By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar traded lower against all of the major currencies Thursday except for the Australian and New Zealand dollars. AUD ended the North American trading session unchanged versus the greenback while NZD experienced an unexpected recovery. All of Thursday’s price action can be explained in 2 words -- profit taking. After a slow and steady rally to 104.50, traders cashed in on their profits in USD/JPY on China’s disappointing trade numbers. Normally, we expect AUD and NZD to move lower on weaker Chinese data but both currencies held up well, which validates our conclusion that investors cut back on their positions after the extended dollar rally. The excuse was China’s trade numbers, but U.S. yields also tipped lower after rising strongly for the past 1.5 weeks. Anyone trading the U.S. dollar right now should be watching U.S. rates because it has and will continue to be one of the key drivers of currency flows. USD/JPY broke above 104 when the 2-year U.S. – Japanese yield spread hit its highest level since June and the EUR/USD broke 1.10 right after the 2-year spread for German – U.S. yields hit a decade low.
But even as yields declined on Thursday, the dollar rally isn’t over. Fed President Harker was the latest U.S. policymaker to throw his support behind a 2016 rate hike saying that he supported a hike in September. He’s not a voting member of the FOMC this year but his views are aligned with many of his peers who have a say in policy. Jobless claims hovered near a 42-year low last week, validating the central bank’s optimistic views on inflation. Friday is a big day for the U.S. dollar with retail sales, producer prices and the University of Michigan consumer sentiment reports scheduled for release. This data will be accompanied by a speech from Fed Chair Janet Yellen and President Rosengren. We know that Rosengren voted for a rate hike last month but Janet Yellen was more apprehensive. Retail sales will probably rebound because wages are up, gas prices have increased and confidence has improved. But with slow job growth and Johnson Redbook reporting a drop in spending, the improvement should be limited. With that in mind, Friday’s economic reports will most likely confirm that conditions remain in place for a rate hike at the end of the year.
For the second day in a row, sterling rebounded against the greenback, giving investors hope that GBP/USD has bottomed. The recovery has been fueled by Prime Minister May’s concession to allow Parliament to vote on Brexit. Hearings before the British High Court began Thursday and will continue until Monday. May argues that she has the sole right to determine when Article 50 is invoked, but if the court finds that Parliamentary approval is needed, it would delay the process beyond the first quarter of 2017. This outcome could be enough to drive GBP/USD to 1.2450. It would also suggest that there would be a softer exit. However if the high court decides it does not want to interfere with the Lisbon Treaty, then GBP/USD will reverse its gains quickly and aggressively. Either way, the decision will be appealed and sent to the Supreme Court, which should hear the case before year's end. We expect more profit taking in GBP/USD before the weekend is out.
After briefly dipping below 1.10, the euro ended the day higher versus the U.S. dollar, confirming the significance of this key level. Germany reported revised CPI numbers that were inline with estimates, printing an increase of 0.1%. Interestingly enough, the dollar's broad weakness on Thursday was able to lift the Euro -- even as Eurozone bond yields fell. There were also reports that the ECB is mulling over tweaks and a possible extension of its QE program to be discussed during the governing body’s meeting next week. News of such tweaks sent Eurozone bond yields down 3 basis points Thursday. The Eurozone’s trade balance is scheduled for release Friday and the improvement in German and French trade activity signals a stronger number.
In contrast, the Canadian, New Zealand and Australian Dollars traded higher against the greenback on Thursday. The big story overnight was China and its surprisingly weak trade numbers. China reported a surplus of $41.99b vs. $53b expected. Both imports and exports declined with exports falling a whopping -10%, significantly greater than the forecast of -3.3%. This was also the weakest number since Chinese New Year and indicates that slower global growth, particularly in Europe, is having a significant impact on Chinese economic activity. USD/JPY was hit the hardest by this report whereas AUD/USD and NZD/USD were surprisingly resilient. Both currencies recovered to end the day in positive territory after a brief decline. There were no economic reports from Australia but business activity accelerated in New Zealand with the BusinessNZ Manufacturing PMI rising to 57.7 for September from 55.2 in August. Higher oil prices lifted the Canadian dollar. Oil prices seesawed Thursday, initially dropping down to close to $49, but managed to recapture all the losses to settle over $50. The early decline was triggered by the DoE’s weekly Crude Oil Inventories report, which showed a gain 4850k, when only 2000k gain in inventories was expected. Still, the details were quite mixed as Cushing OK Crude inventories, Gasoline and Distillate Inventories fell. No data is scheduled from the 3 commodity-producing countries on Friday.