By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Monday was a great day for the U.S. dollar. The greenback rose against most of the major currencies as the S&P 500 hit record highs and Treasury yields moved spiked up. Some investors may be surprised by the strength of U.S. stocks but the prospect of additional policy action in Japan sent global equities higher. We are now looking at imminent liquidity injections from Japan and the U.K. with possible moves in the Eurozone and Switzerland. The Italian banking crisis makes the ECB nervous and the futures market is pricing in an 80% chance of a SNB rate cut later this year. Helicopter money is good for stocks but central banks are applying a band-aid to a wound that will worsen before it improves. Policymakers want to be proactive but we are looking at another 1 to 2 months of weaker global data that will have investors wondering if more needs to be done. In other words, don't expect this to be a smooth, one-way uptrend for stocks.
As for USD/JPY, Prime Minister Abe won the election over the weekend by a landslide and afterwards he pledged to provide a new round of fiscal stimulus to bolster the economy. No specifics have been announced but the possible combination of fiscal and monetary stimulus drove USD/JPY up 2% Monday. We have long argued that Japan needs this type of coordinated action to permanently reverse the trend of USD/JPY. We now expect USD/JPY to trend higher until an announcement is made. Timing-wise we think this will coincide with a BoJ meeting. With 102 broken, 104 is the next major resistance level for the pair. The U.S. dollar's share of the trade may provide some obstacles with retail sales scheduled for release later this week but there are 9 Federal Reserve Presidents speaking (3 are FOMC voters) and George, who's first to speak, had more positive than negative things to say about the outlook for the economy and monetary policy. As a voting member of the central bank, she was encouraged by the stronger jobs number and worried that keeping rates too low carries risk. She felt that inflation is rising and noted that new construction is unable to keep up with housing demand. It appears that Brexit failed to spook one of the most hawkish members of the FOMC.
It was a rollercoaster ride for sterling Monday with GBP/USD testing 1.30 on four separate occasions. Politics is the big story in the U.K. as Theresa May is set to become Britain's second female Prime Minister. After Andrea Leadsom dropped out of the race, Prime Minister David Cameron announced that he would transfer power to the new leader of the Conservative Party by Wednesday evening. He clearly wants out of the job as quickly as possible. This swift transfer of power eliminates one major uncertainty for the U.K. -- who will lead Brexit talks -- but leaves many questions unanswered. Investors will be keen to see how quickly May invokes Article 50 and chances are she'll bide her time to craft negotiation tactics with the EU before pushing forward with the irreversible decision. While the official departure of Cameron could lead to a relief rally for sterling, the recovery should be short-lived. We like selling GBP/USD between 1.3040 and 1.3150.
Euro ended the day unchanged against the greenback. Since breaking below the 200-day SMA last week, the currency pair remains under pressure and is vulnerable for another test and possible break of 1.10. The ECB continues to buy bonds with its purchases picking up steam over the past week. Reports of Italy's banking troubles continue to grow and while it may not be the biggest story in the financial market right now, it could become the headline in the coming months. There's not much in the way of Eurozone data this week and no major speeches from policymakers are scheduled, so the direction of the euro could largely hinge on the market's appetite for U.S. dollars. Meanwhile the pressure is growing for the Swiss National Bank to increase stimulus. Switzerland is not immune from Europe's troubles and recent data has been weak with manufacturing activity slowing, consumer price growth remaining low and retail sales continuing to fall.
All three of the commodity currencies traded lower against the greenback Monday with the New Zealand dollar experiencing the greatest losses. NZD dropped over 1% against the U.S. dollar, which was a much stronger decline than AUD and CAD. Interestingly enough New Zealand data was better than expected with credit card spending rising 1.2% in June. There was no specific reason for the sharp sell-off in NZD outside of the fact that it was one of the strongest-performing currencies last week. Which means the move was driven largely by profit taking. Australia also reported better-than-expected data with home loans falling by a smaller amount in May. The currency was dragged down by a stronger U.S. dollar and lower gold prices. The Canadian dollar also shrugged off stronger housing starts to trade lower on the back of falling oil prices. Oil was dragged down by an increase in OPEC oil production, which rose to a near 8-year high. There are no economic reports scheduled for release from Canada and New Zealand in the next 24 hours but Australia reports business confidence and credit card purchases. We expect USD/CAD to remain bid ahead of this week's Bank of Canada rate decision and AUD and NZD to recover as relative yield plays.