By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
With many European markets closed for Whit Monday, it was a relatively quiet and subdued North American session for currencies. The unexpected drop in the Empire State manufacturing survey led to initial losses for the greenback but investors quickly shrugged off the release with the dollar ending the day higher against the Japanese yen and Swiss franc. However the greenback's gains were limited to these currencies only, as it lost ground to the euro, British pound, Australian, Canadian and New Zealand dollars. Dollar bulls weren't excited by Friday's strong retail sales report, which showed the largest rise in consumer spending in more than a year and on Monday dollar bears found no reason to jump into fresh short positions after one soft manufacturing report. Although Fed President Dudley who speaks on Thursday may have a hard time justifying a rate rise this year with manufacturing in his district contracting sharply, the unevenness of the U.S. economy highlighted by recent data confirms what everyone knows already -- that the Federal Reserve will keep interest rates unchanged next month. Until some piece of data significantly alters the market's expectations for Fed policy, we expect the dollar to remain confined to its recent range against the euro and yen.
Monday's big story was the fresh 6-month high in oil. Just as Canada's oil services are starting to return after the devastating wildfires in Alberta, outages in Nigeria and Venezuela along with a higher price target from Goldman Sachs (NYSE:GS) sparked a renewed rise in oil prices. According to Goldman, there's been "sharply declining production" that should cause oil to end the year above $44 instead of $38 a barrel. Nigeria is important because they are the world's 11th largest oil producer and the largest in Africa. The problem is that various acts of sabotage have caused the country's oil output to fall to its lowest level in decades. Goldman argues that the balance between supply and demand is beginning to shift and as a result, the prospects for oil have improved. Of course we are skeptical because Iran and Saudi Arabia continue to increase supply -- Genscape reported a buildup of oil inventories Monday -- but with momentum on it side, oil may not stall until $50 a barrel. The move in oil has driven USD/CAD lower but we continue to look at a dip toward 1.2800 as opportunity to buy at a lower level.
For the next 24 hours the focus will shift to the Australian dollar and British pound. AUD shrugged off this weekend's softer industrial production and retail sales reports out of China but it may not be able to ignore dovish RBA minutes. When the Reserve Bank last met, they surprised the market with a quarter point rate cut that sent AUD to its lowest level in 5 weeks. The central bank's frustration with the low level of inflation and subdued labor cost growth will make an appearance in the report but investors will be combing the minutes for hints on additional easing. However considering that the rate cut was not discounted by the market, a generally dovish tone could be enough to drive AUD back to the day's lows.
If AUD falls, so too will NZD, which was lifted by U.S. dollar weakness and a stronger PMI services report. However even if NZD falls, we expect it to outperform AUD. New Zealand has a dairy auction Tuesday and traders will be watching this report closely to see if there will be a back-to-back decline in prices.
Sterling bounced off the 100-day SMA Monday and we believe that a further recovery is likely into Tuesday's UK inflation report. According to the Bank of England's Quarterly Inflation report released last week, inflation is expected to pick up in the medium term as the drag from energy prices fade. They believe that CPI will reach their 2% target by mid-2018, which is slightly quicker than their February projections. These comments along with the improvement in price pressures reported In the PMIs suggest that the risk is to the upside for Tuesday's inflation numbers, which is consistent with the technical bounce seen in GBP/USD on Monday.
Euro ended the day virtually unchanged against the U.S. dollar. Like sterling, the decline in the EUR/USD last week stopped short of a significant 50-day moving average, and even with Monday's pullback, EUR/USD held above this important moving average. The big difference between the U.K. and Eurozone, however, is that there's far less market-moving Eurozone data on this week's calendar. Tuesday's trade balance numbers are expected to improve but Wednesday's consumer price report will most likely confirm that price pressures remain extremely low. The minutes of this month's ECB meeting is also scheduled for release and chances are it will be the most interesting report for EUR/USD this week. In the meantime, the currency pair remains in an uptrend as long as it holds above 1.1250.