USD: S/T Correction To Extend Vs Core FX, But Staying Bullish Into 2017
The USD is losing ground, retracing some of its post-employment report gains vs the EUR and JPY.
There was not obvious catalyst for the reversal yesterday, although
the USD retreat did coincide with a weaker risk sentiment: a pullback in
US yields, a 0.3% drop in the S&P 500 and a slide in front-month
crude prices to new lows for the year.
We remain quite constructive on the USD as we move into 2017, but,
with US nominal and real yields well-off their December highs now and
the market already long USD according to our metrics, we see some scope for a near-term pullback vs the core currencies, particularly if equity markets give back some ground.
The U.S. dollar extended its losses on Thursday as investors continued to unwind their Trump trades. With just over a week until his inauguration, they hoped that Donald Trump would spend some time outlining the scope of his infrastructure plans. Unfortunately, the President-elect failed to do so Wednesday and the U.S. dollar dropped as a result. U.S. equities and Treasury yields also fell as investors across different asset markets expressed their unified disappointment. The selling on Wednesday carried through to Thursday but began to lose momentum during the New York trading session.
We believe it won’t be long before the dollar -- USD/JPY specifically -- find a bottom although we can’t rule out a final flush preceding the base. If we take a step back, the positive outlook for the U.S. economy has not changed since November. American companies are adding jobs, paying more wages and optimism is on the rise. Yes, there are concerns about Trump’s conflict of interests, his alleged relationship with Russia and other issues, but they don’t compromise his plans for tax cuts and big spending. While we are still waiting for Trump’s policy details, there is no reason to believe that he won’t be following through with his promise for tax cuts and spending. Even members of the Federal Reserve believe that the President-elect will deliver. A number of Federal Reserve Presidents spoke Thursday but only 2 are voting members of the FOMC this year (Evans and Harker). Both gentleman said 3 rate hikes in 2017 is plausible. Thursday morning’s U.S. economic reports also showed improvements in the economy with jobless claims increasing less than expected and import prices ticking up. Retail sales, producer prices and the University of Michigan consumer sentiment numbers are scheduled for release on Friday and these reports should confirm the improvements in the U.S. economy. Stronger data should be positive for the dollar with one small wrinkle -- the forecast for spending is very high. So if the data misses slightly, we may have an initial drop in USD/JPY that should be recovered quickly as investors realize that, ultimately, the data reflects a stronger economy.
The correction in the capital markets began shortly after the Federal Reserve hiked rates on December 14. The correction or consolidative phase follows an otherwise strong trending quarter, where moves accelerated after the unexpected victory by Trump. Last week we still anticipated the correction could persist even after the January 4 US jobs report showed more earnings growth than expected. However, now after the additional losses, the dollar appears ready to turn.
Interest rates remain integral to our dollar narrative. It is not coincidental that the dollar's downside move coincided with a pullback in yields and a narrowing of the US premium. Interest rates may be the place to begin our review of the technical outlook.
The 10-year yield fell to nearly 2.30% on January 12, new lows since the end of November, before recovering to close at new session highs of 2.36%. Before the weekend, and despite if anything, softer PPI and disappointing retail sales figures, the yield rose another six basis point. The March note futures stalled at 125-10. It tried separate sessions sine January 6. After failing for the third time before the weekend, a sell-off ensued that brought the contract toward the week's low of 124-07, which is also a 38.2% retracement of the gains since December 15. The 50% retracement is found at 123-28, and the 61.8% retracement is at 123-17.
The 2-year yield peaked on December 15 at 1.30%. It pulled back to near 16 bp through January 12, when, like the 10-year note, the yield recovered and saw follow-through gains ahead of the weekend. After five closes below the 20-day moving average, the two yield closed above it (~1.21% ) before the weekend. The technical tone of the March 2-year note futures contract is deteriorating, which is also consistent with the completion of the corrective phase.
The Dollar Index completed a 38.2% retracement of its gains since the US election on January 12. The small gains before the weekend saw the RSI turn higher, while the MACDs and Slow Stochastics are getting ready to cross higher as well. A move above 102.00 would lend credence to this view and suggest a retest on the January 11 high near 103.00. On the downside, a convincing break of 100.65 could spur a move to the next retracement level near 99.80.
The technicals look further away from turning in the euro than the Dollar Index. A move above $1.0710 could signal a further recovery toward $1.0820. The euro has not closed below its five-day moving average, (~1.0590) since January 3. A potential trendline drawn from this year's lows comes in near $1.05 on January 16 and finishes the week near $1.0575. A violation of the five-day average on a closing basis or a break of the trendline would likely signal the upside correction phase for the euro has run its course.
