By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
November is shaping up to be the best month for the U.S. dollar in 2 years. The greenback is up over 5% against the Japanese yen and more than 3% versus the euro. The dollar’s strength can be attributed to 2 main factors and they both boil down to a positive current and future outlook for the U.S. economy. Compared to many other parts of the world, U.S. data has been stronger with inflation rising and job growth increasing. However it is the prospect of fiscal and monetary stimulus that really sparked the fire underneath the dollar and attracted buyers from around the world. The Federal Reserve is the only major central bank planning a rate rise and this past week Janet Yellen made it clear that the conditions are in place for a December tightening. Initially there was some fear that the sharp rise in U.S. rates would cause her to tone down her hawkishness but instead, in her testimony to the Joint Economic Committee, she expressed confidence in the economy and the progress they are making toward their inflation and employment goals. Yellen even warned that there were risks to waiting too long to raise rates. Heeding these calls, the market is now pricing in a 96% chance of a rate hike next month.
The U.S. is also the only major country with the realistic prospect of a big fiscal spending program. Trump’s win caused a tectonic shift in the financial markets that sent bonds crashing lower, the U.S. dollar to multi-year highs and stocks to record highs. Not only was his victory a major surprise, but his promise of big tax cuts and infrastructure spending forced global investors to reassess the short- and long-term impact of his policy plans. They unwound positions immediately after his victory and laid on fresh long-dollar and long-stock trades this past week. While this trend is likely to continue, the dollar came a very long way in a short period of time. The recent move was supported by stronger spending, housing and inflation data. But with no major U.S. economic reports on the calendar next week and U.S. markets closed for the Thanksgiving holiday on Thursday, we expect some profit taking after these exaggerated moves. The November Fed minutes is the only event risk worth watching and we don’t expect the report to alter the market’s expectations for Fed tightening. Pullbacks in the dollar should remain shallow but it has been 10 to 11 days since we’ve seen a meaningful sell-off in the greenback versus EUR and JPY. For USD/JPY, this is the longest stretch of gains since May 2015 and while the next major level of resistance isn’t until 112, we should see a pullback before that target is reached.
More than 2 weeks have passed without a positive day for the EUR/USD and by now it should be no surprise that the currency pair broke through 1.06 this past week. It wants to test 1.05 and could reach that level before stabilizing next week. We’ve been taking every opportunity to mention Italy’s political troubles but with the first round of Les Republicains party primary scheduled for Sunday November 20, investors felt further compelled to cut their long positions and sell euros. The polls show former Prime Minister Juppe comfortably beating former President Sarkozy to become the conservative nominee, but if there is less than a 50% majority there will be another run-off on November 27. However the focus is not on the Republicain nominee but the momentum of far-right leader Marine Le Pen, whose campaign received a major boost after Donald Trump’s victory in the U.S. The populist movement is gaining traction around the world and the 2 countries at center stage right now are France and Italy, the Eurozone’s second- and third-largest economies. Le Pen is dangerous for the euro because she vowed to pull France out of the Union and to hold a “Frexit” referendum on EU membership. This weekend’s Republicain nominee election may not affect her chances, but the focus will quickly return to her polling results. In about 2.5 weeks. Italy has a referendum on Senate reform that is widely viewed as a referendum on the current government, especially considering that Prime Minister Renzi suggested he would resign if the reforms were rejected. None of these ongoing developments is good news for the euro because while the EU could stand losing Britain, it can’t lose France and Italy. The mere prospect of this possibility is enough to keep pressure on the euro for the next few weeks. The Eurozone is the one of the few countries with significant data on the calendar with November PMIs and the German IFO reports scheduled for release -- but politics will continue to overshadow economics.
While sterling also fell victim to U.S. dollar strength this past week, it is the only currency that has outperformed the dollar so far this month. A number of important U.K. economic reports were released and while they played a key role in keeping the British pound bid versus the euro, they were not enough to prevent GBP/USD from falling. Retail sales rose 1.9% in October, nearly four times stronger than expected. The unemployment rate declined to 4.8% but average weekly earnings growth failed to increase, jobless claims rose more than expected and consumer price growth slowed. None of this mattered though because Brexit was the main reason for sterling’s resilience. Thanks to the British High Court’s recent decision on Article 50, investors no longer see Brexit as an imminent threat. The Supreme Court still needs to decide on the case, but that won’t be until next year and there were reports that Brexit could take another 2 years. This eased the minds of investors and the Bank of England, which sees current policy as neutral. Europe is the greater risk and for this reason, investors have been buying pounds versus the single currency. This, along with sterling short covering, explains the slow drop in GBP/USD. In the week ahead, revisions to Q3 GDP is the only U.K. economic report on the calendar. We continue to expect further weakness in EUR/GBP, which fell to a 7-week low after rejecting the 100-day SMA.
Like the European currencies, the commodity currencies also succumbed to the mighty greenback. The best performer was the Canadian dollar, which benefitted from a rebound in oil prices, which started the week hitting a low of $42.20 before settling Friday above $45 a barrel. The most important release from Canada past week was consumer prices and according to the report, price pressures accelerated in October, lifting year-over-year CPI growth to 1.5% from 1.3%. Core price growth slowed slightly. Canada has a lot to lose if he follows through with this threat but investors shouldn’t underestimate Prime Minister Trudeau, who may be an expert negotiator. Yet with oil prices falling and the U.S. dollar rising, USD/CAD should be trading higher. If the November high is taken out next week, there’s no major resistance until 1.38. How USD/CAD trades will be partially determined by Tuesday’s Canadian retail sales report.
The worst-performing commodity currency was the Australian dollar, but both the Australian and New Zealand dollars ended the week below their 200-day SMA. Initially, AUD was supported by upbeat RBA minutes, but mixed employment numbers, lower gold, copper and iron ore prices -- along with U.S. dollar strength -- caused the currency to fall quickly and aggressively. While the October labor market report was better than expected, investors were simply not impressed. Job growth rose by 9.8K, which was better than the previous month but less than forecast. The unemployment rate held steady at 5.6% as more than 41k full-time jobs were created, offsetting the 31.7k drop in part-time work. Unfortunately, the participation rate was revised down to 64.4%. The problem is that even though full-time jobs increased strongly, they failed to sufficiently offset the massive 74.3K drop in September. Meanwhile, the New Zealand dollar followed the Australian dollar lower despite stronger service-sector activity, a big jump in consumer confidence and a sharp rise in producer prices. Retail sales growth slowed but the increase was in line with expectations. Dairy prices also rose by a smaller amount than the previous auction. There are no major Australian economic reports scheduled for release next week but trade data is expected from New Zealand.