By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar fell to a 4-month low against the Japanese yen Monday, extending a decline that has taken the greenback lower for 8 out of the last 9 trading days. Friday was the first positive one since March 10 and now that 110 is reached -- USD/JPY fell within 10 pips of this key level on Monday -- dollar bears may be thinking about trading the pair the other way. Of course, there are many reasons for why the dollar is so weak. The failure of the healthcare bill raises questions about President Trump’s ability to cut taxes and increase spending and in turn, the Federal Reserve’s ability to raise interest rates in June. While Treasury yields and the U.S. dollar are trading like the chance of a June hike has fallen, Fed fund futures have remained steady since last Thursday. The market thinks there is a 74% chance the next round of tightening will be in September and only a 50% chance that it will happen in June. We believe those odds should be lower as the complicated tax agenda could take even longer to overhaul. Fed President and FOMC voter Evans was the first to admit Monday that the failed GOP health bill adds to uncertainties and that fiscal uncertainty weighs on the outlook.
With this in mind, we see at least 3 reasons why USD/JPY could hold 110. There are 10 Federal Reserve officials scheduled to speak this week and talk about the economy or monetary policy will be unavoidable. Evans, who is more of a dove than a hawk, expressed some concern but still said 2-3 rate hikes in 2017 are appropriate with 4 hikes possible -- if “things really take off.” Kaplan was due to speak Monday evening and Yellen is on tap Tuesday along with a number of other members later this week. Although most will be worried about the administration’s ability to deliver major tax cuts, we don’t expect vocal concerns too quickly. Fed officials will remain hopeful that the fiscal and monetary stimulus will continue to drive growth in the U.S. economy and their optimism could help prevent further losses in USD/JPY. Also, this week is quarter's end here in the U.S. and fiscal end in Japan. Part of the recent demand for yen could be tied to repatriation, most of which has been completed. This time last year we saw USD/JPY fall in the first 3 weeks of March then stabilize in the last week. The year prior, the selling stopped on the March 26 and in 2014, on the 27th. Finally, 110 is a very significant support level and demand is clearly emerging above it. Even if the currency pair breaks 110, the losses could be limited by tiered support below this key level. Does that mean USD/JPY won’t make a run for 110 again? No. Interest rate differentials are the strongest driver of currency flows and if U.S. rates continue to fall or struggle to rise, so too will USD/JPY.
Meanwhile Monday's best-performing currency was the British pound. With 2 more days to go before the U.K. triggers Article 50, sterling is trading as if Brexit will be good for the economy. From high to low, the currency pair appreciated more than 500 pips in 2 weeks. Part of the move can be explained by USD weakness, but stronger U.K. data and hawkish dissent this month completely shifted the market’s outlook for GBP. Investors are looking beyond the article-50 trigger and the EU’s response 48 hours later to the end of easy money. While we think the market may have moved on too quickly because no one knows how strict the E.U. response will be, we need to respect the price action and fundamental drivers behind the move. With that in mind, we continue to believe that GBP will fall after Article 50 is triggered. Yet shortly thereafter, the reality that an exit won’t be finalized until late 2018 will set in. So in the near term, rallies in GBP/USD between 1.26 and 1.27 should be sold.
Stronger-than-expected data drove euro above 1.09 Monday. The German IFO report, which measures business confidence, rose to its highest level since 2011. The business climate sentiment index reached 112.3, besting the 111.1 forecast. The expectations index also surprised to the upside with a reading of 105.7 vs. 104.3 forecast. The Current assessment came in with a reading of 119.3 vs. 118.3 expected. These numbers are consistent with the improvements seen in the PMIs, which bodes well for the Eurozone confidence and German unemployment figures scheduled for release later this week. We also heard from two ECB officials — ECB member Praet said easy monetary policy is still needed and any attempt to remove accommodation could slow or stall ECB efforts in reaching inflation targets. ECB’s Smets also chimed in with mixed comments saying that while the EU's real economy is doing well, sustainable improvement in inflation still seems to elusive. With no major Eurozone economic reports scheduled for release Tuesday, EUR/USD will take its cue from the greenback as the latest string of positive data should help the currency outperform some of its peers.
It was a quiet day for the commodity currencies — the Australian and Canadian dollars ended the NY trading session unchanged while the New Zealand dollar trickled up. There were no major economic reports released from any of these countries and while gold prices rose, AUD was hit by lower copper and iron ore prices. The Canadian dollar was dragged down by lower oil prices and falling Canadian yields. US crude extended its losses as the number of oil rigs continued to increase, adding to supply concerns. A few OPEC and Russian officials met over the weekend to review current levels of compliance. The lack of news coming from the meeting also put a damper on oil prices. NZD managed to make gains against the U.S. dollar even though there was little news on the day. The strength is likely due to AUD/NZD flows. No major economic reports are scheduled for release Tuesday from the commodity-producing countries.