By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
So far this week EUR/USD is the best performing major currency but after 6 straight days of gains, a correction could be right around the corner. With no major U.S. or Eurozone economic reports released in the front of the week, the euro was driven by dollar dumping and short covering. Wednesday’s move above 1.16 was caused by President Trump’s latest political troubles but investors pushed their concerns aside quickly. If the possibility of a sitting president being indicted for violations can’t keep the dollar down, it seems nothing will.
There are a number of reasons why we believe the euro is at risk of a pullback. First, Eurozone PMIs are scheduled for release tomorrow and the recent decline in German factory orders and industrial production could turn into a broader pullback in manufacturing– and service-sector activity. So far the Eurozone has weathered trade tensions well but we are beginning to see signs of slowing. Second, Italian bond yields are on a tear. Foreigners are dumping Italian bonds, causing their cost of borrowing to skyrocket and the government is particularly worried about the widening spread between Italian and German yields. The coalition government is expected to unveil a draft of its budget in October and the fear is that spending plans will cause Italy to bust through fiscal targets. Italy’s economy is also expected to slow, putting further pressure on bond prices. Third, the chance of an actual trade agreement between the U.S. and China is slim and, fourth, the latest rally has taken EUR/USD through the 20-day SMA to its 50-day SMA – this is the perfect place for a pullback because if EUR/USD exceeds 1.1650, the next stop could be 1.18.
The FOMC minutes did not hurt the U.S. dollar but there was definitely a sprinkling of bad news for the greenback. While the Fed said further gradual rate hikes will be needed to keep the economy on track and another move may be appropriate soon, they also saw trade, housing and emerging markets as downside risks. They believe that rates are moving closer to estimates of neutral and weighed the timing of when to stop calling rates accommodative. The minutes are less hawkish than the FOMC statement but the impact on the dollar was limited because the central bank made it clear that rates are rising next month. Beyond that is an open question, which is challenged every day by policymakers and data like Wednesday’s existing home sales report – it fell for the fourth straight month. The greenback traded lower against all of the major currencies except for AUD. New home sales is due for release Thursday but it will be news headlines not data that drives the dollar’s flows. After pleading guilty to felony campaign finance violations, Trump’s personal lawyer, Michael Cohen accused the president of committing a crime and said he was aware of a Russia conspiracy. Its not clear what type of fallout this may have for Trump but taking a look at USD’s move, we see that for now, investors are only mildly concerned.
We are still watching U.S.–China trade talks. So far there have been no updates but the White House did say it sees no reason to change its plans to hit China with $16 billion worth of tariffs on Thursday. Could they decide last minute to delay it? Of course and if they do, it would be very positive USD/JPY and risk appetite. If they don’t and the meetings end with no meaningful progress, we could be looking at broad-based declines. The Fed’s Jackson Hole symposium begins Thursday but the main event will be Jay Powell’s speech at 10AM ET on Friday and we’ll have more on that tomorrow.
Meanwhile, sterling traded higher thanks to more dollar weakness and short covering. The Canadian dollar shrugged off a decline in retail sales last month in favor of the sharp 3% rise in oil prices. Prime Minister Turnbull’s political troubles prevented AUD from rising while NZD was supported by stronger retail sales.