Has The U.S. Dollar Peaked?

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

With every tick lower in the U.S. dollar, investors are wondering if the greenback has peaked. After a tremendous rally in 2016, the mighty buck has struggled to extend its gains and is fumbling hard at the start of this new trading week. With no major U.S. economic reports scheduled for release until Friday, traders are taking their cue from yields. Ten-year Treasury rates dropped 5bp on Monday causing the dollar to fall against most of the major currencies. Sterling was the only currency to face greater selling pressure than the greenback and that was due entirely to the country specific Brexit concerns. Corrective forces may have taken over but it is still far too early to describe the latest pullback in the dollar and USD/JPY in particular as a peak. Last Friday’s jobs report has been viewed positively by all of the U.S. policymakers who have spoken since the release.

We’ve heard from at least 7 Federal Reserve Presidents since 8:30am NY Time on Friday and all of them said the U.S. is getting to, is at or below full employment. They largely agree that the employment component of the Fed’s dual mandate has been fulfilled and their tone indicates that despite the lower 156K payroll growth reported last month, they are ready to raise interest rates this year. In fact, FOMC voter Harker said he’s “penciled in for 3 rate increases” and even Evans -- also a voter and typically a dove -- said 3 Fed hikes in 2017 is “not implausible.” So while the dollar could fall further with USD/JPY slipping to 115, the uptrend remains in tact as long as the currency pair holds above 113. With that in mind, we expect buyers to swoop in near 115, especially as the fundamental story continues to support a rally in the greenback. No U.S. economic reports are scheduled for release on Tuesday, which means the dollar will take its cue from U.S. rates.

Monday's worst-performing currency was the British pound, which fell sharply against all of the major currencies. House prices rose significantly more than expected in December according to Halifax but the big story was Brexit and the growing possibility of a harder exit from the European Union. As reported by our colleague Boris Schlossberg Monday morning, “In a SKY interview PM May stated that UK could not expect to hold on to “bits” of its membership after leaving the EU, seeming to stress the “hard Brexit” line that UK would not compromise on the immigrant issue in return for access to the single market. Meanwhile, Scotland’s First Minister Nicola Sturgeon warned the Prime Minister that she was not “bluffing” over the prospect of a second Scottish independence referendum, which voted to stay in the EU and the idea of a “hard Brexit” is clearly unappealing to Ms. Sturgeon’s constituents. The currency markets were clearly spooked by the heated rhetoric with traders beginning to worry about the possibility of a hard Brexit and a diminished UK, which drove GBP/USD well below the 1.2200 mark toward 1.2125 before finally finding some support. Sensing that Ms. May may have overplayed her hand, the PM’s office quickly came out with a statement that UK wants the best deal within a single market, trying to assuage the markets and reassure its intent to negotiate for some sort of access. With PM May trying to do her best Margaret Thatcher imitation, prospects for some sort of a reasonable compromise appear bleak.” GBP/USD appears poised for a move to 1.2080 while EUR/GBP appears to be aiming for 88 cents.

In contrast, the euro moved higher against the greenback on Monday. Aside from broad-based U.S. dollar weakness, the currency also benefitted from stronger trade and current account numbers. Germany’s trade balance managed to show a larger-than-expected surplus with a report of 22.6b versus 20.3b expected. The current account balance also beat expectations, rising to 24.6b, a slight increase from the previous report of 22.1b. These improvements were driven by higher exports, which is a direct beneficiary of the lower euro. Unfortunately not all news was good. The Eurozone’s unemployment rate held steady in November while German industrial production rose less than expected. Thankfully, year-over-year IP increased by 2.2% vs. 1.9% expected.

All 3 of the commodity currencies managed to pull in gains against the US dollar, but the Canadian dollar really lagged behind. Although Canadian firms reported the highest hiring and investment plans since 2014, the currency could not escape the slide in oil. Crude prices tumbled nearly 4% on concerns about rising U.S. output and Iraqi exports. U.S. oil rigs increased for the 10th straight week to a count of 529 rigs while Iraq, OPEC’s second-biggest producer reported record production levels in December. Canadian yields also fell sharply, adding pressure to the loonie. The Australian and New Zealand dollars, on the other hand, traded strongly. Aside from the rise in gold prices, the latest string of Australia data was better than expected with construction-sector activity accelerating and building approvals rising more than anticipated. Retail sales are scheduled for release and we believe the risk is to the upside for the report following the improvement in service-sector activity.