Is USD Poised For More Losses In August?

The performance of the U.S. dollar over the past month may have left some traders confused. Considering that the Federal Reserve is the only central bank talking about reducing stimulus, most people would assume that the dollar should be headed much higher. However rather than extending its previous gains, the greenback weakened against most of the major currencies in the month of July and extended its losses in August. While it has only been a week into the new month, the dollar is already trading at one-month lows against the euro, British pound and Japanese Yen leaving investors to wonder, what happened?

First and foremost, currencies generally like to take their cue from yields and unfortunately U.S. Treasury yields stopped rising in July. The idea of reducing asset purchases should be negative for Treasury prices and positive for yields but we have not seen much reaction in the bond market outside of the initial rally in June. As a result, it may be difficult for the greenback to resume its rise until bond investors are convinced that yields deserve to be higher. Along these same lines U.S. economic data has been tepid with more downside than upside surprises. In contrast a number of German and U.K. economic reports have beat expectations, helping euro and sterling recover. Economic fundamentals in Japan haven't changed much but when it comes to USD/JPY, the primary focus is yield. There wasn't much in the way of U.S. data this week but a number of Federal Reserve Presidents threw their support behind tapering this year. Unfortunately this failed to lend much support to the greenback so for U.S. yields to resume their rise and to restore demand for dollars, we need some solid upside surprises in U.S. data.

The focus will shift back to the U.S. next week with retail sales, inflation, industrial production, housing and confidence numbers scheduled for release. Consumer spending is the backbone of the U.S. economy and a strong rise in demand could be very positive for the dollar. According to the International Council of Shopping Centers and Johnson Redbook, consumer consumption was healthy in the month of July and if the data beats expectations, the dollar could stabilize. However if the data falls short like NFPs, the dollar could extend its losses. At the same time, we will also be keeping an eye on U.S. stocks. They have struggled in the month of August but remain above support and next week's economic reports could determine whether support holds.

GBP: The Most Important Event Risk Next Week
Aside from the U.S. dollar, the British pound should also receive quite a bit of focus in the coming week. Sterling has performed extremely well since the Bank of England's upgraded GDP forecast. The rally in the British pound has taken the GBP/USD pair to an important resistance level at 1.5550, the 200-day SMA. Whether or not this level is broken in a meaningful way will hinge on next week's top tier event risks. On the calendar is U.K. retail sales, employment and inflation reports. For the most part, we are looking for firmer releases after the employment component of the PMI reports show improvement in the labor market and the British Retail Consortium reported a solid increase in spending. However what may be more important than these releases will be the minutes from the most recent Bank of England meeting. If you recall, the monetary policy committee left their asset purchase program unchanged and failed to release a statement. The question at hand is how many members voted in favor of more asset purchases, if any at all AND also how many members voted for the new unemployment rate threshold. If the decision on a threshold was not unanimous, sterling could come under some selling pressure. It is worth noting that this morning's U.K. trade data beat expectations with the deficit shrinking to £8.082bn from £8.491bn, the month prior. Imports increased but the real story was exports, which hit a record high and it is upside surprises such as these that have helped sterling hit a six-week high against the U.S. dollar this week.

EUR: Data Shows Divergence Between Germany And France
After rallying for three consecutive trading days, the euro slipped back against the U.S. dollar. The only piece of noteworthy Eurozone data released today was from France and unfortunately industrial production in the region's second largest economy contracted by 1.4% in the month of June. This was the largest decline in nine months and highlights the divergence in the economic performance of the region's two largest economies. Earlier this week, Germany reported a 2.4% increase in industrial production. Like the U.K., there are a number of key euro zone economic reports scheduled for release. The most important of which are the German ZEW survey and euro zone second quarter GDP figures. Growth in the euro zone is finally expected to turn positive after six quarters of contraction but the expansion will be meager (expected to be only 0.2%). As a result we still expect the euro to trade in a wide range in the coming week. The two most significant event risks for the EUR/USD will be U.S. retail sales and German GDP. The performance of the currency pair will hinge on which release has the larger surprise.

CAD: Shrugs Off Plunge In Employment
With no major U.S. economic reports scheduled for release today, the focus was on Canada. Going into the release, economists were looking for an improvement in the labor market after an uptick in the employment component of IVEY PMI but unfortunately instead of creating jobs Canada lost 39.4k jobs in the month of July. This was the second consecutive month of job losses and also the second largest decline in job growth in more than four years. Even the unemployment rate rose back to 7.2% from 7.1% and the participation rate declined to a 9 year low, a level revisited a few times in the past year. Losses in both full and part time work also reflect broad based weakness in the labor market. The gradual recovery in the U.S. economy was supposed to support growth in Canada but persistent trade deficits have restrained economic performance. As a result, the surprise decline in jobs sent the Canadian dollar plunging against the U.S. dollar but by the end of the North American trading session, the currency had recovered all of its losses, joining the AUD and NZD in tacking on gains against the greenback. Part of the recovery in the CAD can be attributed to the more than 2.5% rise in oil prices. Meanwhile the best performing currency today continues to be the Australian dollar, which extended its gains on the heels of solid Chinese industrial production numbers. The upside surprises in Chinese data this week triggered a wave of short covering that drove the AUD from a low of 0.8865 to a high of 0.9214 this week and allowed the currency to shrug off dovish RBA minutes. The central bank lowered its GDP forecast and reiterated that the currency value is too high. Finally, the New Zealand dollar also benefitted from the move despite weaker growth in credit card spending. No major economic reports are expected from any of the three commodity currencies this week.

JPY: Consumer Confidence Declines For Second Straight Month The Japanese Yen resumed its slide against the U.S. dollar but traded mixed against other major currencies. We continue to believe that USD/JPY's inability to rise is linked to the pressure on U.S. yields. Last night's Japanese economic reports also fell short of expectations. The Tertiary Activity index fell 0.3% in the month of June while consumer confidence fell in the month of July. Consumer sentiment has slowly retreated after hitting a five-year high in May. The Bank of Japan's monthly economic report confirmed that the central bank did not alter its outlook for the Japanese economy in August. They continue to believe that "Japan's economy is starting to recover moderately." Second quarter GDP numbers are also expected from Japan next week and unfortunately growth is expected to slow slightly. In the first quarter, Japan's economy expanded by 1.0% and in Q2, it is expected to grow by 0.9% which is still in line with a gradual recovery and should therefore ease investor concerns.

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.