Dollar Stumbles but Will it Fall as Markets Debate Fed Hikes?
Fundamental Forecast for Dollar:Bearish
The USDollar suffered its second largest weekly decline in a year this past week, but conviction was uneven
Inflation and Fed talk offered a little more traction for USD selling, but key risk in 1Q GDP and FOMC is further out
See the 2Q forecast for the US Dollar and other key currencies in the DailyFX Trading Guides
The Dow Jones FXCM Dollar Index (ticker = USDollar) dropped 1.1 percent this past week while the ICE Dollar Index tumbled 1.8 percent. That represents the second worst week for the even-weighted measure (USDollar) in 12 months and the second worst performance for the EURUSD-heavy gauge in 22 months. Have speculators over-reached on this advantaged currency? The recent stumble after two months of consolidation alongside speculative positioning suggests that may be the case. However, as market participants weigh the impetus for correction against the tangible fundamental appeal the currency holds over the longer-term; progress will lean heavily on meaningful catalysts to motivate a counter-trend move. And, this week’s docket will struggle for the high profile drivers while the period after is overstocked with redefining updates.
From a fundamental perspective, it is important to establish the longer-term position for the Greenback. Treasury Secretary Jack Lew at the G-20 noted the United States’ economic dominance when he remarked that it was not ‘sufficient’ that the US be the lone driver of global growth. That bodes well for investor returns (and thereby capital inflow) alongside the first-mover advantage the Fed seems to be taking with its relatively hawkish monetary policy standing. Furthermore, in the event of a global financial slump; the Dollar will likely revert back to its ‘haven’ status – after a certain intensity is reached. Medium to long-term, the currency looks well positioned to advance further. Yet, that doesn’t preclude it to interim corrections.
A ‘correction’ is what lurks for the Greenback. Nine-months of steady climb in the most rapid move since the early 1980’s mixes both fundamental reasoning and speculative exuberance. It is the faction that participated to take advantage of momemtum rather than hold positions to realize long-term developments that pose the currency short-term risk. It is difficult to establish exactly how much excess could be worked off, but positioning measures can act as a proxy. The CFTC’s Commitment of Traders (COT) report this past week showed a continued reversal from the record net-long exposure set in January. Now at its lowest level since the end of December, there is still plenty of room for moderation as we’ve only seen a 13 percent retreat from the bullish shift that began in 2012.
The most capable driver for the Dollar in its long and short-term course is monetary policy. This past Friday, a range of inflation measures bolstered the persistent doubt of near-term FOMC rate hikes. The headline CPI reading for March slipped back into negative territory (-0.1 percent), a real average weekly earnings figure retreated from its series high to a 2.2 percent clip and price forecasts from the University of Michigan confidence survey posted sharp declines. Caveats of robust core measures and the general trend of the wage numbers factor in, but viability of a near-term hike is certainly diminished. According to Fed Fund futures, the first hike is once again not fully priced in until January 2016.
Moderated rate expectations reinforced by tepid data, but it’s capability as a fundamental driver is diminished considering the time frame yields imply and the persistent buoyancy of the Dollar – a rate hike may come later but it is still a hike among QE programs. Sentiment may simply tip out of favor for the Greenback and pull it lower, but the most effective means would by through key event risk to focus the selling effort. For the coming week’s docket, there is limited high-profile event risk to hit all traders’ radars. And, marking a meaningful distraction, there are very high profile events in the following week (FOMC decision and GDP amongst others).
As we keep an eye on the evoluation of rate speculation, it will also be important to monitor risk trends. While extreme risk aversion would eventually buoy the USD, the aspect of its meteroric rise based in growth and interest rate expectaitons can be tripped up in initial phases of a speculative retreat.
EUR/USD Appeal Due to Covering Potential, Not Yield Prospects
Fundamental Forecast for Euro:Neutral
- The ECB press conference initially invited limited volatility, but EURUSD eventually settled higher.
- The bearish technical formation in the USDOLLAR Index portends to a stronger EURUSD.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
The Euro treaded water last week, losing ground against half of its major counterparts and gaining a bit more against the other three. The worst performance came against the Swiss Franc (EURCHF -0.91%), while the best performance came against the US Dollar (EURUSD +1.87%). In a week ripe with strife – be it on the political front, with more debt bantering with Greece, or on the monetary front, in the form of the European Central Bank’s third policy meeting of the year – the Euro fared reasonably well, all things considered.
With respect to the ECB meeting, President Mario Draghi has made it quite clear that market-borne talk of the QE program being tapered ahead of its projected September 2016 finale are premature at best, and misguided at worst. Before asset purchases cease, the ECB needs to see a stabilization in both actualized and expected inflation, which haven’t happened yet: core inflation resides at a mere +0.6% y/y; and the 5y5y inflation swaps closed the week at 1.693%, right at the four-week/20-day average of 1.678%. ‘Taper talk’ probably becomes more realistic once core inflation crosses the +1.2% y/y threshold, or if the 5y5y inflation swaps move above 1.800%.
