USD Could Move Next Week

The first trading week of the lunar New Year will be a busy one for forex traders and the potential for big moves or breakouts will be exacerbated by holidays in China, Hong Kong and Singapore. Having come off the first week of Donald Trump’s Presidency, we got a taste of how committed he is to the promises made during his campaign. Currencies see-sawed on his executive orders as investors tried to make sense of their implications for the U.S. and global economy. The ones that had a direct impact on FX included his orders to withdraw from the TPP, construction of the Keystone/Dakota pipeline, plan to build a wall with Mexico and border taxes. The U.S. dollar, which had fallen at the beginning of the week recovered part of its losses by Friday. The biggest winner was USD/JPY but the gains were modest and nominal compared to its losses versus sterling, the Canadian and New Zealand dollars. As for the euro, it ended the week unchanged against the greenback. Although many countries have market-moving events on their calendars, the U.S. dollar will remain in center focus and for the most part will dictate the general trend of other currencies. More executive orders will be announced but the dollar should be driven by the Federal Reserve’s monetary-policy announcement and nonfarm payrolls.

While the February FOMC meeting won’t be accompanied by a Yellen press conference, investors will be reviewing the statement closely to ensure that the Fed is committed to raising interest rates 3 times this year. Of course they won’t be that specific but an unambiguously hawkish tone could drive USD/JPY to 116 whereas divided views and new concerns could sink it back to the 113 handle. For the past 2 weeks, USD/JPY has traded in a relatively narrow 112.50 to 115.30 range and next week’s event risks are significant enough to trigger a more meaningful breakout in the currency. However at the end of the day, we believe that President Trump’s policies from inflation to corporate tax reform, spending, protectionism and future Fed hikes are positive for the greenback so eventually the dollar will catch up to the moves in stocks and bonds. Aside from FOMC, the Bank of Japan also has a monetary-policy meeting on the calendar and it should be less interesting as the central bank is widely expected to keep policy unchanged as the recovery gains momentum on the back of a weaker yen. It won’t be long before the BoJ stops thinking about more QE and starts considering tapering, but that won’t be a topic that makes headlines at the upcoming meeting.

Even with the pullback on Thursday and Friday, sterling was still one of the best-performing currencies against the U.S. dollar and it will challenge the greenback for the market’s focus in the coming week. Since Prime Minister May's speech on Tuesday January 17, we’ve seen a more than 600-pip recovery in sterling. A hard Brexit with no single-market access is the worst-case scenario for the U.K. but investors seem to take comfort in a clear path forward -- especially now that they know the government needs Parliament approval to invoke Article 50. In the coming week, the latest PMI reports are scheduled for release but Super Thursday will steal the show -- that’s when the Bank of England meets, releases the Quarterly Inflation Report and Governor Carney has a speech. The weak sterling has gone a long way in boosting inflation and economic activity. Policymakers including Carney have recognized these improvements and the central bank could go as far as raising its outlook for the second time since Britain voted to leave the European Union. Growth and inflation have been stronger than expected and while Carney may be concerned about the negative impact of Brexit on the economy in the years ahead, the reality is that business activity and sentiment has been improving. We believe that Carney will reiterate his view that rates could go up or down in the months ahead. While the markets are pricing in a 50% chance of a rate hike by the end of the year, the recent recovery in sterling and the possibility of further near-term gains should translate into slower growth in February. We like buying pounds into the Quarterly Inflation Report, especially as it dips toward 1.25 with a target of 1.27/1.28.

Euro, on the other hand, has been left out of the party. The single currency traded lower against most of the major currencies this past week. Data was mixed with the ZEW survey of investor confidence falling short of expectations, the German composite PMI index and IFO business sentiment reports falling in January. Compared to the U.S. and U.K., the data on the Eurozone’s calendar next week is less market moving. With that in mind, we still have Eurozone confidence, GDP and retail sales on tap along with German inflation and unemployment. The weak euro should continue to support the economy and according to the PMIs, job growth was very strong in January. Technically, after struggling to break 1.08, the recent stretch of lower highs and lower lows in the EUR/USD indicates that we have seen a near-term top in the currency pair. With the dollar expected to trade higher on FOMC, we expect EUR/USD to pullback to 1.06 and possibly even 1.0550 in the near term.

All 3 of the commodity currencies performed fairly well this past week with the Canadian dollar enjoying the strongest gains thanks to the rise in oil prices and Trump’s Keystone pipeline announcement. Inflation numbers were released from Australia and New Zealand and surprisingly, price growth missed expectations in Australia while beating them in New Zealand, which triggered a breakdown in AUD/NZD. In the coming week, Canada releases its November GDP report and we have New Zealand and Australia’s trade balances scheduled for release. However the most market-moving pieces of data for AUD and NZD will be Chinese PMIs, Australian PMIs and New Zealand’s employment report. We will also be watching the speeches from RBA’s Debelle, Bank of Canada’s Poloz and Prime Minister English. USD/CAD is due for a recovery but needs to break above the 200-day SMA near 1.3150 whereas AUD/USD and NZD/USD are poised for a stronger correction in the coming week.

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