Have GBP, AUD, CAD And NZD Peaked?
By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The sharp reversal in the British pound and Australian dollar were the two biggest stories in Tuesday’s foreign-exchange market. Both currencies saw strong gains in the first half of October but Tuesday’s decline raises questions about whether these currencies have peaked. The sell-off in sterling was triggered by a surprise decline in consumer prices. CPI dropped 0.1% in September, which was even worse than the market’s forecast for stagnant prices. Low inflation is not surprise. Earlier this month, the Bank of England said that it would take longer for inflation to rise and this view led many to believe that the central bank would be slow to raise rates. However BoE Governor Carney continues to point to strong earnings as a reason to be proactive. So the answer to the question of whether GBP/USD peaked lies in Wednesday’s labor-market report. If wage growth accelerates like economists predict, sterling could bounce off Tuesday’s lows and head back toward 1.54. However if jobless claims spike or weekly earnings slow, it would be a nail in the coffin for pound. Technically, support in GBP/USD is at the September low of 1.5110.
The worst-performing currency Tuesday was the Australian dollar, which dropped over 1% versus the USD, EUR and JPY intraday. It should be no surprise that the sell-off was driven by Chinese data. Although China reported a larger-than-anticipated trade surplus for September, exports and imports continued to fall. Australia relies heavily on Chinese demand and the -20.4% drop in imports, which was the largest decline in 7 months, is alarming. Even if Australian business confidence increased, between the continued weakness in Chinese demand and a stronger currency, (AUD/USD is up more than 5% from its September lows), the Reserve Bank will not be happy with the latest trends. While Tuesday’s decline in AUD/USD puts only a small dent in the currency pair’s recent rise, we believe that further losses are likely because the underlying foundation for Australia’s economy is weak.
The New Zealand dollar followed the Australian dollar lower but the fundamentals for New Zealand aren’t nearly as discouraging as the fundamentals for Australia. Both countries suffer if China slows and New Zealand is sensitive to Australian growth. But the recent upswing in dairy prices will go a long way in aiding New Zealand’s recovery and discouraging the RBNZ from easing again.
USD/CAD on the other hand has been unusually volatile. The currency pair raced to a high of 1.3080 before reversing sharply to fall below 1.3000. It later rebounded back above this key level. With no U.S. or Canadian economic reports released, the currency pair traded purely on oil. On Monday, oil prices dropped more than 4%, sending USD/CAD sharply higher. On Tuesday, oil prices rebounded sharply and the recovery stripped away the pair’s gains. This is a light week for Canadian data, so whether USD/CAD holds 1.29, confirming that CAD has peaked will be determined by the move in oil and Wednesday’s U.S. consumer spending report.
Wednesday’s retail sales report from the U.S. is one of the most important pieces of economic data on the calendar this week and the outcome will have a significant impact on how the USD trades. It will help the Federal Reserve decide whether interest rates can be raised for the first time in 9 years in 2015 or be pushed out to 2016. While we are long term dollar bulls, we recognize that this week’s U.S. retail sales and consumer price reports pose a big risk to the greenback. Slower job growth and stagnant wages is a dangerous combination for consumer spending. According to an earlier survey by Redbook, national chain store sales fell 1.6% in September from August. The Beige Book report is also scheduled for release but the impact on the dollar will be less significant than retail sales. USD/JPY dropped to a 10-day low in an attempt to break the bottom of a tightly wound consolidation triangle pattern and its inability to do so Tuesday signals that investors are not giving up on the dollar quite yet and rightfully so because even though the Fed may choose to delay liftoff, the U.S. economy is still comparatively stronger than most G10 nations.
EUR/USD held onto its gains despite another round of weak data. The German ZEW survey fell sharply in October, reflecting deterioration in investor sentiment. Once again, this softness should not surprise anyone given back-to-back disappointments in German data. In Germany, investor sentiment (as measured by the expectations component of the ZEW) dropped to its lowest level since October. For the Eurozone as a whole, the ZEW index dropped from 33.3 to 30.1, a 10 month low. Wednesday’s Eurozone industrial production report will show further weakness in regional manufacturing activity. Nonetheless, the ECB is in no rush to ease monetary policy and that stance is proving to be extremely supportive for the euro. Most importantly, EUR/USD is moving in lockstep with rates. Treasury yields declined Tuesday while Bund yields increased and that pergence explains the currency pair’s latest performance.