By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- How Far Will the Dollar Correct?
- EUR Bounces But Greece Still a Problem
- USD/CAD Retreats Ahead of Rate Decision
- AUD: All Eyes on Chinese GDP
- NZD: Watch the Global Dairy Auction on Wed
- GBP: Zero Inflation
How Far Will the Dollar Correct?
For the first time in 6 trading days, we saw broad-based weakness Tuesday in the US dollar. Investors needed a reason to take profits on their long dollar trades and Tuesday morning’s soft retail-sales report provided the perfect excuse. Consumer spending increased for the first time in 4 months but the 0.9% rise fell short of the market’s 1.1% forecast. Excluding auto and gas purchases, spending rose only 0.5% while the control group, which is the measure that the central bank follows, rose 0.3%. Spending may have finally increased, but after 3 monthly declines, economists and investors had hoped for a much stronger report. The question now is whether this will affect the Federal Reserve’s plans to tighten. The pullback in the dollar and sharp slide in Treasury yields tell us that market participants are taking Tuesday’s report seriously. The dollar was also hit by small-business confidence, which fell sharply in March while core producer prices rose slightly more than expected. However for the Fed, the recovery in spending should only harden its plans to raise interest rates this year. We have long argued that a rate hike will happen in September versus June and the latest report reinforces our view. With that in mind, EUR/USD could test 1.08 and USD/JPY could drop to 118.25. But we expect the correction in the dollar to be limited to those levels. The retail-sales report won’t change the market’s long-term positive bias for the dollar and the risk of holding other currencies such as the euro, British pound and Australian dollar. It also does not remove the risk of a Grexit, the turmoil that could be created by the U.K. election and the strong possibility of a rate cut by the Reserve Bank of Australia. At the end of the day, we believe that the Fed will be encouraged by the recovery in retail sales and the Beige Book report will contain an air of optimism. In Monday’s note, we said the best way to trade the dollar at these lofty levels is to wait for a retrace and Tuesday’s correction is providing that opportunity. Aside from the Beige Book, the Empire State manufacturing index and industrial production numbers are scheduled for release on Wednesday.
EUR Bounces But Greece Still a Problem
The euro finally rebounded against the U.S. dollar Tuesday on the back of stronger Eurozone and weaker U.S. data. Industrial production jumped 1.1% in February, easily beating the market’s 0.4% forecast. However the IP data had only a small impact on the currency pair whereas the disappointing U.S. retail sales number triggered a sharp rally. The EUR/USD was the day’s second best performer, racing to a high of 1.0703 intraday. It probably would have enjoyed even stronger gains if not for ongoing concerns about Greece. Earlier in the morning our colleague Boris Schlossberg warned that the pressure on Greece continues as the country is clearly running out of time and money. The IMF warned that the negotiations are falling apart but Greece was quick to deny the risk of a default. There were more headlines in the North American session – according to “EU officials,” they most likely will not approve Greek reforms when they meet on April 24 and that the earliest they could make a decision on releasing the funds will be at the May 11 meeting. The problem is that IMF loans are due on May 1 and without the funds, Greece comes dangerously close to default. We doubt it will come to that but the mere risk should make 1.07 the near-term top for EUR/USD. Wednesday’s ECB meeting is not expected to have a dramatic impact on the currency. Having only started buying bonds in March, no changes are expected in April. Mario Draghi will use this opportunity to talk about the initial impact of Quantitative Easing including improvements in data, a weaker currency and lower interest rates. The central bank also bought approximately 60 billion euros worth of bonds last month with ease, and it will tell us that it does not anticipate having problems finding enough bonds to buy in the future. In other words, Draghi will reassure the market that QE is off to a solid start. Of course, he will also remind us that monetary policy remains easy but with QE going well, there’s no need for the central bank to upgrade its level of dovishness.
USD/CAD Retreats Ahead of Rate Decision
The best performing major currency Tuesday was the New Zealand dollar, which rose as much as 1% versus the greenback. All three of the commodity currencies recovered from Monday’s losses but NZD was the biggest beneficiary. This strength was driven by the combination of stronger New Zealand and weaker U.S. data. House prices jumped 6.7% in the month of March with sales rising 20% year over year. However whether or not NZD holds onto these gains will depend on Wednesday’s Global Dairy Trade auction. Milk prices plunged at each of the last 2 auctions and if prices continue to fall, the New Zealand dollar will give up all of Tuesday’s gains. Stronger Australian business confidence also helped to drive AUD higher and the sustainability of its gains will hinge on Tuesday night’s Chinese economic reports. First-quarter GDP, industrial production and retail sales are scheduled for release. If GDP growth falls short of the government’s official 1% forecast, AUD/USD will trade sharply lower and if the data is good the currency pair could catch up to the gains enjoyed by NZD. Finally the Bank of Canada has a monetary policy announcement Wednesday and a small group believes that the central bank could cut interest rates. We don’t see this happening given the recent upside surprise in economic data including Tuesday’s house price index. More than 28k jobs were created last month, housing starts are on the rise, house prices turned positive, the trade deficit narrowed and GDP growth contracted less than anticipated at the start of the year. In addition, crude prices stabilized around $50 a barrel. So while BoC Governor Poloz may be worried about the outlook for Canada’s economy, there’s not enough justification for a rate hike. Steady rates and an unchanged outlook for the economy should lead to a mild pullback in USD/CAD.
GBP: Zero Inflation
Sterling traded higher against the U.S. dollar Tuesday but the move was driven entirely by US dollar weakness because the latest inflation report from the U.K. left much to be desired. According to the consumer price report, inflation remained at a record low of 0% in March. Between February and March, prices rose 0.2%, which was less than the market’s 0.3% forecast. On top of that, the annualized pace of core CPI growth slowed to 1% from 1.2%. If inflation remains at this rate, the Bank of England will have to postpone a rate hike to 2016. Between uncertainty in Europe, the weakness of the euro (which impacts U.K. trade activity), the upcoming election and mixed U.K. data, the Monetary Policy Committee has very little reason to rush a rate hike. As a result, we view Tuesday’s rally as an opportunity to sell the currency pair at a higher level.