For now, the Euro remains a weak buy against a basket of its major counterparts due to its deflating yield appeal and further crystallization as a funding currency. The Euro has lost and continues to lose its appeal as a growth currency as the differential between the short-end and the long-end of the yield curve (in Germany the 2s10s spread fell to 0.347% on Friday from 0.638% on January 1) decreases; and its appeal as a funding currency increases as rates towards the long-end drop into negative territory (German yields out to 9-years are negative).
The drop in sovereign yields decreases the demand for Euros. With nominal yields falling and inflation expectations holding stable (and even slightly rising), real returns on fixed income investments are decreasing; in turn, this fuels demand for higher yielding/riskier EUR-denominated assets like equities; or forces Euro-Zone-based investors to look outside the region for opportunity – which means capital needs to be converted from Euros into foreign currencies. This is the “portfolio balancing channel” effect that ECB President Mario Draghi has been discussing since the beginning of the year.
The Euro’s appeal, therefore, is rooted in the oversized short position currently in the market, which at least in context of EURUSD, could help propel covering in the very near-term (as was seen again this past week). As of March 14, there were 212.3K net-short contracts held by speculators in the futures market, off from 215.3K a week earlier (and down from the 226.6K seen during the week ended March 31, 2015). Otherwise, market participants are viewing the drop in Euro-Zone yields as a sign that the ECB will keep rates for an extended period of time, well-beyond the projected September 2016 finsih for its QE program: the Morgan Stanley ‘months to first rate hike’ index currently resides at 56.5, suggesting a December 2019 or January 2020 rate hike at the earliest. –CV
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USD/JPY Eyes March Low - Japan to Post First Trade Surplus Since 2012
Fundamental Forecast for Yen:Neutral
The fundamental event risks lined up for the final full-week of April may heighten the appeal of the Yen and spark a further decline in USD/JPY as the Japanese economy gets on a firmer footing.
With Japan expected to post a trade surplus for the first time since June 2012, prospects for a stronger recovery in 2015 may encourage the Bank of Japan (BoJ) to retain a wait-and-see approach at the April 30 interest rate decision as Governor Haruhiko Kuroda remains confident in achieving the 2% inflation target over the policy horizon. In turn, Japanese officials may continue scale back their verbal intervention on the local currency, and the bearish sentiment surrounding the Yen may continue to diminish over the near to medium-term as the central bank turns increasingly upbeat on the economy.
In contrast, the recent weakness in the U.S. may further dent expectations for a Fed rate hike in June, and another series of weaker-than-expected data prints may spark a larger correction in the greenback as interest rate expectations get pushed back. Despite expectations for a 0.6% rebound in U.S. Durable Goods, it seems as though lower energy prices are failing to drive private-sector consumption amid the ongoing weakness in retail spending, and another unexpected decline in demand for large-ticket items may trigger a larger correction in the greenback as it drags on the outlook for growth and inflation. In turn, we may see a growing number of Fed officials show a greater willingness to retain the zero-interest rate policy beyond mid-2015 at the April 29 meeting.
With that said, the improving terms of trade for Japan paired with the ongoing slack in the U.S. economy may prompt a further decline in USD/JPY, and the pair may continue to give back the rebound from March (118.32) amid the shift in the policy outlook.
British Pound Forecast to Trade Higher on Fundamental Strength
Fundamental Forecast for British Pound:Bullish
Impressive UK employment data helped push the British Pound sharply higher versus the US Dollar and other major counterparts, and the recent reversal in fortunes leaves us in favor of continued GBP gains through the foreseeable future.
The FX market is a question of relative performance, and the fact that US economic data and interest rate expectations have been notably better than their UK equivalents helps explain why the British Pound/US Dollar exchange rate recently fell to five-year lows. Yet things have turned for the US currency as a recent tumble in domestic yields have left it at a lesser advantage versus the British Pound and others. The difference between UK and US 2-year government bond yields now stands near its smallest since November, 2014, and the GBP/USD exchange rate has moved higher in kind.
Traders will look to upcoming Bank of England Monetary Policy Committee minutes to drive moves in UK interest rates, while a relatively empty US economic calendar suggests broader market volatility may slow through the coming week. The key question is whether recent improvements in UK economic data will be enough to force the Bank of England into action sooner than currently expected.
Headline UK Consumer Price Index inflation printed at exactly 0.0 percent through March—well-below the BoE target of 2.0 percent. This fact in itself suggests the central bank will be in no rush to raise rates through the foreseeable future. And yet recent employment numbers show domestic unemployment has fallen to seven-year lows, while broader consumption and economic activity data points to strong growth through 2015. All else remaining equal, the improvement in the data should have been enough to send the British Pound even higher.
