By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Volatility rocked the foreign-exchange market Thursday with the U.S. dollar hitting multi-year lows versus the euro and other currencies overnight, then recovering at the start of the North American session only to give back all of its gains after the London close. There was no single catalyst for the reversals but profit taking, setbacks on President Trump’s campaign promises, mixed U.S. data and the sharp slide in the NASDAQ all contributed to the moves. The GOP's fading progress seems to be the best bet. After voting to reopen the debate, last night, the Senate rejected full Obamacare repeal and on Thursday they said they would set aside the border tax so they can focus on tax reform. Cutting taxes is the GOP’s only hope right now to restore confidence and make meaningful progress on the president’s campaign promises before next year’s midterm elections. As we said in the past, setbacks for Trump are setbacks for the dollar and the timing of USD/JPY’s nearly 100-pip intraday slide is far from coincidental. We expect the dollar to trade with a downward bias ahead of next week’s nonfarm payrolls report. U.S. data continues to cast doubt on Fed tightening. Jobless claims ticked up this week and even though orders for durable goods jumped 6.5% in June, excluding defense orders, they actually fell -0.1%. Second-quarter U.S. GDP numbers are scheduled for release on Friday and softer numbers will seal the dollar’s fate. Although economists are looking for a sharp increase in growth, the softer level of spending and trade between April and June versus January and May puts the risk to the downside for Friday’s report. Technically, resistance in USD/JPY is at 112.10 and support is at 110.60. If that level breaks, the next stop for USD/JPY should be the May 18 low of 110.24.
The euro experienced its strongest one-day decline in more than 2 weeks and the sell-off was driven entirely by profit taking. What’s interesting about the euro’s move is that unlike the other major currencies, EUR/USD started the North American trading session under water. After rising to a fresh 2.5 year high of 1.1776, the pair sank more than 100 pips on the back of profit taking. Having risen consistently over the past 5 months, bouts of profit taking in EUR/USD can be stronger than other pairs. Investors are also slightly worried about Friday’s economic reports. While Eurozone confidence is likely to be firmer after this week’s higher German business and consumer confidence reports, German consumer price growth is expected to have slowed in July as inflation remains the Achilles heel of the Eurozone economy. On a technical basis, as long as EUR/USD holds 1.16, the uptrend remains intact. Meanwhile the Swiss franc continued to decouple from the euro, with losses far exceeding its peer with the decline driving EUR/CHF to its strongest level since the SNB dropped its cap. It is the Swiss National Bank’s vocal concerns about its currency and its firmly neutral monetary-policy stance that is weakening the currency. SNB policy will lag behind the ECB and Fed, so for that reason we could see continued weakness in the currency, particularly versus the USD.
Sterling also nosedived on the back of U.S. dollar weakness but unlike USD/JPY, it never recovered when the greenback retreated. GBP/USD was performing well at the start of the NY trading session thanks to a strong CBI Distributive Trades Survey. This release has a positive correlation with the broader retail-sales report so the sharp increase from 12 to 22 bodes well for consumer spending. According to the Confederation of British Industry, solid demand for groceries and summer clothing took the index to its highest level in 3 months. With the Bank of England meeting next week, every piece of incoming data will be important in setting expectations for the rate decision. 1.3160 is now resistance in GBP/USD with support at 1.30.
All 3 of the commodity currencies traded sharply lower against the greenback with the Canadian dollar leading the slide. USD/CAD was the day’s worst performer despite a continued increase in oil prices. There were reports that Prime Minister Trudeau is unhappy about the central bank’s latest rate hike. Whether that's true or not (and many believe it is), USD/CAD is deeply oversold and the report was the perfect excuse for profit taking on short USD/CAD positions. After breaking above key resistance levels Wednesday (80 cents for AUD/USD and 75 cents for NZD/USD) and extending its gains overnight, both currencies U-turned and dropped back below these key levels, signaling a potential top. We now expect AUD/USD to test 79 cents and NZD/USD to drop to 74 cents before support is found.