When Will USD/JPY Break 105?

Kathy Lien, Managing Director Of FX Strategy For BK Asset Management

Daily FX Market Roundup August 9, 2019

It has been a very busy week for President Trump. On Sunday, he announced fresh tariffs on China, on Tuesday he ordered the Treasury to label China a currency manipulator, on Thursday he blasted the government’s strong dollar policy and on Friday, he said the U.S. is not going to do business with Huawei and called on the Fed to lower interest rates by a full percentage point. Although it was later clarified that he meant he would be banning the federal government from doing business with Huawei and not U.S. businesses, the damage was done. It is clear that President Trump has no plans to make a deal with China this far from the 2020 election. He’s on a rampage to show his constituents that he’s fulfilling the promises that he made in 2016 and in doing so he’s hurting the markets and the U.S. dollar.

It's only a matter of time before USD/JPY breaks 105 and it could happen next week if U.S. retail sales and consumer prices fall short of expectations. In fact, it's completely feasible for USD/JPY to hit 100 before the end of the year. However while USD/JPY has fallen 6% over the past 4 months, the decline in the trade-weighted Dollar index is more modest. Even though DXY took a big hit this month, it is still up 1.5% for the year. The sharp sell-off in the dollar last week was felt against the euro, Japanese yen and Swiss franc. But sterling, the Australian, Canadian and New Zealand dollars performed worse than the greenback as Trump’s antagonism toward China hits these countries harder. If his fury shifts to Europe, the single currency won’t be immune to the risk aversion.

As we head into the weekend, it is important to take stock of the implications of Trump’s latest moves.The tariffs have the most significant effect because it has a direct impact on U.S. businesses and the Chinese economy. Stocks and earnings will suffer as the slowdown in global growth worsens. However Trump’s talk of wanting a weaker dollar and the Treasury’s currency manipulator label has more symbolic than economic consequences. It mandates the Treasury to “take action to initiate negotiations” and work with the IMF to remedy the problem and if no agreement is reached, the U.S. can impose further penalties and restrict U.S. government business with China. If he so desired, Trump would have hit China with more tariffs with or without the currency manipulator label.

Currency intervention is also a bad idea because it drives up prices, creates more volatility in the markets and makes the Fed’s job more difficult. If Trump’s primary goal is to pressure the Fed to cut interest rates further, he’s accomplished that by escalating the trade war with China. Stocks collapsed, the slowdown in global growth will deepen and Jay Powell will have no choice but to lower interest rates again this year. At the same time, intervention is ineffective if it's not coordinated with the central bank. If the Fed sterilizes the intervention, the impact could be limited and if stocks crash, investors will flock to the safety of U.S. dollars anyway. So while the prospect of more U.S. protectionism, risk aversion and easing will drive USD/JPY lower, the greenback’s direction against other major currencies will depend on how aggressively those central banks match the Fed’s rate cuts.

Meanwhile, rate cuts could also be coming for Canada after last week’s employment report. The market was looking for job growth to return in July but employment fell by -24.2K, the largest drop since August 2018. Full-time and part-time work declined, pushing the unemployment rate up to 5.7% from 5.5%. USD/CAD shot higher immediately after the report but turned sharply lower as selling of dx resumed. Given the current sentiment for US dollars, it may be smarter to wait to buy USD/CAD until selling pressure eases.