By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Investors continued to buy U.S. dollars Thursday, 48 hours after the 2016 Presidential election. We didn’t get a chance to share our views Wednesday because we were busy trading election night and the day after but there’s no doubt that the outcome was a big surprise. It sparked widespread volatility and short covering in the financial markets but when the dust settled, the U.S. dollar and U.S. stocks recovered all of their steep losses. Instead of mourning, investors cheered a Trump victory as they hoped he will be positive for the economy. He ran on a campaign of aggressive spending and this is the first time in 8 years that there’s the prospect of a sizeable fiscal stimulus package. His victory speech was conciliatory and heavily Keynesian, which went a long way in boosting risk appetite and lifting Treasury yields. Perhaps feeling the weight of his new responsibilities, Trump is toning down his abrasiveness and opening his ears to outside counsel and advice. He may not have a specific plan for creating new jobs, offsetting the tax cuts he plans or finding the money for infrastructure spending outside of ballooning the deficit, but the mere promise of a fiscal stimulus program at a time when the Federal Reserve is preparing to raise interest rates reinvigorated hope for a new cycle of growth.
The odds for a rate hike after the election hasn’t changed and in fact increased from 80% to 84% according to Fed Fund futures. This is not a big surprise because stocks recovered strongly. Had they fallen 500 or 600 points on Wednesday, the Fed would most certainly reconsider its plans for tightening. Instead, with the Dow Jones Industrial Average at a record high, Janet Yellen has an even stronger case to boost rates in December. It would be her last decision before President Trump can pressure the central bank and the move would show that she isn’t buckling on future political pressure. Data was also good with jobless claims falling 11k. Weekly claims have remained below 300K for 88 weeks, the longest stretch in more than 45 years. The University of Michigan consumer sentiment index is scheduled for release Friday and a steady reading is expected. Meanwhile, it is important to recognize that rising U.S. yields are the primary reason for the dollar’s strength. Ten-year Treasury yields rose above 2% on Wednesday, taking USD/JPY above 105 and Thursday’s extension in rates drove the pair within 5 pips of 107. There’s no question that USD/JPY is overbought, but we could see the pair break 107 before the rally finally fizzles. Of course, it could also stall here, right at the 200-day SMA and 38.2% Fibonacci retracement of the 2011 to 2015 rally.
Thursday's best-performing currency was sterling, which broke through 2 big figures to trade as high as 1.2585. The move caught the market by complete surprise, as there were no major U.K. or U.S. economic reports on the calendar. Furthermore, the U.S. dollar is strong. The only explanation for the move is that U.K. yields rose more than U.S. yields Thursday, though the difference was small. Clearly, more short covering needed to be done in GBP/USD and as each key level was taken out, more stops were triggered. U.K. yields are closing in on their pre-Brexit levels but it is important to remember that even though the British High Court delayed the activation of Article 50 with its recent decision, it is still happening. With 1.2550 behind us, the best place to fade GBP/USD could be near the 50-day SMA at 1.2680.
The euro, on the other hand, remained under pressure versus the greenback. The day was light on data and European yields moved higher alongside U.S. yields. ECB Vice President Vitor Constancio said that he expects inflation to reach 1.3% by March of 2017. This may be short of the targeted 2% but means that inflation is on the right path. Constancio also stated that he expects unemployment for the Eurozone to drop below 10% next year. He cautioned that core inflation was still a cause for concern. The rather upbeat statement was brushed off by euro traders as they continued to take the currency pair lower following the election. A lot of the move was affected by EUR/GBP, which fell nearly 1.5%. No data is expected from the Eurozone on Friday.
All 3 commodity currencies sold off against the greenback on Thursday with the New Zealand dollar experiencing the sharpest losses following the Reserve Bank of New Zealand’s 25bp rate cut. Although the Australian dollar initially received a boost from higher commodity prices, it ended up on pressure from USD strength and mixed data. Consumer inflation expectations dropped to 3.2%, slightly lower than the 3.7% expectation for October. Home loans for the country managed to show an increase by 1.6%, out-pacing the expected decline of 1.6%. Investment lending for Australia also managed to show a dramatic rise when compared with last month showing an increase of 4.6%, which was much better than the 0.8% drop from last period. Canada’s New Home Price Index reported an increase of 0.2%. This report was in line with expectations but falling oil prices and a rising dollar drove the loonie lower. For the time 1.35 appears to be holding as resistance for USD/CAD.