By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
- Dollar Off to a Strong Start in September
- Euro Extends Losses Ahead of ECB Meeting
- NZD Crashes after Another Weak Dairy Auction
- CAD: Bank of Canada Rate Decision on Tap
- AUD Slips on Weaker Data and Lower Gold Prices
- Sterling Hit Hard by Weaker Data and Scottish Independence Fears
- USD/JPY Breaks 105, Cabinet Reshuffle Coming
Dollar Off to a Strong Start in September
August was a great month for the US Dollar and September is off to a fabulous start. The dollar traded higher against most of the major currencies with the trade-weighted dollar index climbing to its strongest level since July 2013. While a pick-up in manufacturing activity, construction spending and economic optimism contributed to the move, the primary catalyst for the strong performance of the dollar was the sharp rise in U.S. yields. The Ten year Treasury rate rose 8bp Tuesday -- the last time we saw a move of this magnitude was in April -- on a day when many Fed officials including Janet Yellen spoke on the economy and monetary policy. Investors are hoping that Tuesday's sharp rise in U.S. yields will mark a bottom for U.S. rates but the market's voracious demand for U.S. dollars can also be attributed to the persistent weakness in foreign data. Discouraging news continues to come out of the Eurozone, U.K., Japan, Switzerland, Australia and New Zealand. As economic and monetary policy divergence between the U.S. and the rest of the world widens, the dollar will become more attractive to foreign investors, providing room for further gains. As we noted in the past, the voracious demand for dollars stems not from the impressiveness of the U.S. economy but from the lack of better alternatives. However at bare minimum, the prospect of a stronger non-farm payrolls report on Friday should keep the dollar bid. Weekly jobless claims printed below 300k three out of the last four weeks with the 4-week moving average of claims consistent with +200k job growth. In the meantime, we expect Wednesday's factory orders and Federal Reserve's Beige Book report to help and hurt the dollar.
Euro Extends Losses Ahead of ECB Meeting
With less than 48 hours to go before the European Central Bank's monetary policy announcement, the EUR/USD fell to a fresh 11-month low against the greenback. The currency pair actually came within a few pips of its 1-year low before stabilizing. While part of the move can be attributed to U.S. dollar strength, continued disappointments in Eurozone data also gave investors more reasons to sell euros ahead of Thursday's meeting. Manufacturing activity was revised lower in august while producer prices fell 0.1%. Lower inflation and weaker growth hardens the case for additional stimulus from the ECB. On Wednesday, revisions to the Composite PMI index is scheduled for release along with retail sales and we do not expect an upside surprise in either report. This week's ECB meeting could trump the U.S. non-farm payrolls report in terms of its impact on the EUR/USD. In no way, shape or form is the ECB ready to roll out Quantitative Easing but given recent economic reports, particularly from Germany, the case for additional stimulus is growing. The course for the ECB is clear and the only question is how quickly and in what form they will ease again. There are many ways that the central bank could prepare the market for more stimulus without actually making any immediate changes to monetary policy. The easiest way would be to significantly lower their GDP and inflation forecasts -- don't forget that their staff forecasts will be released this week. The ECB could also pre-announce ABS purchases with details to follow. The latter would obviously have a more significant impact on the euro than the former. Some economists are also calling for a 10bp deposit rate cut -- which would constitute easing -- but we think the central bank will postpone this move to September. Unless the ECB does nothing at all or makes only a small change to its staff forecasts, the ECB meeting should accelerate the losses in the EUR/USD.
NZD Crashes after Another Weak Dairy Auction
All 3 of the commodity currencies traded lower with the New Zealand dollar experiencing the steepest losses. Slower manufacturing activity in Australia and China kept NZD under pressure during the Asian and European trading session but the sharp decline in North America was triggered by yet another weak dairy auction. Dairy prices dropped 6% to a 2-year low bringing the total decline to 40% since the start of the year. At this rate, there is a very good chance that Fonterra will reduce payout further, putting the country's terms of trade and GDP growth at risk. Surprisingly enough, New Zealand's terms of trade actually improved in Q2 but that was because imports fell faster than exports. In the second quarter, export volumes dropped by the largest amount since March 2008. While we expect continued weakness in NZD/USD during the Asian trading session, the focus will be on AUD as Australia had Q2 GDP and service sector PMI scheduled for release Tuesday evening. Given the deterioration in retail sales and trade activity between April and June, we anticipate another soft release that could accelerate the Australian dollar's losses. Meanwhile the Bank of Canada also has a monetary policy announcement on Wednesday. No changes are expected but the recent improvement in Canadian and U.S. data could lead to slightly less dovish bias.
Sterling Hit Hard by Weaker Data and Scottish Independence Fears
The British pound traded sharply lower against the U.S. dollar Tuesday on the fears of Scottish independence. At the end of last week, we said that sterling could rally if this week's PMI reports surprise to the upside, reflecting a turnaround in the U.K. economy. Unfortunately while construction sector activity accelerated significantly, manufacturing activity, which is far more important slowed. The service sector PMI index was scheduled for release Tuesday evening and if it also falls short of expectations, there is no data to support the call for earlier tightening by U.K. policymakers. In that case, the Scottish referendum and the inconsistency between data and policy will keep sterling under pressure. According to our colleague Boris Schlossberg, "With only a few weeks to go before the Scottish referendum vote scheduled for September 18th, the latest YouGov poll has revealed that the gap between the No and the Yes vote has narrowed markedly. The No vote still leads at 53% to 47% for the Yes vote, but that represents a narrowing of 8 points from the 14 point lead just a month ago. Although most analysts still expect Scotland to remain within the UK, the latest uptick in the Yes vote for independence has spooked the markets which did not expect the vote to be this close. A move to independence would introduce massive uncertainty into the UK economy including the issue of what currency Scotland may use. Currency markets are notoriously sensitive to political risk and if the polling suggests that the Yes vote is approaching the margin of error then cable could see a further sell off" toward the 1.64 level.
USD/JPY Breaks 105, Cabinet Reshuffle Coming
Nearly all of the Japanese Yen crosses traded higher Tuesday thanks to the strong rally in USD/JPY. Over the past 2 weeks, the currency pair gained significant traction as investors finally get the rally they have been waiting all year for. According to the CFTC's IMM report, the rise from 102.50 to 104 encouraged speculators to reinitiate some of the long positions abandoned earlier this year. U.S. rates are on the rise with positive economic surprises raising hope that the trend will be here to stay. In contrast, continued deterioration in Japanese data raises the risk of additional easing from the Bank of Japan. The manufacturing PMI index was revised lower for the month of August as capital spending growth slowed in the second quarter. While the increase in labor cash earnings in the month of July is encouraging, alone it will not be enough to eliminate the chance of further stimulus. The BoJ is not expected to change monetary policy later this week but without an improvement in activity, investors could continue to sell in the yen in anticipation of that possibility. Prime Minister Abe is set to reshuffle his Cabinet Wednesday in an attempt to boost approval ratings. Although Finance Minister Aso and Economic Minister Amari are expected to remain, there is widespread belief that LDP lawmaker Shiozaki could be appointed head of the Ministry of Health, Labor and Welfare. This is relevant to the market because Shiozaki is a major advocate of aggressive investing by the Government's Pension Investment Fund. His appointment could pave the way for faster change within the GPIF. The Nikkei rose 1.2% overnight on the hope that this could mean greater exposure to Japanese stocks and foreign assets.