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Behind US Dollar Weakness and its Potential Recovery

Posted on: 08 February 2018 , by: Boris & Kathy , category: Market Review

FX Weekly with Boris and Kathy

January is shaping up to be the worst month for the U.S dollar since Jan 2017. The Dollar Index declined week after week and this latest leg drove the greenback to its lowest level in 3 years.

With a relatively light U.S. economic calendar this past week, very few investors expected big moves. Yet the greenback sold off against all of the major currencies, losing 3% of its value against the Swiss Franc, 2% against sterling and 1.8% against the Japanese yen. This decline took EUR/USD to 3 year high and AUD/USD to a 2.5 year high. Further gains were also seen in other major currencies but the milestones were less significant. Official rhetoric and central banks rocked the markets, leading to unusually wild swings in FX. As tempting as it may be to pick a bottom in the dollar or fade the rally in stronger currencies, trends in the forex market can last longer and extend further than most would anticipate so its premature to assume that the end of week rebound off the lows marks a bottom for the greenback and a top for other currencies.

5 Day Return vs. USD 22 January - 26 January 2018

US DOLLAR

Data Review

  • House Price Index 0.4% vs. 0.5% Expected
  • Manufacturing PMI 55.5 vs. 55 Expected
  • Services PMI 53.3 vs. 54.3 Expected
  • Composite PMI 53.8 vs. 54.1 Prior
  • Existing Home Sales -3.6% vs. -1.9% Expected
  • New Home Sales -9.3% vs. -7.9% Expected
  • Advance Goods Trade Balance $-71.6b vs. $-68.9b Expected
  • GDP Annualized 2.6% vs. 3.0% Expected
  • Personal Consumption 3.8% vs. 3.7% Expected
  • Core PCE 1.9% vs. 1.9% Expected
  • Durable Goods Orders 2.9% vs. 0.9% Expected
  • Durables Ex. Transportation 0.6% vs. 0.6% Expected

Data Preview

  • Personal Income, Personal Spending and PCE Deflator- Higher wages will be offset by weaker retail sales
  • Consumer Confidence- Potential for downside surprise given sharp decline in University of Michigan Index
  • Employment Change- ADP is important leading indicator for NFP but hard to predict
  • Chicago PMI and Pending Home Sales- Potential for downside surprise given weaker Empire State and Philly Fed
  • FOMC Rate Decision- Yellen's last FOMC meeting not expected to be big mover
  • ISM Manufacturing- Will update after Chicago PMI but Empire and Philly Fed were both weaker pointing to softer release
  • Non-Farm Payrolls- NFP is incredibly market moving but hard to predict and best traded reactively
  • Trump First State of the Union Address

Key Levels

  • Support 108.00
  • Resistance 110.00

There are no shortages of factors driving the U.S. dollar lower. On a broad basis, stronger global growth makes U.S. assets less attractive especially during a time when investors are worried about trade wars and the country’s fiscal finances. In the latest week, however, it was the Bank of Japan’s inflation language tweak, stronger data abroad, the U.S.’ solar import tariff, Treasury Secretary’s comment about the benefits of a weaker dollar and softer U.S. data that sent the greenback tumbling lower. At the end of the week, President Trump tried to walk back those comments by saying they were taken out of context and the U.S. supports a strong dollar policy and Bank of Japan Governor Kuroda did the same when he said in Davos that they did not revise inflation outlook. Confusion about policy only compounded the volatility. Add to that the weakness of jobless claims, housing data, trade balance and Q4 GDP and its no surprise that investors are reluctant to trust the dollar’s recovery. 

