By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar has fallen for 5 straight days as Thursday’s decline took the Dollar Index to its lowest level since June 24 -- the day Britain voted to leave the European Union.Thursday morning’s U.S. economic reports should have helped the dollar but the selling pressure was too strong. The low level of jobless claims, uptick in the Philadelphia Fed index and increase in leading indicators was simply not enough to convince investors that the Fed is seriously considering another rate hike this year. The fed may be open to the idea but the market clearly believes that it needs to see consistently strong data to justify tightening this close to the U.S. Presidential election. December, on the other hand, is open for discussion, especially since it is an important meeting where the Fed will release its latest economic projections and Janet Yellen will deliver a press conference. If the fed were to raise rates this year, it would happen days before Christmas -- when Americans are well into their holiday shopping.
Unfortunately there’s still 4 months before the December meeting and there’s zero chance the Fed will raise rates in September or November. So in order for the dollar to bottom, we need overwhelmingly positive data and there’s nothing powerful enough to shift negative sentiment until Janet Yellen’s Jackson Hole speech next Friday ahead of U.S. nonfarm payrolls in the beginning of September. Which means the dollar will either continue to fall, consolidate for the next week or experience shallow bounces. USD/JPY is still struggling around 100 and while a move to 101 is possible, the chance of a new August high above 103 is unlikely whereas we could see numerous attempts below 100. At the end of the day, we believe the June low of 99 will hold, but USD/JPY has set a new lower range.
Thursday's best-performing currency was the British pound, which soared on the back of a strong retail sales report. Every piece of data we have seen this week indicates that the economy did not collapse as a result of Brexit. Yes it's early, but between the stronger inflation, employment and consumer spending report, Brexit fears may be overblown. A stronger retail-sales report was anticipated but a 1.4% increase blew away the market’s 0.1% projection. The weak sterling attracted tourists, the hot weather boosted demand for clothing and discounting kept consumers coming to the stores. If spending grows 0.5% or more in August and September, we could be looking at a very strong Q3 GDP report. However for the time being, with short sterling positions still near record highs, there should be more short covering with GBP/USD poised to rise above 1.32 and EUR/GBP to drop to 85 cents.
The euro also extended its gains for the 7th out of 8th straight trading day despite a smaller current account surplus and a larger-than-anticipated drop in consumer prices. The account of the July ECB meeting provided no fresh insight into monetary policy but ECB member Praet warned that weak price pressures are an ongoing concern. The only takeaway from the ECB report was that it did not want to foster “undue expectations on policy path,” which means it doesn't want to fuel speculation for more easing -- especially if it has no intention of so doing. Euro is clearly benefitting from anti-dollar flows, rising to its strongest level since the U.K. referendum. There’s resistance at 1.1350, but the main area to watch is the pre-Brexit high of 1.1425.
Thursday's second-best performing currency was the Canadian dollar. Nine trading days have past without a pullback in the currency, the longest stretch since December 2010. The sell-off in USD/CAD coincides with the sharp rise in oil. Crude price settled at its strongest level since July 7. The loonie is in play Friday with retail sales and consumer prices scheduled for release. While economists are looking for spending to rise, last month’s weak employment numbers leave the door open to a downside surprise. Both AUD and NZD held onto their gains. There was no data from New Zealand but overnight, the Australian dollar briefly punched past 77 cents after Australian labor-force data came in stronger than expected. More than 26K jobs were created, well above the 10.0k forecast. The unemployment rate for the country also dropped from a previous reading of 5.8% to 5.7%. However there was a major decline in full-time jobs of -45.4k full time jobs, the largest decline in nearly 3 years. Investors were satisfied that part-time work made up for the difference but at the end of day, we view the contraction in permanent work as negative for the economy and the currency. That said, AUD and NZD are trading on the market’s (lack of) appetite for U.S. dollars and for these currencies to peak, that sentiment has to change.