By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Will Yellen Destroy or Revive the Dollar Rally?
- Euro Traders Disappointed by Greece’s Latest Move
- GBP/USD Pushes Higher Ahead of BoE Speak
- USD/CAD Extends Gains on Lower Oil
- AUD Slips on Concern for China
Will Yellen Destroy or Revive the Dollar Rally?
The US dollar will take its next direction from Fed Chairwoman Janet Yellen’s testimony on the economy and monetary policy. For the past 2 weeks, the dollar has been trading in a narrow range against most of the major currencies, waiting to breakout on a big event like Tuesday’s Congressional Testimony. Most investors will agree that the Fed will raise interest rates in 2015 but how quickly they will move is up for debate. In December, Yellen set the stage for a summer rate hike when she said rates would not move in at least 2 months. More than 2 months have passed since that meeting and investors want to know now how the timeline has shifted. There’s no doubt that in her next 2 days on Capitol Hill, some member(s) of Congress will ask about how quickly rates will rise and her answer will either destroy or revive the dollar’s rally. Based on the inconsistent performance of the dollar on Monday, there is no clear consensus on which way Yellen will lean. A June rate hike is off the table but we felt that the chance of summer tightening was slim to begin with. According to the minutes from the most recent Fed meeting, many policymakers want rates to remain near zero for a longer period of time and the latest housing/manufacturing reports reinforce their need for patience. Yet, personal consumption is strong and if the Fed wants to raise interest rates this year, their message needs to remain consistent, giving investors plenty of time to adjust to the idea of tightening so that when the time comes to raise rates, the reaction in the markets is limited. Between the improvement in the unemployment rate and increase in average hourly earnings, there is still a strong case for normalizing monetary policy this year. So in terms of how the dollar reacts, a clear timing on when rates will rise will be positive for the dollar as long as it is sometime this year. The more convoluted and muddled her message is on when rates will rise, the more negative it will be for the U.S. dollar. But even in this case, we do not expect the dollar to crash because rates are still poised to move higher. Therefore while we believe Yellen will err on the side of caution and provide less transparency in order to avoid backing the Fed into a corner if the economy fails to regain momentum, we still view a decline in the dollar as an opportunity to buy the currency pair at a lower level.
Euro Traders Disappointed by Greece’s Latest Move
To the disappointment of EUR/USD traders, Greece dragged its heels and missed the Monday deadline to send a list of reforms to its Eurozone partners. According to the Greek government, the list will now be provided on Tuesday morning and reviewed by Eurozone Finance Ministers in a conference call on Tuesday afternoon. While the modest decline in the EUR/USD indicates that investors are not overly concerned about Greece’s latest move, this delay shows how difficult it is for the Greek government to identify areas they are willing to reform. In order for Greece to receive a 4-month extension to their bailout, their reforms need to be deemed comprehensive and satisfactory by the Eurogroup. Otherwise their bailout will expire on Saturday – so a lot is at stake. We have long been optimistic that an extension will be made and we still believe that both parties will reach an agreement to restructure Greek debt avoiding a Grexit but we along with the broader market are not happy that the can has been kicked down the road. An extension is not a resolution even though it is a necessary step toward one. Greek headlines will continue to affect the euro on Tuesday along with ECB President Draghi’s testimony on monetary policy. Both Yellen and Draghi are speaking Tuesday with Yellen starting at 10am ET and Draghi at 11:30am ET. This means that Tuesday is a big day for the EUR/USD and we would be surprised if the currency pair did not break out of its increasingly tight consolidation. If Yellen talks about tightening and Draghi emphasizes the need for easy monetary policy, the currency pair will break to the downside. But if Yellen sounds slightly less eager to raise rates and Draghi seems more comfortable with regional risks now that Greece has received an extension, a short squeeze could finally drive EUR/USD higher.
GBP/USD Pushes Higher Ahead of BoE Speak
The British pound continued to drift higher against the U.S. dollar Tuesday despite a surprisingly weak retail sales report from the Confederation of British Industry. The consumer spending index dropped to +1 from +39 in February, the weakest level since November 2013. Even with heavy discounting, retailers are struggling to attract shoppers to the stores. However according to CBI, “the outlook for the retail sector is fairly positive, with the boost to household incomes from falling inflation likely to support spending. Indeed, firms remain upbeat about the businesses situation over the coming quarter.” It is this promising outlook -- along with last week’s mostly better-than-expected economic reports -- that have made sterling so attractive versus the euro and U.S. dollar. In fact EUR/GBP dropped to its lowest level in 7 years. While this week is light in terms of U.K. data, there are a number of policymakers scheduled to speak including Bank of England Governor Carney on Tuesday. Carney is generally one of the more hawkish members of the central bank so his positive outlook on the economy and monetary policy could drive GBP/USD above 1.55.
USD/CAD Extends Gains on Lower Oil
The Canadian and Australian dollars traded lower against the greenback while the New Zealand dollar ended the North American trading session virtually unchanged. USD/CAD was driven higher by a 2% decline in oil prices and the fear that Bank of Canada Governor Poloz will talk down the currency by talking up the need for more stimulus. Economic data from Canada has been very weak -- on Friday, retail sales dropped by the largest amount in 4 years. The Bank of Canada preempted the slowdown in the economy with a 25bp rate cut in January and the market is currently pricing in another round of easing in the next 2 months. There was no specific catalyst for the decline in the Australian dollar but manufacturing data is scheduled for release from China this week and there is some concern that the data will show a further slowdown in Asia’s largest economy.