By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar is off to a strong start this week as the greenback recovered earlier losses against the euro and British pound and drifted to the top of its range versus the Japanese yen. This strength can be attributed completely to pre-Yellen positioning because yields are down and data was weak. Durable goods orders fell -1.1% in May, which was significantly softer than anticipated. Manufacturing activity in the Chicago and Dallas regions also fell short of expectations, supporting concerns about the justification for Fed Chair Janet Yellen’s hawkishness. Yet U.S. rates spent the majority of the day in negative territory, making us leery of the dollar’s rally, especially ahead of Tuesday’s consumer confidence report, which should be softer given the drop in the University of Michigan index. But what matters most this week is Fed speak and investors are buying dollars on the hope that Yellen will repeat the hawkishness that sent the dollar sharply higher in mid June. If she does, USD/JPY could minimally reach 112.20 but if she expresses even a hint of concern, USD/JPY will slip back down to 111.00. Having closed at its highs of the day, a break of 112 could even happen before Yellen speaks. Backpedaling on optimism is exactly what drove EUR/USD lower on Monday. Even though German business confidence rose strongly in June, ECB President Draghi said interest rates needs to be low for growth to recover, suggesting that he is not eager to start tapering asset purchases. After rejecting 1.12, EUR/USD appears poised for a move back below 1.1150 on a technical basis but fundamentally, there’s no doubt that at a time when U.S. data consistently misses, Eurozone data has been improving. Germany’s business climate index hit a record high as businesses look forward to a continued upswing in the region’s largest economy. Not only are businesses pleased with current conditions, but their confidence in future activity climbed to its highest level since February 2014. For this reason, we like buying euros on dips but prefer to wait for a move down to the 1.1075-1.1120 region. Monday’s biggest story was Prime Minister May’s deal with the Democratic Unionist Party. It has been a long time coming and there were times when the talks looked as if they could have completely broken down, but after painstaking negotiations, a minority government has been formed. May offered 1 billion pounds of extra spending and new tax powers to Northern Ireland in a deal that will be reviewed in 2 years in case the DUP wants to increase its demands. The good news is that May gets to keep her job but the bad news is that it cost her handsomely. Sterling traded slightly higher because this deal removes a key layer of uncertainty for the U.K. economy but the rally was unimpressive because the hung Parliament puts May in the difficult position of battling to pass other laws while striking deals on non-budget and Brexit issues on a case-by-case basis. We are also at the very early stages of Brexit negotiations and on Tuesday Bank of England Governor Carney could end up talking down the currency. The House of Commons also holds a crucial vote on the Queen’s Speech Wednesday or Thursday of this week. The DUP will be voting with the Conservatives but the vote could be very close as Labour bands together to weaken the power of the new minority government. All of this explains why GBP/USD failed to end the day higher, even though the Tory-DUP deal is good news. All 3 of the commodity currencies appreciated against the greenback Monday with the Australian dollar leading the gains. Oil prices ended the day in positive territory as gold prices struggled after an unexpected drop before the NY open. There were no economic reports released from any of the 3 commodity-producing countries. USD/CAD remains in a downtrend but Monday’s bounce could take the pair back up to 1.3340, which would be a great place to sell before Bank of Canada Governor Poloz’s speech on Wednesday. New Zealand trade numbers were due Monday evening. While manufacturing activity is on the rise according to the latest PMI index, the stronger currency and weaker dairy prices could drag down trade activity. For the time being, the uptrend in AUD/USD and NZD/USD remains intact but after such overstretched moves, a pullback is very likely.