By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar traded sharply lower against all of the major currencies on Wednesday as investors dumped the greenback in pre-holiday trade. At first, there seemed to be no rhyme or reason for the move but at least 3 factors contributed to the weakness. The U.S. dollar started the NY session on its back foot after Fed Chair Janet Yellen warned that tightening too quickly could strand inflation below 2%, which could become a problem as there are signs that inflation expectations may be drifting lower. While she also added that hiking too slowly could overheat jobs, her concerns for inflation were enough to worry a market that is already uncertain about the Fed’s path in 2018. Then durable goods came in weaker, falling -1.2% in the month of October. Although excluding transportation, orders rose 0.4% and the University of Michigan Consumer Sentiment index increased, the headline miss was enough to press yields lower. Falling rates was the primary problem for the greenback and the slide in yields and the dollar exacerbated when the FOMC minutes were released. Although many Fed policymakers saw a near-term hike as warranted, a few also opposed it on weak inflation and these concerns about price pressures were enough to do the dollar in. Consolidation is likely Thursday with U.S. markets closed and many traders taking Friday off as well.
Sterling shot higher on the back of U.S. dollar weakness and a disappointing but benign budget. The Office of Budget Responsibility cut their 2017 GDP forecast to 1.5% from 2%, their 2018 GDP forecast to 1.4% from 1.6% and their 2019 forecast from 1.7% to 1.3%. Growth is expected to be lower for the next 3 years as Brexit takes its toll. Initially sterling traded sharply lower on these downgrades but the currency recovered as these changes were widely anticipated. Although market watchers were disappointed by the lack of new fiscal stimulus and the government’s plans for more borrowing, none of this was surprising, which allowed investors to move on quickly to the sliding dollar. Having broken above 1.33, GBP/USD appears poised for a move higher but sterling bulls need to be careful as all is not clear until GBP/USD breaks 1.3350. Revisions to UK GDP are due for release Thursday – changes are rare but if they are made, they can have a significant impact on the currency, especially in periods of low liquidity.
Euro will be the main focus for the next 48 hours with November PMIs scheduled for Thursday release followed by the German IFO report on Friday. Marginally firmer data is expected for Germany and softer numbers are expected for France, but with industrial production and factory orders falling over the past month, we believe the risk is to the downside for the German and Eurozone reports. EUR/USD raced above 1.18 today on the back of a weakening U.S. dollar and a small uptick in Eurozone confidence. According to Reuters, the ECB has no plans to change its guidance until late 2018, which is consistent with what we’ve heard all along from the central bank. That mattered little however to a currency pair that was driven entirely by the market’s appetite for U.S. dollars. While that will change on Thursday, there’s no doubt that the technical outlook for EUR/USD shifted with Wednesday’s break above the 50- and 100-day SMAs though low liquidity and holiday position adjustments make the move questionable. Until EUR/USD breaks above the November 17 high of 1.1822 in a more meaningful way, the bears still have a chance, especially with fundamentals on their side.
The falling U.S. dollar extended the slide in USD/CAD, which spent the entire day below the 20-day SMA. This is significant because it’s the first time in a week that the pair has closed below the SMA, which is generally a precursor to further weakness. No Canadian economic reports were released Wednesday but oil prices rose strongly, allowing the Canadian dollar to shrug off another day of declines in 10-year bond yields. However whether the loonie extends its gains against the dollar hinges entirely on Thursday’s retail sales report. With very few U.S. traders on the desk, the Canadian dollar could experience a more dramatic reaction. Economists are looking for a strong recovery in spending but based upon the largest decline in wholesale sales in a year, the risk is to the downside for this key report.
The New Zealand dollar spent most of the North American trading session in positive territory and extended its gains despite a relatively benign retail sales report. Spending rose 0.2% in the third quarter, which was significantly weaker than the previous 3 months but a small upward revision from 1.7% to 1.8% for Q2 and the fact that spending did not decline was enough to encourage more profit taking on short NZD/USD positions. The strength of the day’s rally is purely a function of the New Zealand dollar being deeply oversold because over the past few weeks we’ve learned that spending is soft, dairy prices are falling and manufacturing- and service-sector activity slowed from the previous month. Thursday night’s trade balance report is expected to be weak as well. All of this is bad news for the Reserve Bank of New Zealand, which could express fresh concerns in its Financial Stability Report, scheduled for release next week. Meanwhile we think AUD/USD has hit a near-term bottom. The 3-month decline stopped right at the 100-week SMA and with this week’s positive comments from RBA Governor Lowe and the recovery in gold, iron ore and copper prices, AUD/USD should find its way back to 0.7650.
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