Given how quickly and aggressively the U.S. dollar soared since Donald
Trump’s victory in the U.S. Presidential election, a correction is in
the coming week is likely but chances are, it will be shallow. Trump’s
win was unexpected and enough of a game changer for the dollar that the
gains are here to stay. Part of the reversal in fortunes for the dollar
can be attributed to his spending plans and short covering but in the
week ahead, it will be the prospect of a December rate hike that keeps
the dollar going. U.S. stocks hit a record high providing the Federal
Reserve with leeway to raise interest rates. While they won’t be happy
with the rising dollar, higher yields and lower oil prices, this is the
last chance for Janet Yellen to hike before the Trump Presidency and
there’s enough justification for tightening. Raising interest rates in
December would boost Yellen’s credibility and allow her breathing room
to take things slowly in the new year when she will need to assess the
economic impact of Trump’s policies.
The market is banking on a rate hike with Fed fund futures pricing in an
84% chance of tightening and all of the Fed Presidents who have spoken
since the election have been consistently hawkish. On Friday,
Vice Chair Fischer said they are close to achieving their two goals with
the case of a hike relatively strong. Lacker and Williams agree and
even Bullard who tends to be one of the less hawkish members of the FOMC
believe that rates should rise, although he favors only 1 rate hike
from now to the end of 2019 which seems a bit far fetched. The focus
next week will be on Janet Yellen’s testimony before the Joint Economic
Committee. She’s will almost certainly reiterate her view that rates
should rise next month which would validate the dollar’s rally and
potentially send it to new highs. The dollar and stocks have performed
well because Trump ran on a campaign of aggressive spending and this is
the first time in 8 years that there’s prospect of a sizeable fiscal
stimulus package. Fed officials have said they look forward to more
government spending. His victory speech was conciliatory and heavily
Keynesian which went a long way in boosting risk appetite and lifting
Treasury yields. Perhaps feeling the weight of his new responsibilities,
Trump is toning down his abrasiveness and opening his ears to outside
counsel. He may not have a specific plan for creating new jobs (yet),
offsetting the tax cuts he plans or finding the money for infrastructure
spending outside of ballooning the deficit, but the mere promise of a
fiscal stimulus program at a time when the Federal Reserve is preparing
to raise interest rates reinvigorated hope for a new cycle of growth.
However with Yellen not speaking until Thursday and the Dollar Index
trading at its strongest level since January, a pullback in USD/JPY and
the greenback in general in the front of the week is likely. U.S. retail
sales and consumer prices are the main reports scheduled for release
but manufacturing data and housing market numbers are also worth
watching. If USD/JPY drops to 105.50, we view this level as a great
opportunity to reestablish long positions.
Sterling will also be in focus with inflation, employment and spending numbers on the calendar along with speeches from Bank of England Governor Carney, Shafik and Saunders. Their continued confidence in the economy and concerns about rising inflation would extend gains for GBP/USD but if the emphasis is on uncertainty, it will hurt the currency. Sterling has performed unusually well thanks to short covering, rising gilt yields and the market’s view that the U.K. will be less vulnerable to the rise in nationalism post Trump than the Eurozone. Carney’s views will be particularly interesting because while upcoming economic reports should be strong with spending, employment and inflation on the rise, this was mostly based on the positive impact of a weaker currency. Over the past week, sterling soared more than 400 points versus the euro and nearly 300 points vs. the U.S. dollar. Since its low in October, GBP/USD is up more than 600 pips which means that the previous support from a weaker currency will begin to fade. Gilt yields are also closing in on pre-Brexit levels, tightening financing conditions in the economy.
Meanwhile the euro dropped to its lowest level since January on
Friday. There was no specific news to justify the move but with the
U.S. dollar continuing to power higher, the University of Michigan Index
surprising to the upside and 1.0850 too close for comfort, traders took
the currency pair through this support level easily near the end of the
European trading session. EUR/USD had not seen a positive day
this past week and now investors are worried that nationalism will
escalate in Europe. Italy has a referendum on Senate reform on December
4th. If voters vote yes, it would allow for continued progress on an
ambitious reform package but if they vote no, it could lead to political
and social turmoil. Prime Minister Renzi said he would resign if the
reforms were not passed. Austria also has a Presidential election 3
weeks from now and the fear that the populist far-right candidate could
win in the closely fought race is growing. Most of next week’s Eurozone
economic reports are second tier except for Q3 GDP and EZ inflation
numbers, Mario Draghi speaks at the end of the week and as usual, his
views will be market moving.
All three of the commodity currencies traded sharply lower today with the New Zealand dollar experiencing the steepest losses.
This should be no surprise since the Reserve Bank of New Zealand cut
interest rates, expressed dissatisfaction with the high currency and
suggested that more easing could be necessary. NZD/USD has fallen
within arms reach of 71 cents and we believe that a move to 70 cents is
likely. However the RBNZ statement wasn’t completely dovish as the
central bank noted that growth is strong enough for inflation to reach
target and at this stage, they don’t feel its necessary to cut rates
again. So while NZD is being pressured by the recent hike and a stronger
U.S. dollar it should find support near 70 cents. In the coming week,
retail sales and inflation numbers will be released and given how
overstretched the sell-off in NZD/USD has become, investors will be
eagerly waiting these reports.
The Australian dollar took its cue from commodity prices this past week.
It held up well against the U.S. dollar when copper and iron ore
prices were rising but on Friday, prices peaked and that led to support
levels being broken in AUD. Australian economic data was mostly weaker
with business and consumer confidence falling. Housing data was
better but construction activity dropped back into contractionary
territory. The RBA minutes and Australian employment reports are the
main focus next week. Considering the optimism of the Reserve Bank and
the rise in the employment component of manufacturing and services PMI,
we expect AUD positive reports. With that in mind, the key driver should
continue to be the market’s demand for U.S. dollars and commodity
prices.
Lastly a Trump victory puts the North American Free Trade Agreement at risk so it is not surprising that the Canadian dollar traded lower this week, especially with oil falling to a 3 month low near $43 a barrel. Between the positive impact of Trump’s win for the U.S. dollar and the negative impact for Canada, the latest developments is a worst case scenario for the Canadian dollar. The only hope is that Trump backs off his pledge to renegotiate NAFTA. Meanwhile OPEC is pumping oil at record levels putting the promises of a production cut in doubt. USD/CAD is a buy on dips especially between 1.3350 and 1.3400. No major economic reports were released from Canada this past week but consumer prices and housing numbers are on tap in the coming week.