Technically, the dollar is due for a bounce but on a fundamental basis, there needs to be a catalyst. It could range from anything like comprehensive central bank jawboning to intervention talk, other comments from government officials, data or a sudden correction in U.S. stocks. All of this is plausible given the aggressive moves in currencies and equities but its also speculation because until it happens, bears will remain in control. Looking ahead, there’s certainly no shortage of catalysts for a dollar reversal. The Federal Reserve will hold its first monetary policy meeting of the year, non-farm payrolls are scheduled for release and President Trump will deliver his first State of the Union Address. We don’t expect much volatility off of this month’s FOMC meeting because the most important part of this meeting is that it will be Janet Yellen’s last. With no press conference, she’ll go out quietly leaving most of the FOMC statement unchanged. Since the last policy meeting, there’s been slightly more deterioration than improvement in the U.S. economy so there’s very little reason for Yellen to change the Fed’s tune right before she passes the baton over to Powell. With that in mind, there have been significant changes to market dynamics with the dollar falling which is inflationary, 10-year yields rising 25bp and the S&P shooting up 7% to fresh record highs. Its hard to predict whether Trump’s State of the Union will be market moving – he will certainly tout the gains in stocks and the performance of the economy, but he could also inflame trade tensions and set back U.S. funding talks. Non-farm payrolls are the wildcard. Job growth slowed significantly last month but wage growth was strong – economists are looking for payroll growth to accelerate and wages to hold steady but that’s unlikely to be the case. However if the dollar truly turns and other currencies succumb to profit taking, the corrections could be sharp and aggressive. 

US Economy - Federal Reserve Meeting


BRITISH POUND

Data Review

  • ECB Keeps Rates Steady at 0.00% as Expected
  • GE ZEW Survey Current Situation 95.2 vs. 89.5 Expected
  • GE ZEW Survey Expectations 20.4 vs. 17.7 Expected
  • EZ ZEW Survey (Economic Sentiment) 31.8 vs. 29 Prior
  • EZ Consumer Confidence 1.3 vs. 0.6 Expected
  • GE Manufacturing PMI 61.2 vs. 63 Expected
  • GE Services PMI 57 vs. 55.5 Expected
  • GE Composite PMI 58.8 vs. 58.5 Expected
  • EZ Manufacturing PMI 59.6 vs. 60.3 Expected
  • EZ Services PMI 57.6 vs. 56.4 Expected
  • EZ Composite PMI 58.6 vs. 57.9 Expected
  • GE GfK Consumer Confidence 11.0 vs. 10.8 Expected
  • GE IFO Business Climate 117.6 vs. 117 Expected
  • GE IFO Expectations 108.4 vs. 109.2 Expected
  • GE IFO Current Assessment 127.7 vs. 125.3 Expected

Data Preview

  • EZ Economic and Consumer Confidence - Stronger ZEW means stronger confidence
  • EZ Q4 GDP – Tough call as weaker EZ trade offset by slightly stronger retail sales
  • GE CPI- Potential for upside surprise given slightly stronger PPI and PMI’s
  • GE Employment Report and EZ Unemployment Rate- Will update after GE CPI but slightly stronger PMI’s    
  • GE and EZ Manufacturing PMI- Revisions are hard to predict but can be market moving
  • EZ PPI- Potential for upside surprise given stronger GE and FR PPI

Key Levels

  • Support 1.2300
  • Resistance 1.250

While euro was not the best performing currency this past week (that title goes to the Swiss Franc) it was one of the biggest stories as the European Central Bank basically endorsed the currency’s slide by focusing on the strength of the economy. Data was healthy all around with PMIs, ZEW and IFO beating expectations. Although ECB President Draghi said euro volatility creates uncertainty, the main takeaway from the ECB meeting is that they are optimistic and satisfied with the performance of the economy. According to Draghi, economic momentum remains solid and broad-based, which could lead to positive growth surprises and gradual increases in core inflation over the medium term. In response, the EUR/USD broke through 1.25, rising to its strongest level since December 2014.  While fundamentals and the central bank’s lack of concern support further euro gains, on a technical basis, the pair’s inability to hold above 1.25 invited profit taking. If EUR/USD fails to recapture 1.2470, it could slip back down to 1.22 on nothing more than a technical correction. Looking ahead, inflation, confidence and employment numbers are scheduled for release from Germany but the market’s appetite for U.S. dollars could have a more significant impact on the currency’s trade. The Swiss Franc was the best performer, rising nearly 3 percent against the greenback – these along with previous gains sparked concerns by the Swiss National Bank who warned that they could intervene if necessary. 


