By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
U.S. stocks started the week with a rally strong enough for market participants to hope that the panic selling is over. Between Friday’s positive close and today’s nearly 2% rally in the Dow Jones Industrial Average, this classic reversal structure certainly gives investors reason for optimism. Even with today’s 400-point rise in the Dow, currencies failed to follow as USD/JPY ended the day unchanged, while EUR/USD and AUD/USD mustered small rallies. Some currencies like the Canadian and New Zealand dollars extended their losses, albeit modestly. FX traders were initially pleased with the budget deal to reopen the government, but they are not as encouraged by President Trump’s budget proposal for 2019 that signaled a disregard for the deficit. No U.S. economic reports were released but with 10-year Treasury yields hitting fresh 4-year highs today, the equity market and the U.S. economy are still in the danger zone. While we expect equities to trade a bit higher and the yen crosses to follow suit, there will be waves of choppiness in the weeks ahead, unless yields start to fall in a meaningful way.
One of our favorite currencies this week is the euro. It is finding nice support above 1.2200 and is positioned for a stronger move above 1.2300. The Eurozone economy is performing very well and while we are bearish German GDP, the risk is to the upside for this report. Let's not forget that stronger end-of-year growth encouraged the central bank to consider changing guidance and if the recovery in stocks is real, high-beta currency pairs like EUR/USD should be a big beneficiary. Should EUR/USD break above the January 17 swing-high and 20-day SMA near 1.2330, then it's clear sailing to 1.24.
With consumer prices scheduled for release, Tuesday should be a busy day for sterling. Although the recent rise in the currency and decline in shop prices point to softer CPI growth, the Bank of England’s hawkishness and Governor Carney’s view that domestic inflationary pressures are likely to firm suggests that the risk is to the upside. Even if CPI falls more than expected, investors may look past the report after the central bank pushed the message that rates may need to rise earlier and faster than what they had seen in November. Brexit worries have kept the currency down but if data beats, it could shift the focus back to monetary policy.
Monday's best-performing currency was the Australian dollar, which traded sharply higher against the greenback. As a high-beta currency, it is not unusual to see AUD trade well when stocks recover, especially after the deep slide that it experienced over the past 2 weeks. Gold, iron ore and copper prices are also up across the board, providing additional support to the currency. We think further gains are likely up to at least 78 cents. The New Zealand and Canadian dollars, on the other hand, ended the day lower against the greenback despite higher credit card spending in New Zealand. No data was released from Canada but an intraday reversal in oil prices (crude was up 2% before settling up only 0.19%) kept the currency hovering near 1.26.