By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
1.15. There's no shortage of reasons to explain EUR/USD's strength ranging from stronger Eurozone data, disappointing U.S. data to a rising German – U.S. 10-year yield spread. While the European Central Bank is in no position to raise rates, President Draghi acknowledged the improvements in the economy and the reduction in downside risks. If Tuesday’s German IFO and Eurozone PMI reports surprise to the upside, we could see EUR/USD hit 1.13. But 1.15 is a stretch ahead of next month’s Federal Reserve monetary policy meeting. According to Bloomberg, the market is pricing in 100% chance of a rate hike next month and so far we haven’t heard any Fed officials cast doubt on those expectations. The ECB won’t be happy with euro's recent climb — over the past 6 weeks, the currency appreciated approximately 6% and these gains will ease inflation as well as growth. So even if all of Tuesday’s very important Eurozone economic reports beat, EUR/USD will rise, but will still have a hard time reaching 1.15 unless there’s some reason for investors to doubt a June U.S. rate hike.
The U.S. dollar traded lower against most of the major currencies on Monday. No major U.S. data was released and of the 3 Federal Reserve presidents who spoke, only Kaplan touched on monetary policy. As a voting member of the FOMC, his call for 2 more rate hikes this year should not be discounted. U.S. rates have moved higher so while USD/JPY looks weak on a technical basis, fundamentally we believe that the greenback will rebound this week because the FOMC minutes are likely to reinforce the market’s expectations for tightening. If you recall, when the central bank met this month, it was overwhelmingly positive, choosing to ignore the disappointing payroll growth in March and the slowdown in retail sales. It described the data deterioration as “transitory” and said fundamentals underlying consumption growth stayed solid even as retail sales fell in April. So chances are this optimism will be echoed in the FOMC minutes, lending additional support to the greenback. Technically, USD/JPY's gains appear to be capped below 111.75 but we also believe losses should be limited to 110 for the time being. Given the technical structure of USD/JPY, perhaps the more attractive option would be to buy yen crosses, which would also benefit from any gains in USD/JPY.
Although sterling underperformed today, the fact that GBP/USD is still hovering near 1.30 is a sign of strength for the currency. At the same time, it hasn’t “cleared” it in a meaningful way, which means it is too soon to declare that GBP/USD has peaked at 1.30. According to our colleague Boris Schlossberg, cable is mildly weaker because of “news over the weekend that UK will walk away from Brexit talks if it is forced to pay massive exit bill of as much as $100 Billion. The French Finance Minister La Maire decided to pour salt on a wound by stating that Brexit will represent an opportunity for financial markets. The two sides are clearly preparing for tough negotiations, which begin formally June 19th. Cable has seen a very strong rally in anticipation of a large Tory win in the UK elections, but PM May’s lead has declined considerably and if she does not win an overwhelming majority her position at the bargaining table may be weakened.” It’s a quiet week for U.K. data so sterling traders will need to watch headlines and yields.
Monday's best-performing currency was the New Zealand dollar. With no New Zealand data on the calendar, the move was driven entirely by AUD/NZD selling. The Australian dollar underperformed after S&P lowered the credit scores of nearly a dozen financial institutions in the country. Property-market risk is becoming a growing problem in Australia as domestic and external (Chinese) demand begins to ease. USD/CAD traded near 1.35 for most of the North American session. Higher oil prices kept USD/CAD from rallying but investors are nervous about selling the pair further ahead of this week’s Bank of Canada and OPEC meetings. OPEC nations are headed for supply-cut extensions but it is not clear whether it will opt for a 6- or 9-month extension. Saudi Arabia and Russia prefer the longer time frame and it appears that Iraq is on board with the idea as well. Technically, there’s moving-average support for USD/CAD at 1.3480. If that level is broken, then it should be as swift slide down to 1.34.