By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The new trading week started with the U.S. dollar extending its gains. Although the greenback retreated during the NY session, the reversal did not occur until after EUR/USD hit a 1-month low and GBP/USD a 10-month low. The European currencies were hit the hardest but none of the majors escaped the dollar’s rally. Trade tensions and yuan weakness are the primary reasons why investors are buying dollars. After rising briefly after the People’s Bank of China hiked reserve requirements for FX forwards Friday, the yuan resumed its slide. We’ve gotten messages from our readers who are confused about why USD/JPY is rising and not falling on trade tensions and why the price gold is sliding and not strengthening. The general belief is that the Japanese yen should rise on risk aversion but it is not behaving like a safe-haven currency because Japan is heavily exposed to the trade war. China has been weakening its currency and the following USD/JPY and USD/CNY chart shows that USD/JPY is the poster child for the trade war. USD/JPY (the orange line) has been moving in lockstep with USD/CNY (white line) with the weakness of the yuan leading to weakness in the yen. Gold isn’t rising because the dollar is strengthening, causing prices to fall. Looking ahead, there are no major U.S. economic reports scheduled for release on Tuesday but with U.S. – Chinese trade tensions running high, the focus will be on the headlines.
The Australian dollar is in play tonight with a Reserve Bank monetary policy announcement. AUD/USD has been trading in a tight .7318 to .7464 range for the past month and is prime for a breakout. However it is not clear whether this month’s RBA rate decision will be enough to take the pair out of this range. When the RBA last met, it talked about progress in the labor market and pickup in inflation. Since then, we’ve seen even stronger job growth and rise in consumer confidence. Inflationary pressures eased slightly but still remain strong on a quarterly and annualized basis. The bad news is that manufacturing- and service-sector activity weakened and although the trade surplus increased significantly in June, it most likely worsened over the past month with the Chinese yuan falling to a 6 month low against the Australian dollar. So far, the RBA has refrained from commenting on slower growth in China and trade wars but U.S. – China trade tensions pose a serious risk to Australia’s economy that cannot be ignored. If Governor Lowe finally addresses it, AUD/USD will see fresh 1-year lows. However if they choose to ignore external risks once again and keep most of the policy statement unchanged, AUD/USD could head back to 75 cents. NZD/USD should remain weak ahead of RBNZ while USD/CAD traders eye Tuesday’s IVEY PMI report.
The worst-performing currency today was sterling as talk of a no-deal Brexit grows. Over the weekend, UK Trade Minister Fox said “the intransigence of the commission is pushing us towards no deal” and today, UK Government spokesman James Slack said Prime Minister May believes no deal is better than a bad deal. While they are still confident that a Brexit deal can be reached, the government is preparing for the possibility of no agreement. BoE Governor Carney acknowledged this risk last week and the broader government is starting to do so as well. GBP/USD fell to an 11-month low on the back of these headlines and with the 1.30 support level broken, the next stop for the pair could be its 1-year low of 1.2775.
Meanwhile, significantly weaker-than-expected German factory orders drove EUR/USD to a one-month low. The pair fell for the 5th consecutive trading day after investors learned that manufacturing orders dropped by the largest amount in 4 years. Despite the weakness of the euro, demand from non-eurozone nations fell sharply on trade uncertainty. On a year-over-year basis, sales fell for the first time since July 2016. This decline reflects the fall in investor confidence and business expectations. Given this drop, Tuesday’s German industrial production and trade balance numbers could also take a hit. With this in mind, EUR/USD ended the day much closer to its highs than lows so a further recovery is possible before we see a deeper correction.