NFP Seals USD’s Fate

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

Friday’s nonfarm payroll report sealed the U.S. dollar's fate. As hiring and wages eased in May, investors scaled back their expectations for a Federal Reserve rate hike this month. Fed fund futures are no longer pricing in a 100% chance of a hike in June and the odds of 2 more hikes this year have fallen below 50%. The next 2 weeks is the “quiet period” before the FOMC meeting, so there won’t be any comments from U.S. policymakers to bolster those expectations. For this reason, we expect the U.S. dollar to underperform over the next 8 days ahead of the June 14 FOMC meeting. U.S. data hasn’t been great and even if the Fed hikes they won’t provide any strong guidance on future tightening, which would be disappointing to dollar bulls. Yet U.S. policymakers haven’t said anything to cast doubt on the market’s rate-hike expectations and for this reason we believe they will follow through with a quarter-point increase this month. But the hike won’t help the dollar unless the Fed suggests that more tightening is on the way, which is unlikely given the lack of progress on tax cuts and fiscal spending – 2 things that are crucial to ongoing optimism from the Fed. With no major U.S. economic reports scheduled for release next week, traders should look for the U.S. dollar to underperform with US Dollar (JPY) likely to fall below 110.

Speaking of central-bank meetings, the Reserve Bank of Australia and European Central Bank have monetary policy announcements. The RBA meets first so we’ll start with it as it will be an exceptionally busy week for AUD/USD traders. Aside from RBA, Q1 GDP, the trade balance and PMI services are also due for release along with China’s trade balance and Caixin PMI reports. When the RBA last met it failed to acknowledge the improvements in the economy and instead said its forecasts for Australia’s economy has not changed much, causing the Australian dollar to spiral lower. Over the past month, labor-market conditions and inflation weakened slightly while manufacturing and trade conditions deteriorated due to the slower Chinese export growth. Stocks, bonds and commodity prices also declined. Improvements were seen in retail sales, the housing market and business confidence but that won’t be enough for the RBA to turn positive. So while AUD could hold its own versus the USD, it is likely to underperform other major currencies such as EUR and NZD. AUD/NZD in particular has been very weak and unless the RBA is surprisingly hawkish, the downtrend should remain intact.

The New Zealand dollar on the other hand closed in on a 3-month high thanks to the ongoing improvements in New Zealand’s economy. Increases in the terms of trade and activity indices helped to bolster business confidence in May. Comments from RBNZ Governor Wheeler this past week were relatively benign with the central-bank head noting that house price growth has slowed and the risks to the financial system have fallen. With no major New Zealand economic reports scheduled for release next week beyond another dairy auction, the New Zealand dollar, which is aiming for 72 cents, should outperform its peers. USD/CAD rallied every day last week despite stronger GDP growth. Canada’s economy grew by 0.5% in March, which was over 2x faster than forecast, bringing the year-over-year rate to 3.2% from 2.9%. The problem was that Q1 GDP growth accelerated less than anticipated and the current account deficit widened. Most importantly, oil prices fell sharply after rejecting an attempt to rise back above $50 a barrel. Looking ahead, it will be another busy week for the loonie with IVEY PMI and employment report scheduled for release. Job growth was soft in April so a recovery could be seen in May. USD/CAD has major resistance between 1.3550 and 1.36 so oil probably needs to hit $45 a barrel for the pair to break above these levels.

The euro hit a 6-month high despite weaker-than-expected Eurozone data. According to the latest reports, economic confidence in the Eurozone, inflation and retail sales in Germany declined over the past month, a sign of the pressure created by a stronger euro. Since the last European Central Bank meeting in late April, the EUR/USD rose more than 4 cents, or more than 3.9%. For an export-dependent economy like the Eurozone and a central bank that is worried about low inflation, the stronger currency can be a major deterrent to future economic activity. However since the last meeting, we’ve seen widespread improvements in the Eurozone economy. Aside from the latest decline in retail sales and German consumer price growth, Eurozone consumer spending is up, labor-market conditions improved with economic activity accelerating across the board. Even ECB President Draghi acknowledged the improvements in the economy although he was adamant about the need for accommodative policy. So it will be interesting to see which way he leans because the next round of data could be much weaker given the rise in the currency.

Politics has and will continue to play a big role in the performance of sterling in the coming week. Although GBP/USD ended the week slightly higher than where it started because of the softer U.S. labor market report, it did not enjoy the same gains as its peers because of election uncertainty. Prime Minister May’s party now leads the opposition party by only 5 points, down from 15 two weeks ago. What once appeared to be a sure win could turn into a victory by only a small margin — or worse, a surprise loss. The June 8 election is supposed to be a tactic that would increase her negotiating hand but a failure to win with a strong majority would weaken her stance as Brexit talks begin. Although U.K. PMI numbers are scheduled for release along with industrial production and the trade balance, politics is likely to play a larger role in the currency’s performance than economics. If the day-to-day polls leading up to Thursday’s vote show a shrinking majority for PM May, GBP/USD will fall. However if her party climbs in the polls near the end, GBP will recover smartly — either way it will be a big week for the British pound.