The dollar initially saw follow through buying in Asia though Japan was on holiday, after the US employment data. The greenback was buoyed from JPY117.00 to JPY117.50. However, it was greeted with fresh selling versus the yen that ultimately drove the dollar to JPY113.75. The technical indicators we use have not turned, but they are getting stretched. A move above JPY115.60 could signal a move in the JPY116.20-JPY116.80 band.
US Dollar at Risk as Traders Cut Exposure Amid Information Vacuum
Fundamental Forecast for the US Dollar: Neutral
US Dollar at risk of kneejerk volatility as markets struggle to form outlook
Murky fiscal policy may limit market-moving potential of 4Q US GDP data
Information vacuum may encourage profit-taking on long USD exposure
A mostly thin economic calendar leaves the US Dollar to ponder the
implications of a still-murky fiscal policy of newly-minted President
Donald Trump in the week ahead. The promise of generous stimulus
initially stoked bets on faster growth and inflation, sending shares
higher alongside the greenback as investors foresaw richer earnings and a
steeper Fed rate hike cycle. The absence of details has soured optimism
however and the currency has been mostly on the defensive since the
calendar turned to 2017.
Big-ticket fundamental news-flow does not enter the picture until
Friday, when market participants will get their first look at fourth
quarter US GDP figures. The annualized growth rate is expected to have
slowed to 2.2 percent in the final three months of the year, down from
3.5 percent in the preceding period. Robust improvement in US data
outcomes relative to consensus forecasts over the same period suggests
analysts may be underestimating the economy’s vigor, opening the door
for an upside surprise.
Under normal circumstances, such a result might’ve encouraged bets
on a more hawkish Fed and sent the US currency upward. It seems
unlikely that the central bank will do anything but wait until there is
greater clarity about where the White House is steering however. Indeed,
policymakers including Chair Yellen have consistently stressed that much
for their outlook depends on the impact of whatever fiscal program Mr
Trump pursues. This may mean that the GDP release loses much of its
This makes the US unit vulnerable to kneejerk volatility as
markets jump from one headline to the next, attempting to divine
direction. If price action so far this year is telling, investors faced
with such a backdrop prefer to scale back exposure and wait for greater
clarity from the sidelines before committing one way or another. With
net speculative long USD exposure still at the highest in over a year
(according to CFTC data), ample room for profit-taking remains. This
hints that the path of least resistance leads downward.
The dollar fell against a currency basket on Monday as the lack of economic policy detail in U.S. President Donald Trump’s inauguration speech coupled with concerns over his protectionist rhetoric weighed.
The U.S. dollar index, which measures the greenback’s strength against a trade-weighted basket of six major currencies, was down 0.44% to 100.33, the lowest level since December 8.
The index climbed around 3.5% since Trump’s election win in November, buoyed by expectations that his pledges to cut taxes and hike infrastructure spending would spur growth in the U.S. economy, leading to inflation and higher interest rates.
But the index has fallen 1.9% so far this month amid a lack of clarity over his economic policies, worries over his protectionist stance and following recent remarks in which he said the dollar was too strong.
On Friday, Trump said his administration would put "America first" and also promised new roads, bridges and highways.
But market sentiment was hit by the negative tone of the speech, which underlined uncertainty over how Trump will govern.
The dollar was sharply lower against the traditional safe haven yen, with USD/JPY trading at 113.55, off 0.94% after touching overnight lows of 113.17.
USD: Here Is Why The Divergence Trade Is Actually Strengthening
The ECB’s already-low forecast of 1.1 percent for core HICP this year is subject to downside risk. This analysis for core is compatible with our Rates strategists' view of long Euro zone breakeven inflation as a 2017 Top Trade, given that the dynamics of headline and core inflation are different. Their trade aims to capitalize on a normalization of an “excessive” deflation risk premium, which may also lead to a rebuilding of term premia in nominal European government bonds.
The same downside risk exists in Japan,
where a large rebound in core inflation is needed for the BoJ to meet
its forecast of 1.5 percent in FY2017, especially given that the
appreciation of the Yen over the past year is only now feeding into the
data. Special factors – large amounts of slack and periphery structural
reforms in the Euro zone and entrenched low inflation expectations in
Japan – will keep underlying inflation low in both places, so that further ECB tapering or a hike in the 10-year yield target from the BoJ are unlikely this year.
The “global reflation” theme has therefore drowned out what in reality are increasingly divergent fundamentals in the G10,so that what markets are calling “global reflation” is really a strengthening of the divergence theme that will ultimately drive the Dollar stronger.