By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Thanks to President Trump’s promise to announce “something phenomenal on taxes in the next 2 to 3 weeks,” the U.S. dollar along with U.S. stocks and bond yields soared on Thursday. For the past few days, forex traders have been waiting for a catalyst to take USD/JPY out of its tight 111.60-112.50 trading range and Trump’s comments were a gift to the bulls. These were the very same promises that drove the dollar sharply higher after the election, so it is no surprise that investors were excited about their prospects. Does this remove the risk of a deeper correction in the U.S. dollar? No. But it's a welcome distraction from the president’s attempts to talk down the currency.
While we can’t forget that one of President Trump’s main policy goals is to strong-arm other countries into strengthening their currencies, for the time being the market has found an excuse to revisit the Trump trade and this sentiment could last through the new trading week. There has been very little U.S. data on the calendar this week and that remains true for Friday. Today we learned that jobless claims dropped to its lowest level since November, which supports the Federal Reserve’s assessment of improving labor-market conditions. And while continuing claims ticked up slightly, that did not draw away from the positive tone of the overall report. Import prices and the University of Michigan Consumer Sentiment index are scheduled for release on Friday. We heard from Fed Presidents Bullard and Evans today. Bullard -- not a voting member of the FOMC this year -- did not see reason for a hike in March as he did not believe that fiscal uncertainty would be resolved by then. Evans, who is a voting member this year, repeated his call for gradual tightening. Neither of these comments had much impact on the greenback.
Friday's main focus is on Prime Minister Shinzo Abe’s meeting with President Trump. Trade and currency will be on the agenda and both gentleman have vastly differing views. Trump has criticized Japan for deliberately weakening the yen to boost exports and gain an unfair trade advantage over the U.S. He also criticized the country for giving U.S. producers very little access to the Japanese auto market. Abe is likely to defend the country’s currency policy and its auto sector, stressing that its monetary policy and its affect on the currency is targeted to boost inflation and not competitive devaluation. Chances are Trump will be less deferential than Abe, which could stifle USD/JPY’s rally.
While USD/JPY was the day’s best-performing currency, NZD/USD was the worst. The currency sold off aggressively after the Reserve Bank of New Zealand’s monetary announcement. Although the RBNZ left interest rates unchanged and Governor Wheeler said the easing bias has been removed -- describing current policy as “very neutral” -- traders latched onto the central bank’s call for a lower currency. He said the New Zealand dollar remains higher than sustainable for balanced growth and that a decline in the exchange rate is needed. We are a bit surprised by the magnitude of the decline in the currency because Wheeler’s comments were relatively upbeat. But perhaps the market did not anticipate anything controversial from the Governor as he prepares to step down in September. Instead, he placed greater weight on the views of Assistant Governor and Head of Economics McDermott, who said the central bank wants to make sure inflation will hit 2% before tightening since the strong currency will continue to press down tradables inflation. We're looking for further weakness in the New Zealand dollar, particularly versus the euro, British pound and Aussie.
The Australian dollar held up extremely well in the face of U.S. dollar strength thanks to comments from Reserve Bank of Australia Governor Lowe and steady business confidence. He said it is hard to say if the Australian dollar is too strong given the reasonable growth outlook. This view should help fuel further gains in AUD/NZD. China’s trade balance was due Thursday evening and the outcome of the report could have a significant impact on AUD and NZD -- especially if the trade surplus rises as much as economists anticipate. Of the 3 commodity currencies, however, the greatest volatility on Friday should be in the Canadian dollar. Canada releases its monthly employment report and after the sharp rise in December, a steep pullback is expected in January.
Both euro and sterling traded lower against the greenback. Euro resumed its slide against the U.S. dollar on the back of weaker economic data. Germany printed a trade balance of €18.4b for December, slightly lower than the €20.5b expected. The current account balance for Germany also shrank to a surplus of €24.0b vs. €24.8b expected. These disappointments caused the currency pair to give back all of Wednesday’s gains to end the day firmly below 1.07. Sterling, on the other hand, reversed violently after hitting a high of 1.2582 during the European trading session. In contrast to the Eurozone, U.K. data was better than expected. RICS’ house price balance saw an uptick of 25%, increasing from 23% the prior month and beating the 22% expected. As with the rest of the majors, however, things turned south after Trump pledged to announce tax-cut plans in the next 2-3 weeks. There are no Eurozone economic reports scheduled for release Friday but the U.K.’s industrial and manufacturing production are on tap.