What's With USD's Lack Of Follow Through?

• Should Dollar’s Lack of Follow Through Be a Concern?
• EUR: From Politics to Economics
• GBP: Week of Steady Losses
• USD/CAD – Will Positive Data Mean a Top?
• AUD: Shrugs Off Drop Slowdown in Leading Indicators
• NZD: Supported by Stronger Data
• JPY: Beware of Further Liquidation of Japanese Assets

Should Dollar’s Lack of Follow Through Be a Concern?


The action in the foreign exchange market this week was marked by the strong rally in the U.S. dollar on Wednesday. Outside of the one-day rise, however, we have not seen much follow through. In fact, on an otherwise quiet Friday, U.S. 10 year yields dropped 2.5bp, leading to a mild sell-off in the greenback. Earlier this week Fed Chair Janet Yellen made it clear that the central bank is in the process of normalizing monetary policy. If all goes well, Quantitative Easing will end this year and interest rates will start to rise in 2015. This clearly mapped out plan should drive both Treasury yields and the dollar higher but so far we haven’t seen much upward movement beyond the initial rise and this raised some concerns that U.S. rates will reverse once again. We have seen this story play out before with yields retreating after the central bank tapers. Part of the reason why this happens is because the central bank is still buying bonds, just less on a monthly basis. Also over the past 2 months, we had an unusually harsh winter that depressed economic activity that caused downside surprises in data. Looking ahead, the only question that investors are interested in is whether this pattern will repeat because the slide in U.S. yields from its post taper high of 3% in December also drove the dollar lower. While arguments can be made for a reversal in yields, the outlook for the economy is an important difference between now and December. With the weather improving, economic activity is expected to accelerate, leading to stronger job growth and consumer consumption. We have already seen the initial signs of improvements with some of this week’s economic reports and looking ahead we should continue to receive upside surprises that will reinforce the rally in U.S. rates and the dollar. Certain currencies will perform worse than others versus the greenback and it all boils down to monetary policy direction. The New Zealand dollar for example will probably see shallow losses because the economy is growing and the RBNZ is raising interest rates. The euro on the other hand could experience steep losses given the European Central Bank’s discomfort with low inflation.

While no U.S. data was released, a number of Federal Reserve Presidents spoke Friday. Bullard supports Yellen’s view that rates will rise approximately 6 months after QE ends and Kocherlakota who dissented against dropping the unemployment rate threshold as forward guidance clarified that he would have preferred to lower the threshold to 6.5% from 5.5% and to add a 2.25% inflation threshold. While there is a number of U.S. economic reports scheduled for release next week, upcoming speeches from Federal Reserve officials will also be important in light of Yellen’s comments this week.

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EUR: From Politics to Economics

For the past few weeks, the euro traded primarily on geopolitical developments and more specifically, the shifting tensions between, Ukraine, Russia and the West. While the crisis could still affect risk appetite, Vladimir Putin’s comment that Russia will refrain from retaliating further against U.S. sanctions helped to diffuse some tensions. Next week it should be back to economics for the euro. We know that Germany is leading the recovery and the European Central Bank is not happy with the strong euro’s affect on inflation but the sharp decline in the ZEW survey raises concerns about whether the recovery is slowing. We will get our answer in next week’s Eurozone flash PMI and German IFO reports. Consumer prices from the region’s largest economy will also be released, rounding out the data on activity and inflation. Although EUR/USD fell sharply after the FOMC rate decision on Wednesday, its ability to hold above 1.3750 suggests that investors haven’t given up on the currency due in part to its massive current account surplus which hit record highs in the month of January. Foreign direct inflows and equity portfolio flows also remains strong indicating that investors are still buying European assets. According to the consensus forecast activity in the Eurozone is expected to have slowed in the month of March but if it surprises to the upside, EUR/USD could recapture 1.3850.

