On the surface, it appears to have been a great week for the U.S. dollar with EUR/USD peaking below 1.13 and USD/JPY climbing from a low of 108.83 to a high of 111.40. However if we look beyond these 2 pairs, the dollar’s performance was uneven with the greenback losing ground versus the Canadian and Australian dollars and ending the week virtually unchanged against sterling and the New Zealand dollar. This tells us that Fed Chair Janet Yellen, who was unabashedly hawkish failed to convince the market that the economy is as rosy as she sees. Investors are skeptical because of the all the recent disappointments in U.S. data including Friday’s consumer confidence and housing market reports. With no major U.S. economic data scheduled for release next week, investors will be watching Fed speak to see whether the 6 U.S. policymakers scheduled to speak will confirm Yellen’s hawkishness. If they do, the dollar will resume its rise with USD/JPY moving back above 111. However if they don’t sound very confident, we could see USD/JPY sink to 110.20.
We had 4 major central bank meetings this past week and the most significant were the Federal Reserve and Bank of England announcements. The Bank of Japan and Swiss National Banks left interest rates unchanged and made no particularly market moving comments. The Fed raised interest rates for the third time since the election, maintained its view for another hike in 2017, raised its GDP forecast and cut its inflation projections. Yellen downplayed the lower CPI projection by attributing the decline in price growth to one off factors and spread her hawkish wings. Yellen put on a brave face, talked up the improvements in the labor market and economy and shared the central bank’s plans to reduce its balance sheet by unwinding asset purchases. The dollar traded sharply higher in response but there wasn’t any follow through as incoming data tell a very different story. So unless every single FOMC official who speaks next week confirms her hawkishness, investors will be reluctant to share her optimism, which means rallies in USD/JPY will be met by selling.
The biggest surprise this week came not from the Fed but the Bank of England meeting where 3 members voted for an immediate rate hike. Their hawkishness also comes in the face of softer data. Although consumer prices increased more than expected, wage growth slowed while retail sales fell more than expected in the month of May. It is the increase in inflation that deepened the split within the central bank, convincing 2 additional members that tightening is needed. Forbes, Saunders and McCafferty worried that inflation would overshoot their target more significantly than they previously anticipated. This hawkishness is surprising given subdued wage growth and political concerns. So the question is, what’s more important – the BoE’s surprise hawkishness or Theresa May’s political troubles. Politics should have a greater impact on sterling in the coming week than economics as Brexit talks begin. May’s position is significantly weakened allowing the talks to start on the EU’s terms, which means agreeing on the divorce settlement before negotiating a trade deal. BoE Governor Marc Carney is also scheduled to speak and he may take the opportunity to express his concern as he is far less hawkish than those who have voted for an immediate hike. Either way, we believe the risk is to the downside for GBP/USD in the coming week. If GBP/USD fails to break above 1.29, it should sink back to 1.2650.
Euro on the other hand found significant resistance at 1.13. Data was mixed with the Eurozone trade balance shrinking and German economic sentiment falling. Although the outlook for Germany’s economy deteriorated, investors were more confident in current conditions. This offset prevented the euro from extending its gains. Of course it was the Fed’s hawkishness than truly capped the currency. Looking ahead, the most important piece of data on the Eurozone calendar next week will be the June PMIs. According to the German ZEW survey, investor assessment of current conditions increased and factory orders ticked up but the decline in industrial production and the weaker ZEW outlook has economists looking for softer numbers all around. If they are right, 1.13 will be confirmed as the top in EUR/USD. According to the CFTC, euro longs are at their highest level since 2007 so the risk is to the downside for the report as any uncertain could spark a wave of profit taking.
The best performing currencies this past week were the Canadian, Australian and New Zealand dollars – in that order. The Canadian dollar shot higher after Bank of Canada Senior Deputy Governor Carolyn Wilkins, a favorite to become the next head of the central bank said they will assess whether less stimulus is needed. This is the first time that the Bank of Canada has hinted of a rate hike in 7 years with Wilkins expressing confidence in their recent economic performance and noted that diverse growth makes the recovery strong and sustainable. Governor Poloz spoke a day later and said nothing to counter her perspective, offering only his view that rate cuts have done their job. Investors will be looking to next week’s retail sales and consumer price reports for evidence that the economy is performing well enough to justify a 2017 rate hike and if they do, we could see USD/CAD sink below 1.31.
A large part of the gains in the Australian dollar were driven by the country’s stronger than expected labor market report. The strength caught investors by surprise and helped take AUD/USD out of its 0.7520-0.7567 trading range to its strongest level in 2 months. Further AUD gains are likely as long as the RBA minutes don’t cause any damage. When the central bank met earlier this month, they held rates steady and expressed confidence in the recovery. The New Zealand dollar also climbed to a 2 month high and recovered all of Thursday’s post GDP losses. The RBNZ meets next week and there is very little reason for the central bank to move away from their neutral and cautious stance. Taking a look at the table below, there’s been as much improvement as deterioration since the last monetary policy meeting. Spending is soft, job ads are down and housing activity has slowed. However, consumer and business confidence increased, which bodes well for future activity. Technically, NZD/USD is overbought with significant resistance between 0.7350 and 0.7500.