Will Yellen Save The Dollar?

Will Janet Yellen Save the Dollar?

The slide in Treasury yields drove the trade weighted dollar index to its lowest level in 6 months. The greenback sold off against all of the major currencies with its steepest losses seen against the Australian and New Zealand dollar. Investors have been selling dollars aggressively over the past month despite better-than-expected economic data and further losses are likely unless Janet Yellen steps in to stop the slide in the currency Wednesday, but why would she? Unless inflation is skyrocketing, central bankers rarely have a problem with a weak currency especially in an environment where growth is a premium. Federal Reserve officials have also gone to great lengths to prevent yields from rising as they unwind Quantitative Easing so they won’t be eager to say or do anything that could risk sending yields sharply higher. At the same time, given the recent decline in labor force participation, the U.S. economy could certainty use some of the help provided by lower yields. While Yellen previously said that rates would rise 6 months after QE ends, she will be careful not to repeat these words in Wednesday’s testimony to the Joint Economic Committee. Instead, we expect Yellen to stress that tapering does not equal tightening which represents their dovish monetary policy stance. The timing of the first rate hike will be a major topic of conservation in the fall but for now, forward guidance is working and policymakers will want to keep it that way.

In a nutshell, while it would be easy to attribute Tuesday’s dollar weakness to stronger external data, the broad based sell-off indicates that the move is also driven by the lack of desire to own dollars. The U.S. trade balance fell short of expectations in March, raising the risk of negative GDP growth in the first quarter. 10 U.S. Treasury yields also closed below 2.6%. There is a major head-and-shoulders pattern forming in the Dollar Index. If the greenback continues to fall and the index breaks through 78.85, there will be no major support until 76 but this would most likely require 10-year Treasury yields dropping to 2.5%. In the off chance that Janet Yellen ignores the weak reports and talks about when rates could rise, the dollar index will bounce off 79 and move back above 80.

Will the RBNZ Governor Kill the Rally in NZD?

The New Zealand, Australian and Canadian dollars were the best performing currencies Tuesday. AUD broke through 93 cents while NZD rose to its strongest level in 2.5 years. The currency had only a nominal reaction to the highly anticipated dairy auction. While prices fell another 1.1%, volumes increased, raising hope that prices could soon be stabilizing. Over the past 2 months, dairy prices have fallen more than 20%, fueling speculation that the Reserve Bank could slow their pace of tightening. RBNZ Governor Wheeler was scheduled to speek on the significance of dairy on New Zealand’s economy Tuesday night. We know that dairy represents 30% of New Zealand’s exports and 7% of GDP so the question is not so much how significant the sector is to growth but rather what the central bank will do about the recent decline in prices. This is the perfect forum for Wheeler to signal a slowdown in tightening and if he does, it would deal a big blow to the NZD/USD rally. However if whatever reason, Wheeler decides to downplay the drop in prices and focus on the potential bottom, the currency pair would make a run for its 2011 high of 0.8842. After the speech, New Zealand employment numbers are scheduled for release and we are looking for firmer results. Last night’s Reserve Bank of Australia monetary policy announcement was a nonevent for AUD/USD. Nothing new was said by the RBA who continued to call the value of currency high by historical standards. Australian retail sales were scheduled for release Tuesday evening and the steep drop in the sales component of the PMI services index signaled the potential for a downside surprise. There are no economic reports scheduled for release from Canada Wednesday but USD/CAD fell sharply Tuesday despite a slowdown in manufacturing activity and a decline in the trade surplus. With the rally in the Canadian dollar at odds with economic data, it will be difficult for the current moves to last.

GBP/USD – Break of 1.70 Seems Inevitable

Over the past few days, we have been saying that GBP/USD was prime for a test of 1.70. The currency pair traded within 4 pips of this key level and we think its only a matter time before this psychologically significant technical level is broken. The last time that one sterling was worth more than 1.70 U.S. dollars was in August 2009 and at the time, the value of the pound peaked at 1.7043. Unlike 2009 the recent rally in the sterling has been slow and gradual while the move 4 years ago was sharp and choppy. The improvements in U.K. data and speculation that the Bank of England will be the next major central bank to raise rates supports the uptrend but with long positions at extreme levels, we want our readers to understand that it won’t take much to scare investors into taking profits. The latest push higher in sterling was driven by healthy activity in the service sector. The PMI Services index rose to 58.7 from 57.6 with the employment component rising to its best level since October 2013. As our colleague Boris Schlossberg noted “Services is the largest component of the UK economy and Tuesday’s data provides further fuel to cable bulls who anticipate that the BoE will be the first of the G-7 central bank to raise rates perhaps later in the year. Indeed Tuesday’s OECD report increased its projection for UK growth to 3.2% from 2.4% forecast earlier, even as the organization lowered the growth rates for China and US.”

EUR Hits 1-Month Highs on Stronger Data and Dollar Weakness

Stronger than expected economic data and the slide in U.S. yields drove euro to a 1-month high against the U.S. dollar (EUR/USD). Following the steep slide in German and French consumer spending, economists were looking for Eurozone retail sales to fall by -0.2%. However thanks to gains in many Eastern European countries and resilience in France, retail sales rose 0.3% in the month of March. No revisions were made to the Eurozone’s PMI Composite or Services index but the numbers for France were revised slightly higher while the numbers for Germany was revised slightly lower. The rally in the euro is purely a function of dollar weakness and our concerns about the upcoming ECB press conference remains unchanged. EUR/USD is poised for a test of its March high, which also happens to be a 2-year high unless Yellen is surprisingly optimistic Wednesday or Draghi is exceptionally critical of the euro’s strength on Thursday. Otherwise if they tow the party line and repeat much of what they have said in recent weeks, the current trend in the EUR/USD could remain in place. German factory orders and French industrial production are scheduled for release Wednesday – softer data is expected all around.

Watching the Yield Spread in USD/JPY

After 2 consecutive holidays, trading was set to resume in Tokyo Tuesday evening with the release of last month’s Bank of Japan meeting minutes and the latest PMI reports. Considering that policymakers have made their lack of desire to increase stimulus at this time very clear, we don’t expect much from the BoJ minutes. Instead U.S. rates will continue to be the main driver of USD/JPY especially with Fed Chair Janet Yellen scheduled to speak Wednesday. While the rise in high beta currencies Tuesday helped other yen crosses buck the trend and rally, their gains were hampered by the slide in USD/JPY. Having broken below 102, USD/JPY is now poised for a test of its February low at 100.75. How far USD/JPY falls will depend on the spread between U.S. and Japanese 10 year yields. Over the past 3 months, the yield spread has remained between 192 and 220bp. Recently the spread dropped below 200bp. If it continues to fall in favor of the yen, it will coincide with additional losses in USD/JPY. The currency pair dropped to 100.75 in February when the yield spread hit 192bp.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.