By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
September is traditionally an active month in the foreign-exchange market as investors are back from their holidays and ready to close the year strongly with new trades and positions. We saw currencies extend to new multi-year highs this past week and these moves give investors a taste of the wild swings we can expect this month. The U.S. dollar got shellacked because the Federal Reserve — once the only major central bank tightening monetary policy — is finding more and more reasons to keep rates unchanged in December. With Hurricane Harvey and now Hurricane Irma set to wreak havoc on Southern states in the U.S., the dollar depreciated against all of the major currencies. USD/JPY broke through 109 and 108 to hit a low of 107.32 on Friday. At the start of the week we talked about how Harvey, North Korea and the debt ceiling would pose major threats to the greenback and while the buck traded lower, the White House and Congress actually reached a deal to extend the debt ceiling for 3 months and China is tightening the noose on North Korea. Aside from reports that they are closing part of their borders, the White House said military action is not their first choice as Presidents Trump and Xi are committed to taking further action with the goal of achieving denuclearization on the Korean Peninsula. None of these problems has gone away but at least they haven’t escalated over the past week. But investors are aware that NK tensions could return at any time, the debt ceiling will become an issue again at the end of the year and everyone is watching how badly Hurricane Irma affects Florida so they have sold dollars.
The greenback has also been tracking the 10-year Treasury yield, which dropped to its lowest level in 10 months. Although Fed Presidents Dudley and Mester remain optimistic, economists and investors have resigned themselves to expecting a month of weaker economic reports as they watch how quickly activity in these areas recover. This uncertainty means that the central bank isn’t likely to provide much guidance on the timing of rate rises after they make changes to the balance sheet later this month. Fed Vice Chair Fischer’s resignation is worth highlighting because he is not only one of the main architects of U.S. monetary policy but his departure gives President Trump the opportunity to completely reshape the Fed because there will now be 4 empty board seats. For all of these reasons we expect the dollar to remain under pressure with USD/JPY eyeing a break of 107 and eventually a move below 106. Two very important economic reports — U.S. consumer prices and retail sales — are scheduled for release in the week ahead and unfortunately we believe these reports will hurt more than help the U.S. dollar.
Having hit a nearly 3-year high just shy of 1.21 on Friday the euro is on track for more gains after European Central Bank President Mario Draghi made it clear that it is not a question of 'if' but 'when' they will start tapering asset purchases. Although the ECB did not announce a reduction in asset purchases this month, Draghi signaled that they have enough confidence to make a decision in October over December. The central bank also raised their 2017 GDP forecast from 1.9% to 2.2%, which would be the strongest pace of growth since 2007. While they reduced their 2018 inflation forecast, the 0.1% drop was small and they left their forecast for 2017 unchanged. Draghi did not forget to mention the euro but his comments were relatively benign — he simply said the exchange rate is not a policy target but as it is important for growth and inflation, they must take it into account in their decisions. Between the ECB’s plans to reduce QE purchases in October, their upgraded GDP forecasts, limited concerns about the euro and our negative outlook for the U.S. dollar, we expect the EUR/USD to rise into the October meeting taking out 1.2135, an area where EUR/USD found support in 2010 and 2012 before making its way to 1.22. There are a handful of U.S. economic reports scheduled for release next week, none of which is exceptionally market moving. The Swiss National Bank also has a monetary decision and no changes are expected and they will continue to express concerns about a strong currency even though the Swiss franc weakened significantly in recent months.
The focus now shifts to sterling, which has performed extremely well against the U.S. dollar and euro over the past week with GBP/USD gaining more than 300 pips. The primary catalyst for the GBP/USD’s rise was U.S. dollar weakness because the PMI services and composite indices eased in August. That will change however in the week ahead when U.K. data dominates the calendar. Inflation, employment and consumer spending numbers are scheduled for release along with a Bank of England monetary policy announcement. Unlike other major central banks, the BoE has no immediate plans to change policy. When they last met, they voted 6-2 to leave interest rates unchanged, cut their forecasts for GDP and wage growth and expressed concerns about a “smooth transition to a new economic relationship with the EU.” Governor Carney said the bank’s forecast revisions factor in “uncertainty about the eventual shape of the U.K.’s relationship with the EU, which weights on the decisions of businesses and households and pulls down both demand and supply.” Since then we’ve seen continued weakness in consumer spending and inflation, which is why we don’t expect the BoE to veer away from their cautious tone. Yet we are looking for consumer prices, retail sales and labor-market activity to improve in August so GBP could rise in the front of the week and fall at the end if the BoE is more cautious than optimistic.
One of the best-performing currencies last week was the Canadian dollar, which hit a 2.5-year high on the back of the Bank of Canada’s 25bp rate hike. Although the market expected the BoC to be hawkish, they did not anticipate back-to-back tightening at a meeting without a press conference. But perhaps that was exactly what the BoC wanted, which is to tighten and then stay mum until they see how the markets and the economy absorb the move. They also felt that they could not wait any longer with the economy running on all cylinders. They said removal of some of their considerable stimulus was warranted with growth becoming more broad based and self sustaining as business investment and exports were solid. The timing of the move has investors and economists looking for a third round of tightening this year. Although Friday’s mixed labor-market report eased some of the gains in the loonie, it will not be enough to halt the currency’s rise. More than 22K jobs were created in August. This 9th straight month of gains helped to take the unemployment rate down to 6.2%, the lowest level in nearly 9 years. Investors weren’t happy that all of the gains were part time as -88K full-time jobs lost, but the fact that Canada continued to add jobs at a healthy rate is a sign of strength for the economy. For this reason, we still expect USD/CAD to make a run for 1.20. Yet with no major Canadian economic reports scheduled for release next week we could also see profit taking.
The Australian dollar had a good week thanks to the RBA’s optimism with AUD/USD climbing to a 2-year high. The Reserve Bank left interest rates unchanged after RBA Governor Lowe said lower rates would add to risk in household balance sheets. Investors interpreted these views as positive for the currency because it increases the chance of a rate hike, albeit marginally. With that in mind, retail sales stagnated in July, the trade surplus contracted, service-sector activity slowed and GDP growth fell short of expectations. Next week’s labor-market numbers aren’t expected to help the currency because weaker labor-market activity was seen in the manufacturing- and service-sectors according to the latest PMI reports. If that’s the case, AUD may retreat off its highs and Friday’s intraday reversal is a sign that AUD/USD is already beginning to lose momentum. The New Zealand dollar also ended the week higher versus the greenback but underperformed its peers despite the first uptick in dairy prices in 2 months. With no New Zealand data on next week’s calendar, the NZD will take its cue from risk appetite and the market’s demand for U.S. dollars.
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