The critical point remains that political uncertainty surrounding UK elections on May 7 have hurt the British Pound against major counterparts. Derivatives markets show that GBP/USD volatility prices/expectations trade near multi-year highs given clear indecision in UK electoral poll figures. Ultimately, however, fears over post-election political disarray may be overdone. And indeed further improvements in economic data and interest rate expectations could fuel a larger British Pound recovery versus the US Dollar and other major FX counterparts.
1173 Key Support in Focus as Gold Preserves Monthly Opening Range
Fundamental Forecast for Gold:Neutral
Gold prices are softer for a second consecutive week with the precious metal off nearly 0.27% to trade at $1204 ahead of the New York close on Friday. Price action has been uninspiring over the past few sessions despite broader volatility in equity markets, with S&P posting its largest single-day decline since March 25th.
The March US Consumer Price Index (CPI) released on Friday was mixed with the headline year-on-year print showing a contraction of 0.1% while the core rate increased from 1.7& to 1.8% y/y. The data offered little assistance to the battered greenback with the dollar trading heavier against all of its major counterparts heading into the close of the week. Gold looks to close the week within the initial weekly opening range with prices continuing to contract after failing to breach above the March highs earlier in the month.
Economic data will be light next week with US Durable Goods Orders on Friday highlighting the docket. Aside from the ongoing political uncertainty in Europe, traders will be closely eyeing the greenback with the Dow Jones FXCM U.S. Dollar Index (Tickers:USDOLLAR) now at risk for a correction lower after breaking below multi-month slope support. The broader picture for gold remains bearish as expectations for a Fed interest rate hike this year continue to weigh on demand for non-yielding assets. However, the Fed now runs the risk of further delaying its first interest rate hike in nearly a decade as growing geopolitical concerns, strength in the dollar and soft inflation continue to limit the central bank’s scope to begin the normalization cycle. As such gold may continue to see a reprieve with the momentum profile suggesting more upside may be on the cards before the resumption of the broader down trend.
From a technical standpoint, the near-term outlook remains clouded as the monthly range continues to compress. Key support rests at 1173/77 and we will reserve this threshold as our medium-term bullish invalidation level. Interim resistance is eyed at 1214 (April high day close) backed by the 50% retracement of the 2014 range / 200-day moving average at 1225/29. Key resistance stands at 1245/48 with a breach above targeting objectives into 1300. That said, we’ll be looking for a break of the monthly opening range to validate our near-term bias with the broader outlook weighted to the topside while above 1173.
Swiss Franc Opportunities Seen Beyond Breakneck Volatility
Fundamental Forecast for Swiss Franc: Neutral
SNB Shocker Fuels Highest Swiss Franc Volatility vs. Euro Since 1975
Sharp Counter-Swing Seen Ahead if ECB Delays Launching QE Effort
Buying US Dollar vs. Franc Attractive After Post-SNB Turmoil Settles
The most adept of wordsmiths might be forgiven for struggling to find an adjective strong enough to describe last week’s Swiss Franc price action. A quantitative description is perhaps most apt: realized weekly EURCHF volatility jumped to the highest level since at least 1975, swelling to nearly 2.5 times its previous peak.
The surge was triggered after the Swiss National Bank unexpectedly scrapped its three-year-old Swiss Franc cap of 1.20 against the Euro, saying the “exceptional and temporary measure…is no longer justified.” Appropriately enough, the previous historical peak in weekly EURCHF activity occurred in September 2011 when the Franc cap appeared as suddenly as it vanished. Then too, the SNB acted without warning and sent markets scrambling.
The announcement caught the collective FX space by surprise. Even the world’s top international economic bodies were apparently left in the dark. IMF Managing Director Christine Lagarde quipped that she found it “a bit surprising” that SNB President Thomas Jordan did not inform her of the impending move. “Talking about it would be good,” she added.St. Louis Fed President Jim Bullard hinted the US central bank was not notified either.
The go-to explanation for the SNB’s actions centers around bets that the ECB will unveil a “sovereign QE” program following its policy meeting on January 22. Mario Draghi and company finally secured a green light for large-scale purchases of government debt after the ECJ gave clearance to the similar OMT scheme devised (but never used) to battle the debt crisis in 2012. The SNB presumably scrapped the Franc cap to avoid having to keep pace with the ECB’s efforts.
Another wave of Franc volatility may be ahead next week. While markets seem all the more convinced that an ECB QE announcement is in the cards after the SNB’s about-face maneuver, a delay in the program’s implementation (if not its formulation) is entirely plausible. Securing the acquiescence of anti-QE advocates like Germany to having such an effort in the arsenal is not the same as launching it. The ECB may yet opt to wait through the end of the first quarter as it has hinted previously before pulling the trigger, sending the Euro sharply higher.
