday morning's weaker Eurozone economic reports. German factory orders missed expectations for the second month in a row, falling -0.9% after dropping -2.6% in February. While this data contradicts some of the stronger reports released by the region's largest economy, it also highlights the area's vulnerability. Business sentiment and activity in Germany is only beginning to turn positive and we firmly believe that as long as the euro remains weak, Quantitative Easing will work its way through the economy and provide the basis for a stronger recovery. However the euro needs to remain weak and QE should do the trick. Eurozone retail sales also turned negative, falling 0.2% in February. This decline should not be a surprise because consumer spending in Germany and France was very weak. German industrial production and trade numbers are scheduled for release Thursday and given the softer factory-orders report, the odds favor a downside surprise. News flow out of the Eurogroup meeting could have a larger impact on the euro than data. So far, EU officials are saying that progress is being made but when it comes to Greece, the talks could go sour at anytime. Technically, Wednesday's price action confirms the double top in the EUR/USD. While there is near-term support at the March 31 low of 1.0713, if that level is broken, the next stop should be 1.05.
Sterling Soars on M&A Flow
One of the biggest beneficiaries of dollar weakness Wednesday was sterling. No major U.K. economic reports were released, but news that Royal Dutch Shell (LONDON:RDSa) will be buying the U.K.'s oil and gas exploration firm BG Group (LONDON:BG) for 47 billion pounds has created significant demand for the currency. This is expected to be one of the biggest deals of the year and combined will create a company worth more than 200 billion pounds. Since it is a cash-and-share offer with Shell paying 383 pence in cash and 0.4454 Shell B shares, the cash component will lead to a major FX flow. With that in mind, the impact of M&A transactions on currencies is temporary and therefore we view Wednesday's rally in GBP/USD as an opportunity to sell the currency pair at a higher level ahead of the May election. Wednesday's move took the currency pair to a high of 1.4972 and its continual rejection of the 1.50 level reinforces the currency pair's trading range and the significance of that key level. U.K. trade numbers are scheduled for release Thursday and we are looking for stronger numbers given the increase in the PMI manufacturing index and, more specifically, the rise in export orders.
USD/CAD Lifted by Reversal in Oil
The correction in the U.S. dollar was the most pronounced against AUD and NZD. No economic reports were released from either country but the 2 currencies traded up more than 1% intraday. AUD/USD continued to benefit from the Reserve Bank's decision to leave rates unchanged Tuesday while the New Zealand dollar simply followed in its footsteps. The Canadian dollar, on the other hand, failed to participate in the move because oil dropped nearly 6% as inventories surged. The recent volatility in crude prices has made traders playing the 1.24 to 1.28 USD/CAD range very happy. We expect this range to remain intact, especially given the potential for a downside surprise in Friday's Canadian employment report.