By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
While the U.S. dollar traded higher against most of the major currencies Wednesday, the NY session was marked by profit taking on long-dollar positions. With the exception of the NASDAQ, U.S. equities retreated and along with the move in the greenback, this has many investors wondering if we’ll see a deeper pullback in the dollar and stocks. There’s no doubt that recent moves have been exaggerated, but a large part of it can be attributed to the unwinding of short positions followed by the reestablishment of fresh longs. The U.S. dollar index climbed to its strongest level in 14 years Wednesday with USD/JPY rising within 25 pips of 110. However by the end of the day, USD/JPY slipped close to 109 and appeared poised to break below this level. The greenback also retreated from its highs against other major currencies. The euro was the only currency that struggled against the dollar on growing concerns about this weekend’s elections in France and Italy’s referendum on Senate reform in early December.
The loss of momentum for the dollar can be attributed to 3 key factors. The first is weaker U.S. data -- producer prices and industrial production stagnated in October when stronger numbers were expected all around. These reports reflect the negative impact of a stronger dollar, which appreciated further in November. Although the data contributed to the move, we see the latest Fed comments and move in Treasury yields as the main reasons for the dollar’s pullback. Nearly all U.S. policymakers have been saying that rates will rise in December unless there is a big surprise, but they have also been suggesting that the Fed could be one-and-done. According to St. Louis Fed President James Bullard -- who is one of the most hawkish members of the central bank -- “one rate hike is enough to return policy to neutral.” The fear now is that Yellen, whose prepared testimony before the Joint Economic Committee will be released at 8 am NY Time, will share the same sentiment. Not only does next year’s Trump Presidency mean uncertainty for the global economy, but the recent sharp and aggressive rise in U.S. rates also does a lot of the work for the central bank, reducing the need for an aggressive tightening campaign. Treasury yields stabilized Wednesday after a strong 5-day rally that took 10-year rates from 1.77% to 2.22%. Looking ahead, Yellen’s bias will determine how much further the dollar rises or whether a deeper pullback is warranted. Her speech will be followed by comments from Fed President Dudley and U.S. core cpi, housing and manufacturing reports.
Sterling continued to challenge the dollar’s strength. While euro endured steep losses, sterling’s decline was limited over the past week. The currency pair’s resilience can be largely attributed to the market’s perception that the U.K. faces less near-term risks than the Eurozone. Brexit is a problem but it will be months and possibly even years before it poses a major risk to the U.K. economy. Elections and referendums in the Eurozone on the other hand are coming up quickly. Wednesday’s mixed employment numbers failed to have a significant impact on the currency. Although jobless claims rose 9.8K in October and average hourly earnings growth failed to rise as anticipated, the jobless rate ticked higher. U.K. retail sales are scheduled for release Thursday and a bounce is expected. Bank of England Deputy Governor Cunliffe spoke Wednesday and reiterated Carney's recent comment that there are limits to the central bank’s tolerance for above target inflation.
Euro dropped to a fresh 1-year low versus the U.S. dollar. It's been 8 trading days since the currency has a seen a rally versus the greenback. Wednesday’s low of 1.0662 is now a fresh year-to-date low for EUR/USD. With no data to explain the move, the euro continued to come under the pressure of political uncertainty. Aside from the Italian referendum, we also have the first round of primary elections in France this weekend and later in December, the Austrian Presidential election. Next year, both Denmark and France have general elections. Investors will be watching the polls closely for any signs of growing nationalism. At this stage, it looks like EUR/USD may not find meaningful support until 1.05. Eurozone CPI numbers are scheduled for release Thursday and a slightly lower number is expected.
It was a mixed day for the commodity currencies -- the Australian and New Zealand dollars traded lower while the Canadian dollar edged slightly higher. The biggest loser of the day was AUD, which lost approximately 1% versus the U.S. dollar. Softer data and lower commodity prices were the catalysts for the move. Australia’s wage cost index rose 0.4% against a forecast of 0.5% and as a result, the currency pair dropped below the 200-day SMA, hitting a 2-month low in the process. NZD also extended its gains while CAD traded all over the place on the back of mixed headlines and inventory data. Initially oil prices tumbled on a significantly larger-than-anticipated increase in crude inventories. But by the end of the day, prices turned lower after Russia’s energy minister Novak talked about a possible meeting with Saudi Arabia and the high possibility for an OPEC deal being reached at the end of the month. Novak reiterated that Russia would support any OPEC deal and would be open to oil freezes. Australian employment numbers were due Wednesday evening and even a strong report may fail to drive AUD/USD above the 200-day SMA.