By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Friday's U.S. dollar traded higher against all of the major currencies as Yellen said --
a rate hike in the coming months may be appropriate.
This was exactly the type of endorsement that the market had been hoping for and it rewarded the dollar as a result. It did not matter that Yellen felt that recent productivity growth was miserable or that there hasn’t been much improvement in wage growth because the timing of the next rate hike was all that mattered. Many investors were still skeptical about 2016 tightening even as market expectations and Fed fund futures began to shift. The rally in the dollar is still relatively modest but with Yellen’s blessing, we could see further gains in the greenback next week. Looking ahead, it will be another busy week with many currencies receiving as much attention as the U.S. dollar. The main focus will be Friday’s non-farm payrolls report while Chinese PMIs, U.K. PMIs, the European Central Bank monetary policy announcement and GDP numbers from Australia and Canada will also impact on FX trade. The question for dollar bulls will be whether the labor market and, more importantly, wage growth saw enough improvement to push the Fed to move in June. This is extremely unlikely but rising expectations for June vs. July tightening as well as a summer rate hike will dominate trade for the next few weeks. But before we get to NFPs, personal income, spending, ISM manufacturing and the Fed’s Beige Book reports will be released – all of these numbers will either harden or weaken the market’s appetite for U.S. dollars.
In the first half of the week, Chinese data and its impact on risk appetite will influence how the commodity currencies Japanese yen and U.S. dollars perform. The Australian dollar has done a decent job of holding above 0.7180 but if the Chinese economy slows further and Australian GDP surprises to the downside, support could break. However along these lines, if Chinese data improves and growth in Australia accelerates, AUD/USD could find its way back to 73 cents. The first quarter was a brighter one for Australia with retail sales and trade activity improving from last year so the risk is to the upside for the report. There are no major economic reports from New Zealand, so NZD will most likely take its cue from the market’s appetite for risk and U.S. dollars.
After breaking down earlier this month, EUR/USD remains under pressure. The big question this week for euro traders is whether the central bank is worried about the deterioration in the peripheral economies or relieved by the improvements in Germany and France, the 2 largest countries economies in the Eurozone. Tuesday’s German unemployment numbers will help to shape their views. When the ECB last met, Mario Draghi avoided talk of more easing, choosing instead to say that ECB policies must be given more time to work. These comments sent EUR/USD sharply higher but by the end of his press conference the EUR/USD tanked as investors realized that the central bank remains dovish with ECB policy diverging away from Fed policy. These facts are likely to remain the same, which means that expectations for where the German–U.S. yield spread could still dominate EUR/USD trade.
Even with Thursday’s pullback, sterling was strong. And next week’s U.K. PMIs will help to determine whether this strength is validated. Manufacturing, service and construction sector PMI are scheduled for release and a rebound is expected after last month’s softer numbers. How this data impacts sterling remains to be seen because last month the currency completely shrugged off weak data and instead made its way toward a fresh year-to-date high. All GBP traders cared about was 'Brexit' headlines and short covering, which will remain the case as we head into the U.K. referendum. Yet with momentum on the side of a higher pound, positive data could accelerate the rise and drive the currency to fresh highs.
With oil prices retreating from $50 a barrel, USD/CAD found its way back above 1.3000. Two main forces drove USD/CAD lower this week -- the persistent strength of oil prices and the less dovish Bank of Canada monetary policy announcement. Investors expected the BoC to downgrade their growth outlook after the wildfires in Alberta and while they recognized the drag that it would have on second-quarter GDP, they believed that the economy will rebound in the third quarter. However first-quarter growth will be the focus for the Canadian dollar next week and weaker retail sales and trade activity is expected to weigh on growth. Of course, oil will also play a big role in the loonie’s performance with traders watching the commodity closely to see whether it makes another run for $50 a barrel. On a technical basis, the bounce off the 20 -and 50-day SMA is a sign of strength for the currency pair.