Do High Volatility FX Moves Signal a Turn?

There are no shortages of factors driving the U.S. dollar lower.  On a broad basis, stronger global growth makes U.S. assets less attractive especially during a time when investors are worried about trade wars and the country’s fiscal finances. In the latest week however, it was the Bank of Japan’s inflation language tweak, stronger data abroad, the U.S.’ solar import tariff, Treasury Secretary’s comment about the benefits of a weaker dollar and softer U.S. data that sent the greenback tumbling lower.  At the end of the week, President Trump tried to walk back those comments by saying they were taken out of context and the U.S. supports a strong dollar policy and Bank of Japan Governor Kuroda did the same when he said in Davos that they did not revise inflation outlook.  Confusion about policy only compounded the volatility. Add to that the weakness of jobless claims, housing data, trade balance and Q4 GDP and its no surprise that investors are reluctant to trust the dollar’s recovery.
 
Technically, the dollar is due for a bounce but on a fundamental basis, there needs to be a catalyst. It could range from anything like comprehensive central bank jawboning to intervention talk, other comments from government officials, data or a sudden correction in U.S. stocks.  All of this is plausible given the aggressive moves in currencies and equities but its also speculation because until it happens, bears will remain in control.Looking ahead, there’s certainly no shortage of catalysts for a dollar reversal.  The Federal Reserve will hold its first monetary policy meeting of the year, non-farm payrolls are scheduled for release and President Trump will deliver his first State of the Union Address.  We don’t expect much volatility off of this month’s FOMC meeting because the most important part of this meeting is that it will be Janet Yellen’s last.  With no press conference, she’ll go out quietly leaving most of the FOMC statement unchanged.  Since the last policy meeting, there’s been slightly more deterioration than improvement in the U.S. economy so there’s very little reason for Yellen to change the Fed’s tune right before she passes the baton over to Powell.  With that in mind, there have been significant changes to market dynamics with the dollar falling which is inflationary, 10 year yields rising 25bp and the S&P shooting up 7% to fresh record highs.  Its hard to predict whether Trump’s State of the Union will be market moving – he will certainty tout the gains in stocks and the performance of the economy, but he could also inflame trade tensions and set back U.S. funding talks.  Non-farm payrolls are the wildcard. Job growth slowed significantly last month but wage growth was strong – economists are looking for payroll growth to accelerate and wages to hold steady but that’s unlikely to be the case. However if the dollar truly turns and other currencies succumb to profit taking, the corrections could be sharp and aggressive.
 
While euro was not the best performing currency this past week (that title goes to the Swiss Franc) it was one of the biggest stories as the European Central Bank basically endorsed the currency’s slide by focusing on the strength of the economy.  Data was healthy all around with PMIs, ZEW and IFO beating expectations. Although ECB President Draghi said euro volatility creates uncertainty, the main takeaway from the ECB meeting is that they are optimistic and satisfied with the performance of the economy. According to Draghi, economic momentum remains solid and broad based, which could lead to positive growth surprises and gradual increases in core inflation over the medium term. In response, the EUR/USD broke through 1.25, rising to its strongest level since December 2014.   While fundamentals and the central bank’s lack of concern supports further euro gains, on a technical basis, the pair’s inability to hold above 1.25 invited profit taking.  If EUR/USD fails to recapture 1.2470, it could slip back down to 1.22 on nothing more than a technical correction. Looking ahead, inflation, confidence and employment numbers are scheduled for release from Germany but the market’s appetite for U.S. dollars could have a more significant impact on the currency’s trade.  The Swiss Franc was the best performer, rising nearly 3 percent against the greenback – these along with previous gains sparked concerns by the Swiss National Bank who warned that they could intervene if necessary.
 
The prospect of a Brexit deal this year, U.S. dollar weakness, risk appetite and stronger U.K. data helped propel GBP/USD above 1.43 making sterling the second best performing currency this week.  Public sector finances beat expectations, earnings grew at a faster pace in November after a strong October and GDP growth accelerated in the last 3 months of the year.  2018 will be the year that a Brexit deal gets done and all signs point to continued progress.  Recent comments from Bank of England Governor Carney were also positive with the central bank head looking for the global growth to accelerate and for the U.K. to recouple with the rest of the world. Despite these developments, sterling was driven higher primarily by U.S. dollar weakness and we expect that to remain the case in the coming week as the manufacturing and construction sector PMI reports are the most significant releases on the U.K. calendar.  Technically, the 2 flameout candles at the end of the week are concerning particularly as the peaks come right underneath the 200-week SMA. If GBP/USD fails to recapture 1.43, the next stop will be 1.40.
 
The Australia, New Zealand and Canadian dollars continued to trade higher versus the greenback despite softer data and lower commodity prices. Gold may be up but iron ore prices have fallen sharply and there’s been quite a bit of volatility in copper.  None of that mattered to the Australian dollar, which rose to its strongest level since May 2015.  These gains will take a bite out trade and inflation but given that the 6 cent move only began in mid December, we may not see evidence of that until next month’s economic reports.  With that in mind, consumer and producer prices could still fall short of expectations with food prices falling towards the end of the year.  Although AUD/USD is still well off its 5 year high, the velocity of the recent move could invite jawboning from the Reserve Bank of Australia.  The Australian and New Zealand dollars are the most vulnerable to profit taking, especially NZD which rose 600 pips in 6 weeks on the back of softening data.  Consumer price growth slowed materially at the end of the year and could fall further given the recent strength of the currency. Considering that the New Zealand dollar was trading at its weakest level in 18 months in late November, early December next week’s trade balance is expected to improve. However if NZD/USD breaks 73 cents, the next stop could be .7150.
 
USD/CAD traded lower 4 out of the last 5 trading days despite mostly weaker data. Consumer prices fell -0.4% in the month of December, driving the year over year rate down to 1.9% from 2.1%.  Retail sales growth also slowed to 0.2% in November after rising 1.6% the previous month but a sharp 1.6% rise in sales highlighted the underlying demand of Canadian consumers. Part of the reason why the loonie did not respond to these softer reports is because investors are looking at these releases as a natural pullback after a few months of strong data. Oil prices have also been on tear and Western Canada Select prices are finally perking up. Although the risk is to the downside for next week’s Canadian GDP report, the downtrend remains intact for USD/CAD.