By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
- Dollar Slips but Bulls Unfazed by Weak Retail Sales
- Euro: First and Not Last Test of 1.05
- Sterling Extends Losses as Yields Crash
- CAD Traders Eye Employment Report
- AUD Soars After Drop in Unemployment Rate
- NZD Up 1.6% Post RBNZ
Dollar Slips but Bulls Unfazed by Weak Retail Sales
The U.S. dollar traded lower against all of the major currencies Thursday with the exception of the British pound. While its weakness could be attributed to the soft retail sales report, that would be an inaccurate assessment of the market's reaction to what was this week's most important economic report. The decline in spending caught everyone by surprise and the dollar fell sharply versus the euro and Japanese yen after the release but the selloff lasted only minutes before bargain hunters swooped in to buy the currency. Despite the improvements in the labor market, rise in wages and decline in gas prices, Americans cut spending for the third month in a row. But judging from the price action of the greenback, dollar bulls are telling themselves that weak retail sales does not change the bigger story of monetary policy and growth divergence. In some ways they are right and in some ways they are wrong. We are still looking for the Federal Reserve to raise interest rates in 2015 but our call has always been for tightening in September versus June. Three consecutive months of weak spending, even if it is driven by inclement weather, is not the right environment for a rate hike. Retail sales fell -0.6% in February after falling -0.8% in January and excluding auto and gas purchases, retail sales fell -0.2%. Many Americans refrained from venturing out to stores and restaurants in the first two months of the year due to unusually frigid temperatures and back-to-back snowstorms, but that's not the whole story. Over the past few months, the savings rate also increased. The last few years has been tough on American households and now that gas prices have fallen and wages are beginning to rise, they are saving their discretionary spending dollars for a rainy day. Nonetheless, as the snow melts and the weather turns warmer, shoppers will return to the stores driving up retail sales and we are confident that spending will rebound strongly in March. In the meantime, the focus is on next week's FOMC meeting. The latest decline in jobless claims and the recent drop in the unemployment rate should push the Federal Reserve to alter its forward guidance by dropping the word patient from its monetary-policy statement. As the Fed hasn't decided whether rates should rise in June or September, it may be prudent to take steps to ensure flexibility if the labor market continues to improve in the coming months.
Euro: First and Not Last Test of 1.05
The euro rebounded against the U.S. dollar Thursday but not before making a run below 1.05 during the Asian trading session. Thursday's test of 1.05 will the first but not the last time the currency pair takes a crack below the key level. Economic data had nothing to do with the move because the euro barely reacted to the Eurozone industrial production report, which fell -0.1% compared to the market's 0.2% forecast. The weaker U.S. retail sales number also had a limited impact on the currency with the EUR/USD giving up its post-data gains quickly. Thursday's intraday rally simply gave fast-fingered traders an opportunity to sell the currency pair at a higher level. We continue to believe that the widening divergence between Eurozone and U.S. monetary policy sets the stage for protracted underperformance. ECB QE just started and Fed tightening has yet to begin. Growing expectations for a change in forward guidance by the U.S. central bank should drive further gains in the dollar ahead of next week's FOMC meeting. At minimum, we expect the EUR/USD to trade down to the 1997 low of 1.0350.
Sterling Extends Losses as Yields Crash
The British pound extended its losses Thursday below 1.49 on the back of falling U.K. rates. The Ten-year Gilt yield dropped 7bp to its lowest level in more than 3 weeks. U.K. data was actually better than expected with the country's trade deficit narrowing significantly in January. The gap shrank to its smallest level in 14 years on the back of a sharp rise in service exports like consulting, advertising and marketing services. However sterling continues to fall and its weakness was seen not only against the U.S. dollar but all the major currencies. The latest decline was attributed to Bank of England Governor Carney's comment that a strong currency could drive down inflation. But in the same speech he repeated that BoE's outlook is consistent with a gentle rate increase. In other words, the BoE is still looking to raise interest rates, which means that the lower the British pound falls, the better entry it provides for long-term traders. Buying sterling versus the dollar is less attractive than buying it against other currencies like the euro, Australian or Canadian dollars. In the meantime, support in the GBP/USD is near the 2013 low of 1.4815.
CAD Traders Eye Employment Report
The Canadian dollar rebounded against the U.S. dollar today despite a further decline in oil prices. The price of crude dropped to its lowest level since January 29. While the rally in USD/CAD can be mostly attributed to the sell-off in the U.S. dollar, some traders may also be squaring up their long positions ahead of Friday's employment report. Job growth is expected to decline with the unemployment rate rising, which would be positive for USD/CAD. But with the currency pair trading at such a lofty level, an unexpectedly good report could trigger a sharp decline. The Bank of Canada shifted to a neutral monetary policy bias after lowering rates at the start of the year when some believed they wouldn't have done so if the labor market was weak. However January was a very good month, so a pullback in February is not unusual. Meanwhile the Australian and New Zealand dollars powered higher, rising more than 1.6% against the greenback. NZD benefitted from Wednesday's upbeat comments from RBNZ Governor Wheeler while AUD traded higher on stronger labor-market numbers.