By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
As tempting as it may be to ride the turns in euro, sterling and other major currencies, it would be wiser to refrain from taking major positions over the next 24 hours. Brexit negotiations are going well but the outcome of U.S.-China trade talks is still unknown and post-meeting headlines could easily reverse the rallies in currencies. If China and the U.S. leave the discussion table without plans for another meeting, the bulls will be crushed. The S&P 500 will descend from its record breaking levels, high-beta currencies like EUR/USD will retreat as the U.S. dollar will come roaring back. But China and the U.S. say the talks went well and more meetings will follow, the rally will continue.
President Trump doesn’t think much will come out of this week’s meeting and he’s probably right but the bar isn’t high. Investors are optimistic and any hint of good news could be enough to satisfy the bulls. If the U.S. and China simply agree to talk some more, it would be enough to give the market hope that the tariffs at the end of the month will be stalled. If that’s the case, all of the major currencies should rally including USD/JPY, which could hit 111. The Fed minutes will also help the greenback by reinforcing the central bank’s plans for September tightening.
Meanwhile, Tuesday's best-performing currency was sterling. GBP shot higher after Michel Barnier, EU’s Chief Brexit negotiator said negotiations have reached the final stage and they will hold continuous negotiations from here on forward. Brexit Secretary Dominic Raab said he is confident they will have a deal by the next European Council Summit on October 18. Barnier’s eagerness to cooperate should be the perfect excuse for a short-covering rally. Although GBP/USD’s move on Tuesday stopped at the 20-day SMA, we believe that the pair will break 1.30. We like selling EUR/GBP in particular because Italy’s troubles aren’t going away and could lead to the underperformance of euro vs. pound. With that in mind, EUR/USD leaped above 1.15 to trade as high as 1.1601 on an intraday basis. With no Eurozone data or news, the move was driven entirely by short covering, stops and the risk rally.
The Australian dollar is particularly sensitive to the outcome of the U.S.-China talks. If they agree to meet again, AUD/USD could extend its gains beyond 74 cents. However if the talks go nowhere, AUD/USD could find its way back to .7250. The RBA minutes had very little impact on the currency. Iron ore prices fell sharply and Prime Minister Turnbull’s weak victory has some investors worried. The New Zealand dollar performed particularly well, which is surprising given the sharp decline in dairy prices. There’s been no relief for one of the country’s most important industries and while the currency is being propelled higher by short covering, the second steepest decline in dairy prices in at least 5 months won’t bode well for the economy. Second quarter retail sales numbers were due for release Tuesday evening and softer data could cause NZD/USD to reject the 20-day SMA at 67 cents.
Last but certainly not least, the Canadian dollar will be in play Wednesday with retail sales scheduled for release. Despite the strength of the labor market, Tuesday’s sharp decline in wholesale sales suggests that retail sales will be weak. Economists are already looking for spending growth to contract after rising strongly in May but the recent strength of the Canadian dollar suggests that investors are not positioned for a soft number. If retail sales falls more than expected, we could see USD/CAD trade back to 1.31 easily.