By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The first two weeks of the year have been marked by profit taking in the U.S. dollar, U.S. stocks and short Treasury trades. Investors unwound their Trump trades after enjoying strong gains at the end of 2016. Donald Trump had the opportunity to revive the rally in stocks and the dollar by providing more concrete details on his fiscal stimulus plans at his first press conference as President elect but he failed to do so, which gave investors very little reason to reload their long dollar and long stock trades. Instead, U.S. yields continued to fall, pushing the dollar lower. But with days to go before the inauguration, the dollar has stabilized. We saw initial signs of this on Friday when USD/JPY avoided losses for the first time in 5 trading days.
According to the latest economic reports, Americans are spending more and inflation is on the rise. Retail sales rose 0.6% in December, up from 0.2% in November. Producer prices also rose by 1.6% year over year, up from 1.3%. Although the details of these reports were less encouraging with spending ex-autos stagnating and inflation growth slowing month over month, Federal Reserve officials have been confident that rates will rise this year and we do not believe that the latest reports alter their views. Nearly all of the FOMC voters who spoke last week felt that 3 rate hikes are possible. We know from earlier Fed minutes that their views hinge on Trump delivering on his tax cuts and infrastructure spending plans. So while investors may be skeptical, policymakers are not, which is important to recognize. The focus has been on concerns about Trump’s conflict of interests and his alleged relationship with Russia, but these issues do not compromise his plans to “make America great again” through a massive spending program. If you believed that he was going to deliver after the election, then as things stand now, there is little reason to believe that he won’t follow through on his campaign promises. Americans are spending thanks to higher wages and continued job growth and as long as this continues, the Fed will need to normalize monetary policy and raise interest rates. For these reasons, we believe that the dollar is near a bottom and while we can’t rule out a final flush, the chance of stabilization before Trump’s inauguration is greater. Next week’s U.S. economic calendar focuses on inflation, housing and Fed speak — 3 factors that are expected to help more than hurt the U.S. dollar.
The coming week will be a busy one. Although news agencies will be focused on the upcoming inauguration, we are focused on the heavy set of economic releases on the global calendar. U.S. markets are closed on Monday for Martin Luther King Day but the action heats up on Tuesday with Prime Minister May’s “important speech on Brexit” and the U.K. inflation report. Sterling will be in play at the start of the week with May’s comments likely to set the tone for the currency’s trade. However the country’s inflation, employment and retail sales reports will also be very important as politics could easily trump economics. We expect sterling to trade heavy leading up to May’s speech, especially against the euro, and then it all hinges on what she has to say. May is expected to lay out her approach to leaving the European Union, including her possible plans for immigration and single-market access. She could certainly suggest that they will try for a softer exit, which would be very positive for the pound. Still, the chance that she will adopt a hard-line approach is just as likely, so while we expect sterling to trade lower ahead of May’s speech, we recommend being flat during the speech and reevaluate afterwards.
The European Central Bank and Bank of Canada have monetary policy announcements on the calendar. Neither central bank is expected to change monetary policy but investors will be watching carefully to see if the recent improvements in Eurozone data is enough for the ECB to start discussing tapering. When they last met, Draghi completely dismissed the idea of unwinding their quantitative easing program by tapering asset purchases. The ECB clearly did not want to jeopardize its fragile recovery by taking any steps that could reverse the uptrend in growth and inflation. One month later, the economy has clearly improved with inflation and manufacturing activity on the rise. The weakness of the euro has gone a long way in supporting the economy and boosting inflation, leading ECB member Villeroy to say that growth will be solid in 2017. We believe that this is a view shared by a number of policymakers. According to the last ECB minutes, headline inflation is rising significantly giving the central bank more reasons to consider reducing asset purchases. Any recognition of tapering would be euro-positive but they could also refrain from talking about this possibility if they still believe that the recovery needs support. Of course it is important to recognize that the euro has also been rising because the U.S. dollar has been falling, so if the Trump ‘unwind’ recedes, EUR/USD could give up its gains. Data-wise, Germany’s ZEW survey is likely to show improvement in investor confidence due to the weaker currency and stronger data.
The Bank of Canada’s monetary policy announcement should have only a limited impact on the Canadian dollar as Canadian policymakers will most likely maintain a neutral monetary policy bias. When they last met in December, the BoC said the dynamics of Canada’s growth were largely as anticipated and current monetary policy stance remains appropriate. Since then, data has been mostly better with retail sales, trade, employment and the IVEY PMI index rising. However consumer price growth has eased and the recent rise in the Canadian dollar could put further downward pressure on prices. The Canadians are also nervous about Trump’s plans to renegotiate NAFTA. Aside from the BoC announcement, Canadian retail sales and consumer price reports are also on the calendar but the focus will be on the BoC.
For Australia and New Zealand, Chinese Q4 GDP, industrial production and retail sales numbers will be in focus. The Chinese economy has been slowing and investors will be watching closely to see if the data reflects that. Australia will also be releasing its employment report. After last month’s strong job growth, a smaller increase is expected. No economic reports are scheduled for release from New Zealand but NZD traders will be watching the dairy auction to see if the downtrend lets up. While the prices of Australia’s key commodities have been on the rise, the price of New Zealand’s main export has been falling, which explains the recent rally in AUD/NZD. Technically, AUD/USD and NZD/USD rose strongly this past week but having rejected the 100-day SMA, we now look for a deeper correction in both currency pairs.