By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The best way to trade currencies into year-end is to ride the monetary divergence wave. The latest U.S. jobs number satisfies the Fed’s preconditions for raising interest rates and the strong prospect of tightening next month should extend the greenback’s gains over the next few weeks. Buying dollars after a strong move can be difficult for many but when a trend is driven by major fundamental news that the market may not have fully anticipated, the adjustment in expectations can lead to a fast, aggressive big move in currencies. There’s not much on the U.S. calendar this week to diminish the strength of the labor-market report and this quiet market environment caused the dollar to trade lower against all of the major currencies on Monday. We hear from Fed Presidents Bullard, Evans and Dudley on Thursday. And on Friday the U.S. retail sales report will be released. Most U.S. policymakers are eager to begin lift off. Bullard and Dudley support Yellen’s bias to move sooner rather than later whereas Evans wants a longer delay or a shallower rate path. Either way, we don’t see this week’s economic reports and event risks threatening the dollar's uptrend.
The best currencies to buy the dollar against are the ones whose central banks are open to the idea of increasing stimulus in the coming months. This includes currencies such as the euro, Canadian dollar, New Zealand dollar, Norwegian krone, Chinese yuan, Russian ruble and Indonesia rupiah. The Japanese yen and Australian dollar could be included in this basket because their data has been weak, but these central banks have been reluctant to reaffirm the market’s belief that they should ease. The most popular trade is selling EUR/USD because the ECB has been taking every opportunity to suggest that stimulus could be increased this month and the Fed has done the exact opposite. There are a handful of Eurozone economic reports schedule for release this week and the most important will be Friday’s German and Eurozone Q3 GDP numbers. The market will be looking to these reports for verification that the economy is slowing and additional QE is warranted. Mario Draghi is also speaking on Wednesday and as usual his reinforcement of the central bank’s dovish views will help sustain the decline in EUR/USD. With 1.08 support level broken, there’s no significant Fibonacci or moving-average support below current levels so the main levels to focus on are the spike lows near 1.0660 and 1.05.
China’s weaker-than-expected trade numbers did not have a significant impact on Monday's commodity currencies. All 3 currencies – the Australian, Canadian and New Zealand dollars traded slightly higher versus the greenback. While China’s trade surplus hit a record high, the increase was less than anticipated and most importantly exports fell -6.9%, two times worse than expected. Imports also dropped -18.8% versus a -15.2% forecast, which means that for China, both internal and external demand weakened last month, whichis bad news for many countries who rely on Chinese growth. In the long run, we can’t see how the Reserve Bank of Australia could maintain its optimistic outlook in an environment of persistently weak Chinese economic activity. However for the time being the RBA’s lack of concern has helped to prevent steep losses in AUD. No news is good news for the New Zealand dollar, which rebounded on the back of profit taking in the greenback.
USD/CAD declined despite a smaller-than-anticipated increase in Canadian housing starts and a decline in oil prices. However the reversal in the pair should be short-lived as the greenback’s expected strength deals a double blow to the Canadian dollar by driving USD/CAD higher and oil prices lower. Canada’s economy is also struggling and that gives us additional reasons to be bearish CAD.
Sterling traded higher against the euro and U.S. dollar. Considering that U.K. data has not been weak, this Wednesday’s employment report will play an important role in shaping the market’s expectations for BoE policy. If wage growth continues to accelerate, it will give investors strong reasons to eye the BoE’s dovishness with skepticism. According to the PMIs, employment conditions improved in the manufacturing, service and construction sectors last month. As we have seen in recent months, the BoE can change its view often so if data improves and sterling weakens, its policy bias could adjust as well.