Has USD Bottomed?

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

The U.S. dollar traded sharply higher against all of the major currencies Wednesday as the fundamentals we have been highlighting returned as drivers for the currency. On Tuesday when the greenback tanked for the seventh day in a row versus the Japanese yen, we said hawkish Fed speak and stronger data meant that further losses were limited. Wednesday's series of healthy U.S. economic reports followed by a positive Beige Book carved out a bottom for the U.S. dollar. The currency’s rebound was then magnified by optimistic comments from Janet Yellen. U.S. rates also shot higher with 10-year yields rising nearly 10bp, validating the reversal in market sentiment.

So unless Donald Trump attacks the dollar again on Friday, we’ve seen the end to a month of losses in the greenback. Of course one damaging comment from the new president and the dollar could start tumbling once again. On Tuesday Trump described the dollar as too strong, making it difficult for U.S. companies to compete with their counterparts in China. This followed earlier comments from a senior advisor who called the strong dollar the greatest risk for the U.S. economy. The president-elect’s policies will be in focus on Friday, especially after his spokesman said there will be four or five executive actions taken on day one. If he focuses on fiscal stimulus, the dollar will rise, if he talks trade, we could see another roller-coaster ride for the greenback.

With oil prices rising, inflation ticked up in December. CPI rose 0.3% month-over-month, boosting the annualized pace of growth to 2.1%, the strongest level since June 2014. Industrial-production growth also accelerated by 0.8%, which not only beat expectations but also erased all of the past month’s losses. The NAHB Housing Market Index ticked down slightly but that was not much of a surprise after the Federal Reserve’s rate hike. More importantly, according to the Beige Book, many Fed districts reported a tight or tightening labor market, intensifying price pressures and wage gains. Fed Chair Janet Yellen also confirmed that the Fed is close to reaching its goals with the economy near max employment and inflation closing in on 2% (although Wednesday’s numbers show CPI exceeding that level). She refrained from providing a timing on the next rate hike but indicated that the hike in December took account of considerable progress. Further tightening will depend on how the economy preforms “over coming months.” Her only cautious comment was in reference to wage growth, which she said was fairly low. Housing starts, building permits, jobless claims and the Philadelphia Fed index are scheduled for release on Thursday. Given how quickly and aggressively the dollar rose Wednesday, we would not be surprised by a shallow pullback.

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Wednesday's worst-performing currency was the Canadian dollar, which tanked after the Bank of Canada’s monetary-policy announcement. Although the BoC raised its growth forecasts for 2016 and 2017 and said that inflation is expected to return to target in the months ahead, the only line that the market cared about was on easing. BoC Governor Poloz said a rate cut remains on the table, which is a departure from last month’s firmly neutral monetary-policy stance. The central-bank head fears the consequences from any U.S. protectionism and worries that excess capacity raises the risks of missing their inflation goal. With that in mind, Poloz tried to diminish the significance of his comment by adding that there is no compelling need to mention consideration of rate cuts. Beneath these headlines on easing, the central bank still believes that stronger demand, exports and government spending will support growth. However given how far the Canadian dollar had risen since the beginning of the year, the mere talk of a rate cut was enough to send the loonie spiraling lower.

The Australian and New Zealand dollars also fell victim to the reversal in the U.S. dollar. Both currencies traded sharply lower with the losses exacerbated by the slide in commodity prices. Australia’s employment report was due Wednesday evening and based on Tuesday night’s higher consumer confidence report and the PMIs, we were looking for another month of positive job growth. Both the manufacturing- and service-sectors reported an increase in employment but the jump in November will be difficult to match. Thankfully, the bar is low with economists only looking for 10K increase in jobs.

The European Central Bank has a monetary policy announcement Thursday and according to the table below, there’s been widespread improvements in the Eurozone economy. The ECB is not expected to change monetary policy but investors will be watching carefully to see if the recent improvements in Eurozone data is enough for the ECB to start discussing tapering. When they last met, Draghi completely dismissed the idea of unwinding the Quantitative Easing program by tapering asset purchases. The ECB clearly did not want to jeopardize its fragile recovery by taking any steps that could reverse the uptrend in growth and inflation. One month later, the economy has improved with inflation and manufacturing activity on the rise. Euro weakness has gone a long way in supporting the economy, prompting inflation-leading ECB member Villeroy to say that growth will be solid in 2017. We believe that this is a view shared by Draghi. According to the last ECB minutes, headline inflation is rising significantly giving the central bank more reasons to consider reducing asset purchases. Any recognition of tapering would be euro positive but they could also refrain from talking about this possibility if they still believe that the recovery needs support.

Despite a stronger-than-expected labor-market report, sterling gave back a large part of Tuesday’s gains. Not only did jobless claims fall, but average weekly earnings surged in November. However none of that mattered in a week when the market was focused on Brexit and while some investors were happy to see a clear path forward, that path will lead to greater near-term uncertainty and volatility for the economy.

Written By: Kathy Lien