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What’s Behind USD’s Big Drop?

Published 07/21/2015, 03:52 PM
Updated 07/09/2023, 06:31 AM
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By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

  • What’s Behind USD’s Drop 1% Drop?
  • NZD Jumps 1%, But Beware of Selling into RBNZ
  • AUD Traders Shrug Off RBA Minutes
  • USD/CAD Rejects 1.30
  • EUR/USD Short Squeeze
  • GBP Consolidates Ahead of Bank of England Minutes

What’s Behind USD’s Drop 1% Drop?

The sell-off in the U.S. dollar Tuesday caught many traders by surprise. No U.S. economic reports were released but that didn't stop the greenback from losing over 1 percent of its value versus the euro and New Zealand dollars. The move was driven primarily by the decline in Treasury yields as ten-year rates fell more than 4bp on a day when Eurozone, Australian and U.K. rates increased. However in the grand scheme of things the decline in rates is small and should not have triggered such a deep slide in the greenback. Instead we believe that the dollar’s weakness had more to do with the currency being overbought. We have been arguing for a pullback in USD/JPY for a few days and now it seems that the decline in the buck carried over to other currencies. Tuesday’s decline in the dollar was driven by profit taking. Over the past 2 months, the EUR/USD, AUD/USD and NZD/USD became deeply oversold and the lack of catalysts today gave investors the perfect excuse to lock in some gains especially as the fear of a Grexit subsides and Chinese stocks stabilize. We are still bullish dollars but the lack of market-moving U.S. data means that we could see further profit taking in the greenback. This decline should be viewed as an opportunity to buy the dollar at lower levels ahead of next week’s FOMC rate decision. Although the Fed is not expected to raise interest rates in July, the tone of the monetary policy statement should be optimistic, reinforcing the notion that the economy is ready for tightening.

We will be looking to buy USD/JPY around 122.75/123.00 and believe that we will have the opportunity to do so not only because there could be some additional correction in the greenback but also because the latest Bank of Japan comments could have a further impact on the yen. Tuesday morning BoJ Governor Kuroda said he expects Japan’s inflation rate to accelerate considerably in the coming months. This improvement in price pressures gave the BoJ head the confidence to say that there is no need for additional easing at this time, which confirms that the BoJ is done for now. Some analysts had been looking for the Quantitative Easing program to be increased in 2015 but given Kuroda’s latest comments and the tone of the latest BoJ minutes, this possibility is becoming less likely.

NZD Jumps 1%, But Beware of Selling into RBNZ

All three commodity currencies traded higher Tuesday with the New Zealand dollar experiencing the strongest gains. Over the past 48 hours, NZD/USD rose more than 2%, which is surprising for many because the Reserve Bank is gearing up to lower interest rates for the second time in a row. In June the RBNZ cut rates by 25bp and an equivalent reduction is expected for July. Considering that the Federal Reserve is preparing to raise rates, the prospect for easing by the RBNZ should be driving NZD/USD lower, not higher. Yet over the past 3 months, NZD/USD has fallen 13% and since the last monetary-policy meeting, it's down 5%. Investors have had plenty of opportunity to price in this week’s rate cut, especially as dairy prices continue to fall. The big question ahead is whether the RBNZ will signal plans to ease again. According to Prime Minister Key who spoke earlier this week, the New Zealand dollar has fallen faster than they anticipated, which suggests that he is comfortable with the decline in the currency and wants to see its effect on the economy before taking additional action. Based on the table below, the RBNZ could shift to neutral. There are many reasons why they could choose to do so – #1: parts of the economy is improving (see table below) #2: there is a housing bubble in Auckland #3: Chinese stocks are stabilizing #4: NZD is down a lot versus AUD and finally #5: three back-to-back rate hikes is not warranted. If the RBNZ shifts to neutral, it could trigger a stronger recovery in NZD/USD. Meanwhile the Australian dollar shrugged off Monday night’s Reserve Bank of Australia meeting minutes. According to the RBA, a further decline in the currency seems likely and necessary because output growth most likely slowed in Q2. However they stopped short of saying that easing is necessary. USD/CAD backed off 1.30 as oil held above $50 a barrel.

New Zealand Data Points

EUR/USD Short Squeeze

The euro enjoyed its strongest one day rally against the U.S. dollar this month. The 1% rise in the currency pair was sparked by the hope that the Greek Parliament will vote 'yes' and approve a second series of bailout measures on Wednesday. This is a necessary step to starting negotiations with international creditors. Having already approved the first round of bailout measures last week, hope is high that the Parliament will vote 'yes'. According to the Greek government, the negotiations should be completed by August 20. EU and IMF officials are scheduled to arrive in Athens on Friday for fresh talks. Based on the rebound in EUR/USD, investors are clearly optimistic and we would be surprised if the Parliament rejected the latest reforms. The next area of uncertainty is the bailout negotiations and whether Germany allows for some form of debt relief. In the meantime, 1.10 is the level to watch on the upside for EUR/USD resistance.

GBP Consolidates Ahead of Bank of England Minutes

Interestingly enough, the British pound was the only major currency that failed to benefit from the anti-dollar rally. Sterling ended the day unchanged versus the U.S. dollar and sharply lower versus the euro. U.K. public sector finances did not have any impact on the currency and the closely anticipated speech from Governor Carney should have lifted the currency. According to the BoE head, higher interest rates will likely be needed in the next few years. They are not expected to raise rates this year but a hike could come in early 2016. While Carney’s choice of words was less aggressive than last week, we expect his optimism to be reflected in Wednesday’s BoE minutes.

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