By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Will the U.S. dollar ever stop falling? The answer is -- of course -- that it will. But the real question to ask is when. Since the beginning of the month not one day has passed without a sell-off in USD/JPY. We are 9 trading days into the second month of the year and USD/JPY has fallen in each and every one of them. This weakness is mirrored in the Dollar Index, which dropped 8 out of the last 9 trading days or 12 out of the last 14 trading days. If that’s not the definition of a downtrend, we don’t know what is. The decline in the dollar is supported by the decline in Treasury yields, which have fallen from 2.27% at the beginning of January to a one-year low of 1.62%. The main reason why investors are selling dollars is because they no longer believe that the Federal Reserve will raise interest rates in 2016. What’s interesting is that Yellen did not say anything in her testimony over the past 2 days to suggest that would be the case. While we believe that the Fed will leave rates unchanged in March, the year is new and there’s still a reasonable chance that rates could be increased at the end of the year. Nonetheless, Fed fund futures are no longer pricing in a rate hike this year, validating the decline in the dollar.
As for the question of when the U.S. dollar will stop falling: it will happen when U.S. data is strong enough for investors to re-price tightening. Thursday morning’s better-than-expected jobless-claims report triggered a short-lived rally in the greenback that was erased almost as quickly as it was incurred. We’ve learned through the past few years that the focus for the Fed is on job growth and not job losses -- as long as jobless claims remain below 300k. Friday’s retail-sales report is very important because the Fed pointed to spending as an area of strength for the U.S. economy. Unfortunately, according to Johnson Redbook, same-store sales fell 0.5% in January. However wages accelerated so it’s a tough call. But either way, we don’t expect spending to be strong enough for the Fed to overlook the volatility in the financial markets and raise interest rates next month. Economists are only forecasting a 0.1% increase after the -0.1% drop at the end of last year. In fact we believe that the U.S. dollar remains a sell on rallies leading up to the March FOMC meeting. Then, depending on the central bank’s guidance, the greenback may have a chance of recovering if the dot-plot still forecasts more rate hikes in 2016.
Thursday's big story was the sharp intraday spike in USD/JPY. In a matter of 2 minutes, USD/JPY jumped from 111.45 to 113.06. The speed and velocity of this move is typically indicative of central-bank intervention although when the Bank of Japan intervenes, we expect to see the currency pair move more than 200 pips over the same period of time. The spike in USD/JPY was attributed to rumors of rate checking by the central bank, which is typically the first tactic before currency intervention. Japanese officials have made no comments about intervention but we would not be surprised if they were behind Thursday’s move because only a big buyer of USD/JPY -- not stop hunting -- can drive USD/JPY up 150 pips in 2 minutes. It now appears that 110 is the line in the sand for the central bank and while that rate seemed far away a few days ago, the currency pair came very close to testing that level Wednesday night. Even though we are trading above that rate now, the risk of intervention is significant.
The euro climbed to fresh 3-month highs versus the U.S. dollar on the back of U.S. dollar weakness. European equities continue to fall, peripheral bond yields are extending higher and Greece is back in the headlines. But EUR/USD traders are ignoring all of those negative developments driving EUR/USD higher. Short covering of funding currency trades continues to be the primary source of euro strength and we can’t help but remain skeptical on how long that can last. German and Eurozone GDP numbers are scheduled for release on Friday and based on the sharp deterioration in consumer spending along with weaker trade activity, we expect fourth quarter GDP growth to slow. No U.K. economic reports were released Thursday but sterling traded lower on EUR/GBP flows as gains in euro drove EUR/GBP to a fresh 1-year high.
All three of the commodity currencies ended the day unchanged against the greenback (CAD, AUD, NZD). Considering the breadth of equity-market weakness, the resilience of these currencies is surprising because the comm dollars typically sell off in periods of risk aversion. However it seems that the optimism of these central banks is going a long way in lending support for these currencies. Yet with the markets continuing to fall and oil prices dropping another 2.5% Thursday, it should only be a matter of time before these central banks share the Fed's and ECB’s concerns about the global economy and market volatility.