By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It was a quiet day in the foreign-exchange market with the U.S. dollar trading lower against most major currencies. The only piece of U.S. data on the calendar was the Dallas Fed manufacturing index and the stronger-than-expected outcome failed to have any impact on the dollar. Instead, currencies took their cue from equities and commodities. While it may appear that U.S. stocks are consolidating near their highs, there are signs of a possible top in the Dow Jones Industrial Average. The decline in the Dow Monday was the steepest since the post-Brexit breakdown in June but that doesn’t say much as the move was less than 0.5%. Risk aversion was the theme of the day but the only currency pair affected was USD/JPY.
Between the Federal Reserve and Bank of Japan monetary policy announcements, USD/JPY is the pair to watch this week. While we firmly believe that the dollar will trade higher into and out of FOMC, the outlook for yen is trickier. The Fed has a lot to be pleased about since the last FOMC meeting. Nonfarm payrolls rebounded strongly with job growth rising 287k in June. Britain decided to leave the European Union and the disruption to U.S. markets was minimal – in fact stocks climbed to record highs post Brexit. The housing market is chugging along, retail sales are up while manufacturing- and service-sector activity are on the rise. Even if the chance of a 2016 rate hike is slim, U.S. policymakers will leave the door open to tightening this year. In other words, we are looking for the dollar to rise on FOMC.
Expectations for Japan on the other hand are running high and conflicting headlines makes it difficult to determine how aggressive the Japanese government will be. The latest comments from BoJ Governor Kuroda, Economy Minister Ishihara and the cabinet suggest that the central bank will be less aggressive. Over the weekend Kuroda sounded somewhat optimistic – he said Japan is in a gradual recovery phase, describing capital spending as solid indicating that CPI is rising. He also noted that there are different definitions of helicopter money, which could be interpreted to mean that “his version” will be more moderate. The Japanese Cabinet also described the economy as experiencing a moderate recovery with recent weakness while economy minister Ishihara seemed comfortable with the latest moves in the yen. Late in the day, Japanese paper Nikkei reported that the fiscal stimulus package could be 2 times larger than initially planned at 6 trillion yen instead of 3 trillion. The headline provided a modest boost to USD/JPY but the initial gains were given up quickly with USD/JPY ending the day below 106.
Monday's other big story was oil. Crude prices dropped nearly 2.5%, driving USD/CAD higher. Both crude and the Canadian dollar fell to 3-month lows as concerns about supply continued to weigh on prices. According to a recent report by market intelligence firm Genscape, inventories rose by 1.1 million barrels at the oil base in Cushing, Oklahoma. The slowing demand for oil products and the increase in oil rigs compounds fears for many oil traders. There was little news out of Australia and New Zealand as the market waits to see if the RBNZ and RBA will cut rates at their next meeting. AUD traded higher Monday while NZD moved lower. New Zealand’s trade balance was scheduled for release Monday afternoon and while the business PMI index ticked higher in June, the strong NZD may have dampened export activity as the currency hit a 1-year high versus AUD last month.
As for euro, it was bid throughout the North American trading session but the rally fizzled below 1.10. Eurozone data was better than expected and according to our colleague Boris Schlossberg, the “IFO report showing surprising resilience in the wake of the Brexit shock. In stark contrast to the ZEW survey, which took a dive in the wake of Brexit vote, the IFO actually printed better than forecast coming in at 108.3 versus 107.4 eyed. Both current assessment and future expectations also improved from the months prior with only the automotive sector showing a slowdown. According to IFO head Fuest, the German economy remained robust despite the Brexit concerns – and that makes sense given the fact that actual trade conditions and agreements have not changed since the Brexit vote and may remain the same for quite some time.”