EURO

Data Review

  • CBI Trends Total Orders 14 vs. 12 Expected
  • CBI Trends Selling Prices 40 vs. 23 Prior
  • CBI Business Optimism 13 vs. -11 Prior
  • Claimant Count Rate 2.4% vs. 2.3% Prior
  • Jobless Claims Change 8.6k vs. 12.2k Prior
  • Avg Weekly Earnings 2.5% vs. 2.5% Expected
  • Weekly Earnings ex Bonus 2.4% vs. 2.3% Expected
  • ILO Unemployment Rate 4.3% vs. 4.3% Expected
  • Employment Change 102k vs. -12k Expected
  • GDP 1.5% vs. 1.4% Expected

Data Preview

  • UK PMI Manufacturing – Slightly lower CBI index points to a softer report but the components were weaker

Key Levels

  • Support 1.4000
  • Resistance 1.4300

The prospect of a Brexit deal this year, U.S. dollar weakness, risk appetite and stronger U.K. data helped propel GBP/USD above 1.43 making sterling the second-best performing currency this week. Public sector finances beat expectations, earnings grew at a faster pace in November after a strong October and GDP growth accelerated in the last 3 months of the year. 2018 will be the year that a Brexit deal gets done and all signs point to continued progress. Recent comments from Bank of England Governor Carney were also positive with the central bank head looking for the global growth to accelerate and for the U.K. to recouple with the rest of the world. Despite these developments, sterling was driven higher primarily by U.S. dollar weakness and we expect that to remain the case in the coming week as the manufacturing and construction sector PMI reports are the most significant releases on the U.K. calendar. Technically, the 2 flameout candles at the end of the week are concerning particularly as the peaks come right underneath the 200-week SMA. If GBP/USD fails to recapture 1.43, the next stop will be 1.40. 


AUD, NZD, CAD

Data Review

Australia

  • Westpac Leading Index 0.27% vs. 0.05% Prior

New Zealand

  • PMI Services 56.0 vs. 56.5 Prior
  • CPI 1.6% vs. 1.9% Expected

Canada

  • Retail Sales 0.2% vs. 0.8% Expected
  • Retail Sales Ex. Auto 1.6% vs. 0.9% Expected
  • CPI -0.4% vs. -0.3% Expected

Data Preview

Australia

  • Q4 CPI- Potential for downside surprise given significantly lower food prices. Unchanged consumer inflation expectations
  • CH Non-Manufacturing and Manufacturing PMI- Chinese data is very market moving but hard to predict
  • AiG PMI Manufacturing- Potential for downside surprise as strong AUD could negatively affect activity
  • PPI - Will have to see how CPI fares

New Zealand

  • Trade Balance- Potential for upside surprise given sharp improvement in Nov PMI report, uptick in dairy prices

Canada

  • GDP- Potential for downside surprise given significantly weaker trade and weaker retail sales data

Key Levels

  • Support AUD .8000 NZD .7250 CAD 1.2250
  • Resistance AUD .8200 NZD .7450 CAD 1.2500
The Australia, New Zealand and Canadian dollars continued to trade higher versus the greenback despite softer data and lower commodity prices. Gold may be up but iron ore prices have fallen sharply and there’s been quite a bit of volatility in copper. None of that mattered to the Australian dollar, which rose to its strongest level since May 2015. These gains will take a bite out trade and inflation but given that the 6 cent move only began in mid-December, we may not see evidence of that until next month’s economic reports. With that in mind, consumer and producer prices could still fall short of expectations with food prices falling towards the end of the year. Although AUD/USD is still well off its 5 year high, the velocity of the recent move could invite jawboning from the Reserve Bank of Australia. The Australian and New Zealand dollars are the most vulnerable to profit taking, especially NZD which rose 600 pips in 6 weeks on the back of softening data. Consumer price growth slowed materially at the end of the year and could fall further given the recent strength of the currency. Considering that the New Zealand dollar was trading at its weakest level in 18 months in late November, early December next week’s trade balance is expected to improve. However, if NZD/USD breaks 73 cents, the next stop could be .7150.
 
USD/CAD traded lower 4 out of the last 5 trading days despite mostly weaker data. Consumer prices fell -0.4% in the month of December, driving the year over year rate down to 1.9% from 2.1%. Retail sales growth also slowed to 0.2% in November after rising 1.6% the previous month but a sharp 1.6% rise in sales highlighted the underlying demand of Canadian consumers. Part of the reason why the loonie did not respond to these softer reports is because investors are looking at these releases as a natural pullback after a few months of strong data. Oil prices have also been on tear and Western Canada Select prices are finally perking up. Although the risk is to the downside for next week’s Canadian GDP report, the downtrend remains intact for USD/CAD.