On Friday the US dollar turned lower despite good labor market numbers and the move led investors to wonder if the greenback peaked, paving the way for bottom in euro, sterling and other major currencies. On a fundamental basis, the US dollar should be attractive because the US economy is outperforming its peers and the Fed is more hawkish than other central banks but technically, having fallen to multi-month lows, EUR and AUD are vulnerable to a further short squeeze that could take these and other currencies higher. Even though the greenback fell after Friday’s labor market report, job growth exceeded expectations and the unemployment rate fell to a 49 year low. Non-farm payrolls increased by 263K in April, up from 189K the previous month and the jobless rate dropped to 3.6%. The dollar fell because wage growth rose less than expected but last month’s release was revised higher and year over year, earnings growth is just below the cyclical high. So what this data tells us is that the labor market is tight and finding work is easy but salary gains are limited and American pocketbooks aren’t swelling.
Nonetheless Fed Chairman Powell’s optimism should not be underestimated. At this week’s FOMC meeting, he said solid fundamentals are supporting the economy as it continues on a healthy path. He dismissed talk of easing, described the Fed’s policy stance as “appropriate right now” and said “we don’t see a strong case for moving in either direction.” While the FOMC statement focused on the negatives like low inflation, weaker consumer spending and business investment, Powell downplayed all of these concerns. He acknowledged that inflation has been weaker, but attributed the softness to transitory factors. He also said consumer spending and business investment will most likely pick up and noted that some of the risks they were worried about in March (such as Brexit, Europe and China) have “moderated.” These upbeat comments kicked off a dollar rally so strong that it drove EUR/USD below 1.12 and AUD/USD below 70 cents. While that rally fizzled on NFPs, we believe the dollar remains a buy for 2 main reasons – first the Fed chair made it very clear that when it comes to the economy he sees the glass half full. He expects the outlook to improve as the prior weakness eases. Secondly, he sees no reason to be talking about rate cuts. This view contrasts sharply with other central banks that have recently expressed concerns about growth and talked openly about the possibility of a response to counter that trend. Economic and monetary policy divergences were the reasons for the dollar’s strong gains in April and they should continue to be a source of demand for the greenback. CPI and PPI are scheduled for release this week and with gas prices rising to their highest level since October, the risk is to the upside for these upcoming inflation reports.
Yet when it comes to trading currencies, sentiment and technicals are just as important. USD/JPY has not closed above the 20-day SMA since April 25th and EUR/USD found support above 1.11. We could see further profit taking on long dollar positions before buyers come in again. The next support level for USD/JPY is 110.50 and resistance in EUR/USD is near 1.1270. The dollar is a buy but it may pay to wait.