By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It was a roller coaster ride in the foreign-exchange market Tuesday with currencies rebounding strongly after hitting fresh lows at the start of the NY session. We often see turnarounds on Tuesday but the abruptness of the day’s moves caught many investors by surprise. No US economic reports were released and nothing specific triggered the reversal. However EUR and GBP popped right after 14 GMT, a time when many options expire. This coincided with the unexpected resignation by UN Ambassador Nikki Haley so it is not clear whether investors perceived her resignation as a lack of confidence in the Trump Administration or it was all option-related flow. Either way, option expirations and Haley’s resignation should only have a short-term impact on currencies. Broader themes remain in play and that’s why the recoveries in euro and other high-beta currencies may not last.
With US yields reversing lower after hitting 9-year highs, USD/JPY took another trip below 113. Less hawkish comments from Fed President Kaplan didn’t help. While he believes that the central bank should be bringing interest rate toward neutral, he doesn’t seem to share his peers’ concerns that inflation could get out of hand and the Fed may not need to hike rates past neutral. He advocates gradual, patient rate increases. Meanwhile, President Trump isn’t letting up on China. After the Treasury said yesterday that they weren’t happy with China’s weakening currency, Trump reiterated that China is not ready to make a deal and the US stands ready to impose another $267B in tariffs if China retaliates. China promised on Tuesday that they would not weaken the Yuan to boost exports but that may not satisfy the US administration, which could label the country a currency manipulator for the first time since 1994. While none of this changes the positive course of US interest rates and the outlook for the dollar, risk aversion is driving USD/JPY lower. Producer prices are scheduled for release Wednesday and while we expect price pressures to rise, it may take a strong CPI report to turn USD/JPY around.
After hitting 6-week lows, the euro ended the day unchanged against the U.S. dollar. For the second day in a row, Germany’s economic reports were disappointing. Although the trade surplus increased, exports and imports fell but the main focus was Italy and not data. In an attempt to stem the rise in Italian bond yields, Economy Minister Tria tried to reassure investors that they will bring their deficit back to target and pledged to do whatever it takes to contain the rise in yields if the spread between German and Italian yields hits 400 or 500 bp. It seems that these promises may have worked, at least in the short term because the recovery in EUR/USD coincided with a backup in Italian rates. But don’t be mistaken, Italy’s problems haven’t gone away. The desire to expand the deficit is very strong and that should keep EUR/USD under pressure. Recoveries in the currency should be limited to 1.1550-1.1580.
Tuesday’s strongest currency was the British pound, which is trading purely on Brexit speculation. Reports that the EU and UK are making progress sent GBP/USD above 1.31 but nothing official has been announced. The European Union is expected to present a trade offer to the UK Wednesday and judging from the performance of sterling, investors are hoping that it will be good. UK trade, industrial production and monthly GDP reports are also scheduled for release on Wednesday – and while important, these reports will take a backseat to any Brexit developments.
Last but not least, all 3 commodity currencies performed well including the Canadian dollar, which rejected 1.30 for the second time in a row despite weaker housing starts. The pullback in the U.S. dollar and rising oil prices certainly helped. If USD/CAD drops below Monday’s low of 1.2935, the next stop will be 1.2900. The Australian and New Zealand dollars rebounded for the second day in a row. While AUD was supported by slightly better Australian business confidence, these deeply oversold currencies benefitted from anti-USD sentiment while the recovery in stocks helped to boost risk appetite. Despite today’s moves, the downtrend in euro and the commodity currencies remains intact until there are real improvements in Italy and US-China trade relations.