By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The bulls have finally loosened their reins on the U.S. dollar but a move below 117 in USD/JPY is needed to pave the way for a deeper reversal. The surprise decline in pending home sales combined with a sharp drop in U.S. yields sent the dollar tumbling against the yen. However even with this decline, the greenback managed to end Wednesday in positive territory versus euro, sterling and Swiss franc. The commodity currencies have found a near-term button and chances are that in the next 24 to 48 hours we should see a further pullback in the dollar. There are no U.S. economic reports scheduled for release on Thursday, so all the dollar needs is another day of lower yields. Short-term price action aside, with the Federal Reserve looking to raise interest rates three times next year, 2017 should still be a good year for the U.S. dollar. Between Donald’s Trump Presidential victory, the surge in U.S. rates and record highs in U.S. stocks, global investors have found plenty of reasons to own U.S. assets and, in turn, the U.S. dollar. The moves that we have seen so far are in line with the market’s reaction to Ronald Regan’s election in 1980 and if Trump follows through, we could see an even stronger rally for the dollar in 2017. Fiscal stimulus and rate hikes are a powerful combination, but our positive dollar view is predicated on Mr. Trump delivering. In other words, 2017 should be a good year for the U.S. dollar -- unless Donald Trump fails to deliver and the Fed resorts to raising interest rates twice instead of 3 times next year.
Wednesday's worst-performing currency was the euro, but thanks to a late-day U.S. dollar selloff, the currency managed to hold above 1.0350 and end the day above 1.04. After losing close to 1000 pips over the past 2 months, euro parity is in sight. However as weak as the euro may be, the slide in the currency is changing the outlook for inflation and growth. In the recent ECB economic bulletin, the central bank said it sees inflation picking up strongly at the turn of the year, a view the Bank of England shares. As a result, these 2 major central banks may need to start thinking about unwinding their stimulus programs in the coming year. The big question for Europe is whether a weak euro can save the Eurozone economy. We have no doubt that the lower currency will boost both economic activity and inflation, as the data already shows. However Europe’s problems extend beyond day-to-day business activity. The greatest risk for the Eurozone and the euro next year are politics, terrorism, elections and Italy's banking crisis. Many of these events are difficult to handicap but each scenario could have a dramatic impact on the currency, overshadowing positive improvements in the economy. Looking ahead, we hope to sell rallies in the EUR/USD between 1.05 and 1.06 -- targeting a move to 1.01 or lower.
Sterling continued to trade lower against the U.S. dollar on the back of lower-than-expected mortgage approvals and ongoing Brexit concerns. Mortgage approvals dropped to 40.65K in November from 40.83K. Economists had anticipated a rise but the sector is slowing and according to Halifax -- the country’s largest mortgage lender -- a “higher-than-normal degree of uncertainty” should lead to fewer house sales in the coming year with the most-pronounced decline expected in London where affordability is already an issue. Meanwhile, the call for a hard Brexit is growing with hardliners in the U.K. campaigning to put more pressure on the EU. They believe that “businesses across Europe will want trade with the UK to continue as usual.” These are bold assumptions as EU leaders are also looking to take a hard stance on Britain. Either way, the coming year will be marked by uncertainty, which is going to hurt more than help the currency.
The Canadian and New Zealand dollars ended the day lower against the greenback while the Australian dollar remained under pressure. Canadian yields have been falling for some time but it took a sharp drop in U.S. yields to turn around USD/CAD. Ten-year Canadian rates dropped 6bp Wednesday while Treasuries with the same maturity fell 5bp. So, not only should the Canadian dollar underperform the greenback, but it should also see further weakness against the euro and Swiss franc. AUD and NZD are showing signs of a near-term bottom but rallies should still be sold.