The U.S. dollar fell to a 4 month low against the Japanese Yen today, extending a decline that has taken the greenback lower for 8 out of the last 9 trading days. Friday was the first positive day since March 10th and now that 110 is reached (USD/JPY fell within 10 pips of this key level on Monday), dollar bears may be thinking about trading the pair the other way. Of course, there are many reasons for why the dollar is so weak.
The failure of the health care bill raises questions about President Trump’s ability to cut taxes and increase spending and in turn the Federal Reserve’s ability to raise interest rates in June. While Treasury yields and the U.S. dollar are trading like the chance of a June hike has fallen, Fed fund futures remained steady since the Thursday before the bill failed. The market thinks there is a 74% chance the next round of tightening will be in September and only a 50% chance that it will happen in June. We believe those odds should be lower as the complicated tax agenda could take even longer to overhaul. Fed President and FOMC voter Evans was the first to admit today that the failure of GOP health bill adds to uncertainties and that fiscal uncertainty weighs on the outlook.
With this in mind, we see at least 3 reasons why USD/JPY could hold 110. There are 10 Federal Reserve officials scheduled to speak this week and talk about the economy or monetary policy will be unavoidable. Evans, who is more of a dove than a hawk expressed some concerns but still said 2-3 rate hikes in 2017 are appropriate with 4 hikes possible if “things really take off.” We’ll hear from centrist Kaplan tonight and Yellen tomorrow along with a number of other members later this week. Although most will be worried about the Administration’s ability to deliver major tax cuts, we don’t expect vocal concerns this quickly.
Fed officials will remain hopeful that the fiscal and monetary stimulus will continue to drive growth in the U.S. economy and their optimism could help prevent further losses in USD/JPY. Secondly, this week is the quarter end here in the U.S. and the fiscal end in Japan. Part of the recent demand for Yen could be tied to repatriation, most of which has been completed. This time last year we saw USD/JPY fall in the first 3 weeks of March then stabilize in the last week. The year prior, the selling stopped on the 26th of the month and in 2014 on the 27th. Lastly, 110.00 is a very significant support level and demand is clearly emerging above this level. Even if the currency pair breaks 110, the losses could be limited by tiered support below this key level. Does that mean USD/JPY won’t make a run for 110 again? No. Interest rate differentials are the strongest driver of currency flows and if U.S. rates continue to fall or struggle to rise so will USD/JPY.
Meanwhile the best performing currency today was the British pound. With 2 more days to go before the U.K. triggers Article 50, sterling is trading as if Brexit will be good for the economy. From high to low the currency pair appreciated more than 500 pips in 2 weeks. Part of the move can be explained by the weakness of the U.S. dollar, but stronger U.K. data and the hawkish dissent this month completely shifted the market’s outlook for GBP. Investors are looking beyond the trigger of Article 50 and the EU’s response 48 hours later to the end of easy money. While we think the market may have moved on too quickly because no one knows how strict the E.U. response will be we need to respect the price action and the fundamental drivers behind the move. With that in mind, we continue to believe that GBP will fall after Article 50 is triggered, but shortly thereafter, the reality that an exit won’t be finalized until late 2018 will set in. So in the near term, rallies in GBP/USD between 1.26 and 1.27 should be sold.
Stronger than expected data drove euro above 1.09 today. The German IFO report, which measures business confidence rose to its highest level since 2011. The business climate sentiment index reached 112.3, besting the 111.1 forecast. The expectations index also surprised to the upside with a reading of 105.7 vs. 104.3 forecast. The Current assessment came in with a reading of 119.3 vs. 118.3 expected. These numbers are consistent with the improvements seen in the PMIs which bodes well for the Eurozone confidence and German unemployment figures scheduled for release later this week.
We also heard from two ECB officials – ECB member Praet said easy monetary policy is still needed and any attempt to remove accommodation would possibly slow or stall ECB efforts in reaching inflation targets. ECB’s Smets’ also chimed in with mixed comments saying that the real economy of the EU is doing well, however, sustainable improvement in inflation still seems to be elusive at the moment. With no major Eurozone economic reports scheduled for release tomorrow, EUR/USD will take its cue from the greenback but the latest string of positive data should help the currency outperform some of its peers.
It was a quiet day for the commodity currencies – the Australian and Canadian dollars ended the NY trading session unchanged while the New Zealand dollar trickled upwards. There were no major economic reports released from any of these countries and while gold prices rose, AUD was hit by lower copper and iron ore prices. The Canadian dollar was dragged down by lower oil prices and falling Canadian yields. US crude prices extended its losses as the number of oil rigs continued to increase, adding to supply concerns. A few OPEC and Russian officials met over the weekend to review current levels of compliance. The lack of news coming out from the meeting also put a damper on oil prices. NZD managed to make gains against the US Dollar even though there was a lack of news for the day. The strength is likely due to AUD/NZD flows. No major economic reports are scheduled for release from the commodity producing countries on Tuesday.
By Kathy Lien, Managing Director of FX Strategy for BK Asset Management