Measuring the fallout from the SNB’s actions is likely to be protracted. The full breadth of the various ripple effects will probably emerge over weeks and months, not hours and days. The Franc now looks gravely overvalued against currencies whose central banks are set to tighten policy this year, with the US Dollar standing out as particularly notable. It seems prudent to let the dust settle before taking advantage of such opportunities however.
Australian Dollar to Weigh 1Q CPI, China PMI as RBA Bets Evolve
Fundamental Forecast for Australian Dollar: Neutral
Australian Dollar Looks to Core CPI Data to Drive RBA Policy Speculation
Soft Chinese PMI Figures May Cap Aussie Gains Amid Spillover Concerns
Identify Critical Turning Points for the Australian Dollar with DailyFX SSI
The Australian Dollar is on pace to produce the first series of back-to-back weekly gains in three months. The currency shrugged off losses sustained early in the week on the back of disappointing Chinese trade figures following an impressively strong March jobs report. The decidedly upbeat outcome weighed against RBA interest rate cut speculation. Traders now price in a 58 percent probability of a 25bps cut at next month’s central bank policy meeting, down from 78 percent at the start of the week.
Looking ahead, first-quarter CPI figures will continue to inform investors’ RBA outlook. The benchmark year-on-year inflation rate is expected to decline to 1.3 percent, the lowest in almost three years. As with many of its G10 counterparts however, the RBA has been reluctant to fight short-term price growth weakness. Policymakers have argued that downside pressure will dissipate with rebasing as the impact of last year’s sharp drop in energy costs is unwound, leaving medium-term trends targeted by central banks intact.
With that in mind, traders will probably focus on the “trimmed mean” CPI measure, a metric that aims to strip out up- and down-side price growth volatility extremes to get at the core inflation trend. This is expected to hold at 2.2 percent, unchanged from the fourth quarter. That would mark a break from disinflation seen in the second half of 2014, which may further reinforce perceptions that the RBA is in no hurry to top up stimulus and boost the Australian unit.
Chinese news-flow represents another significant inflection point. The Aussie overlooked dismal industrial production figures from the East Asian giant last week, with the release seemingly overshadowed by a concurrently published first-quarter GDP report that printed in line with forecasts. The week ahead will bring a timelier measure of the business cycle in Australia’s top export market via the flash estimate of April’s HSBC Manufacturing PMI measure. Accelerated contraction in factory-sector activity is expected, which may cap the Aussie’s upside potential.
New Zealand Dollar Looks to 4Q GDP, FOMC Outcome for Direction
Fundamental Forecast for the New Zealand Dollar: Neutral
New Zealand Dollar May Fall if Weak 4Q GDP Fuels RBNZ Rate Cut Bets
FOMC Meeting Outcome to Influence NZ Dollar via Risk Sentiment Trends
Identify Key Turning Points for the New Zealand Dollar with DailyFX SSI
The New Zealand Dollar managed to find support against its US counterpart after the RBNZ signaled it was in no hurry to cut interest rates at its monetary policy meeting. Governor Graeme Wheeler highlighted a range of factors underpinning strong economic growth and dismissed soft inflation readings in the near term as largely reflective of the transitory impact of oil prices. Speaking directly to the benchmark lending rate, Wheeler projected “a period of stability” ahead.
Still, the familiar refrainwarning that “future interest rate adjustments, either up or down, will depend on the emerging flow of economic data” was repeated. This makes for a news-sensitive environment going forward as markets attempt to divine the central bank’s likely trajectory alongside policymakers themselves. With that in mind, all eyes will be on the fourth-quarter GDP data set in the week ahead.
Output is expected to increase by 0.8 percent, an outcome in line with the trend average. On balance, that means a print in line with expectations is unlikely to drive a meaningful re-pricing of policy bets and thereby have little impact on the Kiwi. New Zealand economic data outcomes have increasingly underperformed relative to consensus forecast since January however. That suggests analysts are over-estimating the economy’s momentum, opening the door for a downside surprise. In this scenario, building interest rate hike speculation may push the currency downward.
The external landscape is likewise a factor. A significant correlation between NZDUSD and the S&P 500 (0.52 on 20-day percent change studies) hints the currency is sensitive to broad-based sentiment trends. That will come into play as the Federal Reserve delivers the outcome of the FOMC policy meeting, this time accompanying the statement with an updated set of economic forecasts and a press conference from Chair Janet Yellen. Fed tightening fears have proven to be a potent catalyst for risk aversion since the beginning of the month. That means a hawkish tone is likely to sink the Kiwi, while a dovish one may offer the currency a lift.