By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- What Did Yellen Say to Drive Up the Dollar?
- Euro Drops to Fresh 11 Month Lows, Nothing New from Draghi
- Sterling: Nearing a Bottom?
- CAD: Retail Sales Soar, CPI Eases
- New Zealand Trade Balance Next Week
- AUD: Gold Up, Oil Down
- Pullback Risk in USD/JPY
What Did Yellen Say to Drive Up the Dollar?
The U.S. dollar traded higher following Janet Yellen's speech at Jackson Hole Friday, which may be confusing for some traders because nothing new was said. Going into Friday's speech, investors were hoping she would verify that the central bank is moving closer to changing the language in the FOMC statement and could be even considering an earlier rate rise. Unfortunately she did none of that and in fact provided zero clarity on the direction of monetary policy, which perhaps could be the main reason why the dollar strengthened after her comments. Investors were hoping for less dovishness from the Fed Chairwoman but the profit taking that we saw on Thursday indicates that they were bracing for a dovish speech. Yellen has been consistently more cautious than many of peers and there was a good chance she would downplay the recent improvements in U.S. data and the discussion of an earlier rate rise at the last central bank meeting. Instead, her balanced approach turned out to be a relief for dollar bulls because it does not rule out the possibility of a less dovish view at next month's Fed meeting. Yellen confirmed that asset purchases will end in October and indicated that if the faster progress was made on their goals, it could bring an earlier rate rise. This line would have been extremely positive for the greenback had she not added in almost the same breath that if slower progress was made, they could delay a rate rise. With regards to the labor market, Yellen felt that even with recent job gains the labor market hasn't fully recovered and there is a significant under-use of labor resources. In a nutshell, investors bid up the dollar when they realized that Yellen said nothing to discourage the hawks.
Euro Drops to Fresh 11-Month Lows, Nothing New from Draghi
Investors continued to sell euros on Friday, sending the EUR/USD to a fresh 11-month low versus the U.S. dollar. Although the weakness of the currency pair can be blamed on the comments from Mario Draghi and Janet Yellen, the euro started the North American trading session on shaky footing. The problem for the currency pair is that even without fresh guidance from the Fed or the ECB, the fact remains that the paths of Eurozone and U.S. monetary policies are diverging. In his speech Frida, Draghi reminded investors that they stand ready to adjust policy further. While they are confident that their June stimulus, much of which hasn't been even rolled out, will boost demand, they are also worried that monetary policy will lose is effectiveness in generating consumption. He continued to call on EU nations to implement greater structural reforms because a return to full employment requires a combination of monetary, fiscal and structural measures. From a fundamental perspective, the EUR/USD could still trade lower because of the prospect of higher U.S. rates. Unlike U.S. data, which surprised to the upside consistently this week, Eurozone data has been filled with disappointments and chances are Monday's German IFO report will show deterioration in business confidence that could extend the slide in the EUR/USD. Technically however, this week's decline in the currency stalled right at the 38.2% Fibonacci retracement of the July 2012 to May 2014 rally. With EUR/USD short positions hovering near 20-month highs and the currency pair trading right above a key support level, the charts signal that a bounce is likely.
Sterling: Nearing a Bottom?
This has certainly been a tough week/month for the British pound. The currency pair lost approximately 1.5% of its value against the U.S. dollar, dropping to its lowest level in 4 months. In the past 6 weeks, these losses topped 3% with sterling depreciating against all major currencies. While U.K. policymakers ware warming to the idea of earlier tightening, the recent decline in consumer prices, drop in house prices and slowdown retail sales growth questions the central bank's ability to tighten. For the time being, investors are taking the recent comments from BoE Governor Carney, Weale and McCafferty with a grain of salt. However sterling has fallen quickly and aggressively over the past month and with no major U.S. or U.K. economic reports scheduled for release next week, we would not be surprised by and in fact expect a relief rally. The currency is deeply oversold and even though data has been weak and the mixed messages from policymakers leave investors thoroughly confused their comments cannot be ignored. Eventually U.K. data will improve and when it does, all of the talk about earlier tightening will come back to forefront, helping to drive a strong recovery in the currency. It will be a while before that happens but in the meantime, we expect GBP/USD to find support at 1.65 and rebound up towards 1.67.
CAD: Retail Sales Soar, CPI Eases
The Canadian, Australian and New Zealand dollars ended the North American trading session virtually unchanged against the greenback. Canada was the only major economy with economic data scheduled for release on Friday and according to the reports, inflation declined while consumer spending soared. Canadian consumer prices dropped -0.2% in the month of July and on an annualized basis, CPI growth slowed to 2.1% from 2.4%. While lower gas prices played a big role in the decline, core CPI, which is the Bank of Canada's primary gage for inflation fell for the second month in a row by 0.1%. Having come off of lofty levels earlier this year, the decline in CPI is a welcome change for the central bank. They will also be happy to see consumer spending grow 2.2% in the month of June, more than 3 times stronger than economist forecasts. Excluding auto sales, retail sales actually rose 1.5% versus 0.3% expected. Friday's report bodes for next week's GDP number and suggests that the improvement in the labor market is having a positive impact on consumer spending. While USD/CAD's reaction to the data was limited, recent Canadian economic reports will make it extremely difficult for the currency pair to break 1.10. No economic data was released from Australia and New Zealand Friday and next week, all we've got on the calendar for these 2 countries is New Zealand's trade balance report on Tuesday.
Pullback Risk in USD/JPY
There was very little consistency in the performance of the USD/JPY Friday, which weakened against the British pound, U.S., Australian and New Zealand dollars but strengthened against the euro and Swiss Franc. The best-performing Yen cross continues to be AUD/JPY, which climbed to a 14-month high. A large part of its strength has to do with the recent gains in U.S. equities. In the past, EUR/JPY had the strongest correlation with the S&P 500 but weakness in the Eurozone and the European Central Bank's plans to increase stimulus led to a significant underperformance of the euro. So instead, investors have shifted their focus to AUD/JPY because it is not hampered by a dovish central bank. Meanwhile in the past 2 weeks, we have seen a very significant rally in USD/JPY and typically after such overstretched moves, a pullback is not unusual especially since there are not many major U.S. economic reports scheduled for release next week. USD/JPY broke above its April spike high but its inability to end the day above 104.12 raises the chance of a corrective pullback. With this in mind, we view any decline in USD/JPY as an opportunity to buy the currency pair at a lower level in an anticipation of a rise in U.S. rates. There are a number of important Japanese economic reports scheduled for release next week including consumer prices, retail sales, and industrial production.