By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It was a great week to be long U.S. dollars versus the Japanese yen and commodity currencies but long dollar trades struggled against the euro, sterling and New Zealand dollar. Friday’s nonfarm payrolls report failed to inspire new gains in the greenback, but Fed fund futures continued to price in a nearly 100% chance of a rate hike in June and for this reason, the dollar could renew its gains in the coming week. The April labor-market report was pretty good as job growth rebounded to 211K in April. The unemployment rate dropped to 4.4% — the lowest level since May 2007 and most importantly, average hourly earnings rose 0.3%. The problem was in the revisions. March payroll growth and average hourly earnings were revised lower with the former falling to 79K from 98K and the latter dropping to 0.1% from 0.2%. In other words, the enthusiasm about wage growth following last month’s report was unfounded. However if dollar bulls believed that the Fed would raise rates in June before the April jobs report, the case only strengthened with the latest data. We are still looking for USD/JPY to hit 113 and find resistance right around 113.25.
Investors are likely to spend most of the week trading the fallout from the nonfarm payrolls report and watching for more Fed speak. We’ll hear from a number of U.S. policymakers but the ones to watch are Dudley and Harker, who are voters and on the complete opposite sides of the dove-hawk spectrum. The numbers to watch will be Friday’s retail sales and consumer price reports. While job growth was good, the real question is whether it translates into spending. Consumer consumption has been very weak but according to the most recent FOMC statement, fundamentals underlying consumption growth remain solid. After leaving interest rates unchanged this past week, the Federal Reserve turned a blind eye to all of the recent weakness in U.S. data and its optimism was validated by Friday’s jobs report — another reason why we believe U.S. dollar bulls could remain in control during the new trading week.
The EUR/USD rose to its strongest level in nearly 6 months as the single currency closed on 1.10. Its strength can be attributed to better-than-expected data and the optimism for this weekend’s final French Presidential election. It is an important weekend for the euro and Emmanuel Macron, the politically moderate independent who is widely expected to become the country’s next leader. However with the U.S. election and Brexit still fresh on everyone’s minds, investors will be weary of an upset. The chance is low because unlike the other 2 votes, France had a first round that gave everyone a good sense of where voters stand. But the fact that far right candidate Le Pen got this far represents the country’s deep desire for change. This will be a long battle for the new French President but for now, investors will cheer a Macron victory (if that’s the outcome) when markets open on Sunday. Then, it will be time to shift focus back to the economy and monetary policy. We’ve seen improvements in consumer spending, growth and German unemployment but at the last ECB meeting, President Draghi made a point to emphasize that monetary policy remains accommodative because the ECB isn't sure if the rise in inflation is durable. German industrial production, trade, GDP and inflation numbers are scheduled for release next and while they are important, risk appetite and the market’s demand for dollars will drive euro flows. The longer the currency pair holds above last month’s gap, the stronger and more durable the breakout.
Meanwhile, it is going to be a big week for the British pound, which held onto but struggled to extend its April gains. The currency pair consolidated quietly for most of the week and is primed for a breakout. There’s a significant catalyst on the calendar — the Bank of England monetary policy announcement, but in many ways, the Quarterly Inflation report will be more important. Economic forecasts will be updated and Governor Carney typically speaks after the report is released. If major changes were to be made, it would generally be during this time of the year when the latest economic projections are completed. The BoE’s job isn’t easy because while there have been improvements in the economy as evidenced by this past week’s stronger manufacturing, service and construction sector PMI reports, next month’s snap elections and the ongoing process of Brexit poses risks for the U.K.. We know where Governor Carney stands — as Britain prepared to vote to leave the European Union, he described Brexit as the greatest risk to U.K. financial stability. He’s had to eat some humble pie as the economy U-turned following the Brexit vote but his concerns are still validated as the process has only begun. So it will be interesting to see where the central bank’s emphasis is. Activity has been good and inflation turned positive in March with annualized growth exceeding their 2% target. However retail sales and housing activity has been very weak. Technically, GBP/USD appears to be gunning for 1.30 but traders may hold back on taking the pair above this level before the Bank of England’s monetary policy meeting.
The weakest currencies are the Australian and Canadian dollars, which fell hard on the back of lower commodity prices. Oil and iron ore prices plunged 7%, copper prices fell 5% and gold prices dropped 3%. Data from Australia actually wasn’t terrible as manufacturing, service and construction sector activity accelerated. The trade surplus shrank a little but these improvements should ease the central bank’s concerns. The Reserve Bank left interest rates unchanged last week and provided no new guidance. China’s trade balance and Australian’s retail sales report are scheduled for release at the start of the week and good numbers are necessary for there to be a bottom in AUD/USD. Unfortunately, we think AUD remains a sell-on-rallies as the recent weakness of commodity prices filters through the economy.
Canadian data was mixed with stronger manufacturing (IVEY PMI) and trade activity were offset by slower job growth. Only 3K jobs were created in April and all of them were part time. The economy lost -31K full-time jobs and added 34K part-time jobs. Although the unemployment rate dropped to 6.5% — its lowest level since October 2008 — part of the improvement can be attributed to a lower participation rate. After 10 straight days of rallies, we finally saw a pullback in USD/CAD. Typically, when USD/CAD reverses, it’s a multi-day affair and in this case we believe that USD/CAD should fall to at least 1.3650 and possibly even 1.36. Oil prices rebounded at the end of the week and Canadian yields turned higher — something we needed to see before USD/CAD peaked. There are no major Canadian economic reports released next week, which means loonie traders need to keep an eye on oil to see if Friday’s rally is a true bottom.
Unlike AUD and CAD, the New Zealand dollar ended the week higher versus the greenback. Data from New Zealand has been pretty good with dairy prices rising for the fourth auction in a row and job growth improving in the first quarter. Employment increased by 1.2%, which helped to push the unemployment rate down to 4.9%. Unlike other countries, participation is up, which bodes well going into next week’s Reserve Bank of New Zealand monetary policy meeting. There’s been widespread improvement in New Zealand’s economy since its last meeting in March. Consumer spending is up thanks to a stronger labor market. Inflation and dairy prices are on the rise. Consumer and business confidence weakened but that could turn around as service and manufacturing activity continue to improve. The housing market is softer, which the RBNZ wants to see. All of this argues for optimism from the Reserve Bank next week and outperformance for NZD, maybe not versus the USD but certainly against other currencies.