By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Dollar bulls came charging back Monday and they took the greenback higher against all of the major currencies. The biggest gainer was USD/JPY, which experienced its largest one-day rise in 4 months. There are at least 3 reasons to explain USD's comeback. First and foremost, investors were relieved that Hurricane Irma did not cause as much damage to Florida as Harvey did to Texas. Up until the very last moment as Irma barreled toward Florida as a Category 5 hurricane, everyone was bracing for the worst and while some Caribbean nations were devastated, Floridians were mostly spared extensive damage. North Korea also refrained from launching another missile over the weekend and there were early reports that they may be willing to talk with the U.S. So an Irma relief rally is the primary reason why the U.S. dollar and U.S. stocks traded sharply higher on Monday. Ten-year Treasury yields also jumped 8bp and this important because USD/JPY takes its cue from U.S. yields. Lastly, having fallen from 114.50 to 107.30 in 3 months, USD/JPY is due for a short squeeze and a significant reversal is expected given the aggressiveness of the recent decline.
Everyone is now wondering if USD/JPY will continue to rise or back off at the 20-day SMA. Technically, Monday’s rally stopped short of the 20 period simple moving average, which would be a natural place of resistance. Fundamentally, North Korea’s troubles are not behind us because toward the end of the day, the country’s foreign ministry said the U.S. will pay “due price” if new UN sanctions are approved. The U.N. Security Council is slated to vote on North Korea this evening. But technically, whenever we see such a strong move in USD/JPY, continuation is more likely than reversal. There are no major U.S. economic reports scheduled for release until Wednesday so unless the U.N. imposes new sanctions on North Korea and they retaliate either verbally or physically, we would not be surprised if USD/JPY hit 110. Eventually, sellers will sweep in as the fundamentals weighing on the dollar have not changed. Technically, 110 is the next major resistance level for USD/JPY but the pair could extend as high as the 50-day SMA near 110.70.
The rally in the U.S. dollar sent EUR/USD tumbling below 1.20. On Friday we said the euro is headed higher because of the central bank’s plans to reduce QE purchases, its upgraded GDP forecast and its limited concerns and while we continue to hold onto these views, investors may have the opportunity to buy below 1.19. At this stage it pays to wait for EUR/USD to stabilize before jumping in because Monday’s reversal could have continuation. No Eurozone economic reports were released but ECB member Coeure expressed concern about euro volatility, saying FX shocks could have an undesirable affect on inflation and financial conditions. With no major Eurozone economic data scheduled for release this week it looks like euro will take its cue from the market’s appetite for U.S. dollars.
Sterling also fell victim to U.S. dollar strength but it managed to rise strongly against the euro ahead of this week’s Bank of England monetary policy announcement. The currency’s resilience suggests that investors are positioning for hawkishness, which we find a bit surprising considering the central bank’s dovish views last month. However a number of U.K. economic reports are due for release this week and if they are strong, we could see more optimism from the BoE starting with Tuesday’s CPI report. The central bank recently downgraded its outlook for inflation but a smaller decline in shop prices and faster price growth in the manufacturing and service sectors in August point to a recovery. As such, we like buying GBP versus EUR, JPY and AUD for some near-term gains.
The Canadian dollar was the only currency that managed to withstand the greenback's rise. The loonie traded higher despite early losses as oil prices rose 1.2%. Housing starts also increased, which was a surprise as economists had been looking for a decline. Refineries in the U.S. are also restarting, which could be contributing to the moves in oil. Ultimately, the outlook for the Canadian dollar remains bright with the market looking for another rate hike this year. The Australian and New Zealand dollars, on the other hand, lost ground to the U.S. dollar. No data was released from Australia but gold and copper prices declined. Credit card spending in New Zealand was mixed with retail spending falling but total spending rising. On a technical basis, both currencies appear poised for further losses.