By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It has been a terrible week for the U.S. dollar and a great week for risk currencies. If we take a step back and think about the outcome of all the major central-bank meetings, the main takeaway is less tightening and more stimulus, which is positive for stocks and risk appetite. By adding liquidity into the financial system, the European Central Bank helped to cement the bottom in European equities while the Federal Reserve’s less hawkish views set off a renewed rally in U.S. stocks. If the market is right and the Federal Reserve forgoes raising interest rates this year, we could see the S&P 500 trade back to its 2015 highs -- it's already above the 100- and 200-day SMAs, so the next stop should be at least 2,050. Further gains in U.S. equities would provide the fuel for an extended risk-on rally in currencies.
While it may be extremely tempting to pick a top in EUR, GBP, CAD, AUD and NZD, all of these major currencies are still trading near multi-year lows. For example, EUR/USD is up 8 cents from its 2015 low but down 36 cents from its 5-year high. GBP/USD is up 600 pips from its 2016 low and still down 2700 pips from its 5-year high. Even after the strong recovery in AUD/USD, the currency pair is 34 cents off its highs. So from a historical price perspective, there’s plenty of room for these currencies to rise. When trends get going in the forex market, it requires a major unanticipated catalyst to alter the moves and unless commodity prices suddenly crash or the Bank of Japan intervenes in a very big way, there’s nothing significant enough on next week’s calendar to spark a turn in market sentiment. Volatility is also very low with the VIX falling to its weakest levels since November -- low volatility is positive for risk appetite.
However at the end of the day, this is really a story about U.S. dollar weakness because the Japanese yen, which normally falls when risk appetite is strong, is lower this week. Everyone will be watching the BoJ to see how they will respond to the move in the yen. The risk of strong intervention is usually the highest when speculators are positioned the other way and we know that last week yen longs were at their highest level since the global financial crisis.
The focus of the currency market will turn to the euro and British pound next week. The German IFO and ZEW surveys are scheduled for release along with Eurozone PMIs. When the European Central Bank last met, President Draghi said he doesn’t see the need for a further reduction in interest rates. Next week’s economic reports will go a long way in shaping market expectations for additional easing. If the numbers are strong, EUR/USD will extend its rise because the data will validate a steady stance in future meetings. However if the data is weak, the overstretched euro could slip one to two cents.
U.K. inflation and retail sales numbers are scheduled for next week. Sterling had a fantastic run that was supported by optimism from the Bank of England. Unfortunately the decline in prices and same-store sales reported by the British Retail Consortium puts the risk to the downside for these reports. Yet we’ve seen the currency shrug off softer data time and again so it remains to be seen how much impact these numbers will have on GBP, especially if the market continues to send stocks higher and the dollar lower.
The Canadian dollar held onto most of its gains versus the greenback thanks to stronger-than-expected consumer spending numbers. Economists had been looking for spending to grow by 0.6% but instead, demand increased 2.1%. Excluding autos, spending rose 1.2%. Although consumer price growth held steady at 0.2% and failed to increase, the uptick in demand overshadowed the lack of improvement in inflation. The loonie was also supported by rising oil prices, which breached $40 a barrel on Friday. Looking ahead, there’s not much scheduled for release from the commodity-producing countries, which means their direction will be determined by risk appetite and the path of commodity prices. Both AUD and NZD traded lower Friday on the back of the mild recovery in the U.S. dollar, but the uptrend in AUD/USD remains intact.