GBP: Week of Steady Losses

It has been a very tough week for the British pound, which failed to experience even one day of gains against the U.S. dollar. U.K. economic data hasn’t been terrible and in fact the labor market report was quite good but with long sterling positions at extreme levels, there was little motivation to add to existing positions. Instead, less dovish comments from Fed Chair Janet Yellen renewed demand for U.S. dollars, giving sterling traders a compelling reason to liquidate their longs. Friday’s revelation that U.K. public finances deteriorated in the month of February added to the pain. Public finances excluding financial sector interventions showed a deficit of GBP 9.3 billion last month compared to an 8.6 billion forecast and a surplus the previous month. This will make it difficult for Chancellor Osborne to achieve the lower borrowing and higher growth targets that he unveiled earlier this week. The outlook for GBP/USD next week should hinge less on the market’s demand for U.S. dollars and more on U.K. data. We have consumer prices, retail sales and revisions to fourth quarter GDP scheduled for release. While the break of 1.65 in GBP/USD has been shallow, if inflation remains weak and retail sales growth fails to rebound significantly in February, we could find the currency pair trading down to 1.64.

USD/CAD – Will Positive Data Mean a Top?

All 3 of the commodity currencies rebounded Friday but the focus was on the Canadian dollar, which experienced a long overdue relief rally on the back of stronger retail sales and consumer prices. Consumer spending jumped 1.3% in the month of January, nearly 2 times more than expected. Excluding auto sales, demand was still strong, rising 1.0% from the previous month. Inflationary pressures also seem to be improving with consumer prices rising 0.8% in February. However on an annualized basis, CPI growth slowed to 1.1% from 1.5%. These latest economic reports may ease the central bank’s worries and will provide support for a further recovery in the Canadian dollar but the data is from January and February. Governor Poloz’s recent views may reflect a more updated assessment of the economy. Earlier this week, Poloz sent USD/CAD soaring to 4-year highs when he said the BoC could not rule out further rate cuts. The central bank’s concerns center on low inflation and weak U.S. / Chinese growth. In the past the weakness of the Canadian dollar helped to support exports but Poloz has “not seen anything that suggests we’ve actually had a reaction to that.” All of their hope rests in a stronger U.S. recovery and while U.S. data has been improving, tapering by the Fed will keep the economy growing at a steady but slow pace. According to latest CFTC IMM report, long USD/CAD positions remain at extreme levels. Friday’s positive economic surprises could encourage deeper profit taking in the currency pair. If USD/CAD drops below its former breakout level of 1.1150, we could see a sharper correction down to 1.10. If it holds this level, it could still revisit its 4 year highs. The rally in the New Zealand dollar was supported by a smaller decline in consumer confidence and larger increase in job advertisements. The Australian dollar on the other hand shrugged off slower leading indicator growth to experience Friday’s strongest gains. The new trading week starts off with China’s HSBC Flash manufacturing PMI report. March data is generally devoid of any seasonal adjustments but activity in the sector is expected to slow further.

JPY: Beware of Further Liquidation of Japanese Assets


On Friday the Japanese Yen traded lower against most of the major currencies but unfortunately USD/JPY did not participate in the move. Although the outlook for Japan’s economy is important, in the near term, the absence of a continued rise in U.S. yields limited the upside for USD/JPY. Between the holiday in Japan and lack of U.S. data, the currency traded within a narrow 40-pip range. Next week will be a busier one for the Yen with a number of important economic reports on the calendar that will give investors a better assessment of how the economy is performing ahead of the consumption tax increase. This includes small business confidence, overall household spending, the jobless rate, retail sales and the consumer price report. It is widely believed that Japanese growth will slow and most likely contract in the month and quarter of the tax increase, which is why it is extremely important to have a significant buffer of growth and demand. The government is confident they will come out of it stronger but few investors share their optimism. Therefore we would not be surprised to see a further liquidation of Japanese assets next week ahead of the April 1st, 2014 increase.

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

Written By: Kathy Lien