Dollar Won’t Recover Until Yields Stop Falling

• Dollar Can’t Recover Until Yields Stop Falling
• NZD: China Says No to Near Term Stimulus
• AUD: Unemployment Rate Drops to 5.8%
• CAD: Surprise Drop in Chinese Exports
• EUR: Fourth Straight Day of Gains
• GBP: Bank of England Leaves Policy Unchanged
• JPY: Supported by Optimistic Comments from BoJ

Dollar Can’t Recover Until Yields Stop Falling

The U.S. dollar has now erased nearly all of its post March taper gains and the reason why this is happening is simple which is that U.S. 10 year bond yields dropped below its March 19th levels. If you recall, on March 19th, the Federal Reserve tapered asset purchases by another $10B. Even with 2 rounds of reductions in monthly bond purchases and Janet Yellen’s comment on when rates could rise, yields refuse to increase. Of course this is exactly what the central bank wants to see and they are patting themselves on the back for the effectiveness of forward guidance. Their biggest fear with unwinding QE is a surge in U.S. yields that could slow the pace of recovery. While we still believe that U.S. rates are headed higher and will touch 3% again before the end of the year, investors had a very strong reaction to the FOMC minutes and it will be difficult to halt the rally in Treasuries without a catalyst. At the same time, it will be very difficult for the U.S. dollar to rally without a recovery in yields.

This morning’s sharp improvement in jobless claims provided no support to the greenback. For week ended April 5th, jobless claims fell from 332k to 300k, the lowest level since May 2007. The 4-week moving average, which is less volatile also dropped 5k to 316k as continuing claims fell to its lowest level in 6 years. While lower claims do not always translate into stronger payrolls and all of this month’s report is subject to Easter/Passover holiday volatility, the numbers are consistent with a slow and steady improvement in the labor market. Unfortunately that was not good enough to reverse the slide in the dollar. In fact not only did jobless claims dip but import prices also rose more than expected which should have been positive for the greenback yet with annualized price growth falling for the past 2 years, inflation is not a concern for the Federal Reserve at this time. The momentum is still heavily skewed to the downside and without supportive comments from U.S. policymakers or significant improvement in Tier 1 economic data, it may be difficult to get investors excited about buying dollars again especially as a large part of the USD/JPY unwind can be attributed to traders getting stopped out. When that happens, they will be gun shy about jumping back into the same position. Producer prices and the University of Michigan Consumer Confidence Survey for the month of April are scheduled for release on Friday.

NZD: China Says No to Near Term Stimulus

Having climbed to fresh highs on the back of Australia’s strong labor market report, the rally in commodity currencies hit their peak after Chinese Premier Li said the government is not considering near-term stimulus despite signs of downward pressure on growth. Over the past few weeks, back to back disappointments in Chinese data spurred speculation that the China would accelerate stimulus to ensure a soft landing and this hope contributed to the rally in the Australian dollar. However the government has now squashed that theory which could trigger profit taking on long AUD and NZD positions. Nonetheless last night’s Australian economic report was strong and two consecutive months of upside surprises should limit losses in the currency. Our colleague Boris Schlossberg provided a very nice analysis of the Australian jobs report. He said “The labor data from Down Under beat on all points with jobs increasing by 18.1K versus 7.3K eyed while the unemployment rate declined to 5.8% from 6.1% projected. Part of the rise in the unemployment rate was due to a decline in the labor force participation figures, which dipped to 64.7% from 64.8% the month prior. In addition the jump in headline number masked the fact that full time employment declined by -22K while part time jobs rose 40.2K. Nevertheless the market viewed the report as strongly bullish for the Aussie as it signaled that the Australian economy remains surprisingly robust with many economists now projecting growth of 3%. The performance in the AU labor markets was particularly impressive given the weak Trade Balance data out of China. Chinese Trade numbers actually showed a 7.7B surplus versus -0.9B forecast, but the gains came at the expense of declines in both imports and exports. Imports dropped sharply by -11.3% while exports declined -6.6% on a year over year basis. There is still a massive amount of noise in the figures stemming from last year’s over invoicing numbers as China’s exports to Hong Kong and Taiwan fell -42% but actually rose 8% from the year prior.”

EUR: Fourth Straight Day of Gains

There have not been many Eurozone economic reports scheduled for release this week but it has still been a good week to be long euros. The currency appreciated against the U.S. dollar every single day of the week, extending a move that has taken the currency pair from a low of 1.3695 to a high of 1.3875. The European Central Bank maintains a dovish monetary policy outlook and despite Central Bank President Draghi’s decision to list out the various options at their disposal to increase stimulus after the last monetary policy meeting, this week’s comments from European policymakers assured investors that the bar for more aid is high and the risk of QE is low. Nonetheless weak industrial production in France and sluggish price growth keeps the pressure on the central bank to ease. ECB Council member Jen Weidemann said that the central bank will be looking at the projected inflation data to determine its next policy steps and if prices refuse to rise, the EUR/USD may have a tough time extending its gains to 1.40. Revision to German CPI is scheduled for release on Friday along with France’s current account balance. For the time being, it is clear that the euro is benefitting more from the drop in Treasury yields and weakness in the dollar than demand for euros.

GBP: Bank of England Leaves Policy Unchanged

The British pound traded lower against the U.S. dollar after failing to break through its February high of 1.6822. GBP/USD came close, rising to a high of 1.6820 during the Asian trading session but there wasn’t enough momentum to take the currency pair beyond that level. Multi-year highs are always difficult to break especially on the first run and this is particularly true for GBP/USD because 1.6822 is also a 4-year high. Profit taking drove sterling traded lower against all of the major currencies Thursday despite a higher RICS house price balance. As expected, the Bank of England also left monetary policy unchanged, which means they provided no details on their assessment economy and their outlook for monetary policy. Although manufacturing, service and construction sector activity slowed in the month of March, all of PMI indexes remain at high levels and the uptick in industrial production signals underlying momentum in the economy. Some investors believe that the BoE will be the next central bank to raise rates but without an increase in consumer prices, their motivation to act will be limited.

JPY: Supported by Optimistic Comments from BoJ

The Japanese Yen traded higher against all of the major currencies Thursday with the exception of the Australian dollar. For the first time this week the Nikkei did not experience steep losses overnight although it should have recovered more strongly given yesterday’s rally in U.S. equities. According to last night’s economic reports, machine orders fell 8.8% in the month of February. While this data can be volatile, the decline does not bode well for industrial production. Nonetheless, the message from the Bank of Japan is clear – they remain optimistic about Japan’s ability to withstand the sales tax increase. Last night policymaker Miyao said, “Japan’s economy is on a gradual path led by domestic demand” and will continue to grow “above potential growth rate even with a temporary setback from sales tax hike.” This optimism could finally be leaving its impression on foreigners who were net buyers of Japanese stocks for the first time in 3 weeks. The domestic goods price index -- an inflation measure -- was the only piece of Japanese data scheduled for release Thursday evening.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.