November is shaping up to be the best month for the U.S. dollar in 2
years. The greenback is up over 5% against the Japanese Yen and more
than 3% versus the euro. The dollar’s strength can be attributed to 2
main factors and they both boil down to a positive current and future
outlook for the U.S. economy. Compared to many other parts of the
world, U.S. data has been stronger with inflation rising and job growth
increasing. However it is the prospect of fiscal and monetary
stimulus that really sparked the fire underneath the dollar and
attracted buyers from around the world. The Federal Reserve is the only
major central bank planning a rate rise and this past week Janet Yellen
made it clear that the conditions are in place for December tightening.
Initially there was some fear that the sharp rise in U.S. rates would
cause her to tone down her hawkishness but instead in her testimony to
the Joint Economic Committee, she expressed confidence in the economy
and the progress they are making towards their inflation and employment
goals. Yellen even warned that there were risks to waiting too long to
raise rates. Heeding these calls, the market is now pricing in a 96%
chance of a rate hike next month.
The U.S. is also the only major country with the realistic prospect of a big fiscal spending program.
Trump’s win caused a tectonic shift in the financial markets that sent
bonds crashing lower, the U.S. dollar to multi-year highs and stocks to
record highs. Not only was his victory a major surprise but his
promises of big tax cuts and infrastructure spending forced global
investors to reassess the short and long term impact of his policy
plans. They unwound positions immediately after his victory and laid on
fresh long dollar, long stock trades this past week. While this trend
is likely to continue, the dollar came a very long way in a short period
of time. The recent move was supported by stronger spending, housing
and inflation data but with no major U.S. economic reports on the
calendar next week and U.S. markets closed for the Thanksgiving day
holiday on Thursday, we expect some profit taking after these
exaggerated moves. The November Fed minutes is the only event risk worth
watching and we don’t expect the report to alter the market’s
expectations for Fed tightening. Pullbacks in the dollar should remain
shallow but it has been 10 to 11 days since we’ve seen a meaningful
sell-off in the greenback versus EUR and JPY. For USD/JPY this is the
longest stretch of gains since May 2015 and while the next major level
of resistance isn’t until 112, we should see a pullback before that
target is reached.
More than 2 weeks have passed without a positive day for the EUR/USD and
by now it should be no surprise that the currency pair broke through
1.06 this past week. It wants to test 1.05 and could reach that
level before stabilizing next week. We’ve been taking every
opportunity to mention Italy’s political troubles but with the first
round of Les Republicains party primary scheduled for Sunday November
20th, investors felt further compelled to cut their long positions and
sell euros. The polls show former Prime Minister Juppe comfortably
beating former President Sarkozy to become the conservative nominee but
if there is less than 50% majority there will be another run-off on
November 27th. However the focus is not on the Republicain nominee but
the momentum of far-right leader Marine Le Pen whose campaign received a
major boost after Donald Trump’s victory in the U.S. The populist
movement is gaining traction around the world and the 2 countries in
center stage right now are France and Italy, the Eurozone’s second and
third largest economies. Le Pen is dangerous for the euro because she
vowed to pull France out of the euro and to hold a “Frexit” referendum
on EU membership. This weekend’s Republicain nominee election may not
affect her chances but the focus will quickly return to her polling
results. In about 2.5 weeks, Italy has a referendum on Senate reform
that is widely viewed as referendum on the current government especially
considering that Prime Minister Renzi suggested he would resign if the
reforms were rejected. None of these ongoing developments is good news
for the euro because while the EU could stand losing Britain, they can’t
lose France and Italy. The mere prospect of this possibility is enough
to keep pressure on the euro for the next few weeks. The Eurozone is
the one of the few countries with significant data on the calendar with
November PMIs and the German IFO reports scheduled for release but
politics will continue to overshadow economics.
While sterling also fell victim to U.S. dollar strength this past week,
it is the only currency that has outperformed the dollar so far this
month. A number of important U.K. economic reports were
released and while they played a key role in keeping the British pound
bid versus the euro, they were not enough to prevent GBP/USD from
falling. Retail sales rose 1.9% in October, nearly four times stronger
than expected. The unemployment rate declined to 4.8% but average
weekly earnings growth failed to increase, jobless claims rose more than
expected and consumer price growth slowed. None of this mattered
though because Brexit was the main reason for sterling’s resilience.
Thanks to the British High Court’s recent decision on Article 50,
investors no longer see Brexit as an imminent threat. The Supreme Court
still needs to decide on the case but that won’t be until next year and
there were reports that Brexit could take another 2 years. This eased
the minds of investors and the Bank of England who see current policy as
neutral. Europe is the greater risk and for this reason, investors
have been buying pounds versus the single currency. This along with
sterling short covering explains the slow drop in GBP/USD. In the week
ahead, revisions to Q3 GDP is the only U.K. economic report on the
calendar. We continue to expect further weakness in EUR/GBP, which fell
to a 7 week low after rejecting the 100-day SMA.
Like the European currencies, the commodity currencies also succumbed to the mighty greenback.
The best performer was the Canadian dollar, which benefitted from a
rebound in oil prices which started the week hitting a low of $42.20
before settling Friday above $45 a barrel. The most important release
from Canada this past week was consumer prices and according to the
report, price pressures accelerated in the month of October lifting year
over year CPI growth to 1.5% from 1.3%. Core price growth slowed
slightly. Canada has a lot to lose if he follows through with this
threat but investors shouldn’t underestimate Prime Minister Trudeau who
may be expert negotiator. Yet with oil prices falling and the U.S.
dollar rising, USD/CAD should be trading higher. If the November high
is taken out next week, there’s no major resistance until 1.38. How
USD/CAD trades will be partially determined by Tuesday’s Canadian retail
sales report.
The worst performing commodity currency was the Australian dollar but both the Australian and New Zealand dollars ended the week below their 200-day SMA. Initially AUD was supported by upbeat RBA minutes but mixed employment numbers, lower gold, copper and iron ore prices along with U.S. dollar strength caused the currency to fall quickly and aggressively. While the October labor market report was better than expected investors were simply not impressed. Job growth rose by 9.8K, which was better than the previous month but less than forecast. The unemployment rate held steady at 5.6% and more than 41k full time jobs were created, offsetting the 31.7k drop in part time work. Unfortunately the participation rate was revised down to 64.4%. The problem is that even though full time jobs increased strongly they failed to sufficiently offset the massive 74.3K drop in September. Meanwhile the New Zealand dollar followed the Australian dollar lower despite stronger service sector activity, a big jump in consumer confidence and a sharp rise in producer prices. Retail sales growth slowed but the increase was inline with expectations. Dairy prices also rose by a smaller amount than the previous auction. There are no major Australian economic reports scheduled for release next week but trade data is expected from New Zealand.
