May was a very strong month for the U.S. dollar and that was no surprise to our readers because we shared this chart at the beginning of the month showing how well the dollar performs in May. With last month’s gains, the positive seasonal bias continued for 7 straight years but on this first day of June, we are more interested in how seasonality affects currencies in the new month.
Which is why we updated our seasonality tables –
As you can see, there’s a negative bias for the Dollar Index in June. After strong performance in May, profit taking tends to drive the greenback lower in June. The seasonal trends are strongest for GBP/USD, EUR/USD and AUD/USD. However the gains in general are relatively modest with the dollar giving back only part of the past month’s moves.
Seasonal trends are important but with the Federal Reserve poised to make a major decision in June and the U.K. holding a referendum on E.U. membership – this year’s unique factors could easily overshadow seasonal trends. With that in mind, if the U.K. votes to remain in the European Union (and we think they will), the corresponding relief rally could drive the dollar lower against sterling and other high beta currencies.
Over the past few trading days we have seen a very nice breakout in USD/JPY. The move was driven entirely by expectations for this week’s Bank of Japan meeting. There are reports that the BoJ could introduce negative lending rates to complement negative deposit rates.
With the Japanese economy struggling under the weight of a strong Yen and slower global growth and speculators holding a record amount of long yen positions, the chance of easing by the BoJ is high. Take a look at how Japan’s economy changed since the March meeting in the table below.
The Japanese avoided intervening in the currency market when USD/JPY dipped below 108 because they prefer monetary intervention and their next opportunity to help the economy comes next week. With traders so aggressively short USD/JPY, this news could lead to more aggressive short covering ahead of and on the back of the BoJ rate decision.
We have now seen the dollar fall approximately 600 pips against the Japanese Yen in just over week. Alarms should be ringing at the Ministry of Finance and Bank of Japan because the 5% appreciation spells big trouble for Japan’s businesses and economy. However, everything that we have heard from the Japanese government so far suggests that they are not ready to intervene in the foreign exchange market to lower the value of their currency. The last time the Bank of Japan intervened in the currency was in 2011 after the earthquake and tsunami (and that was coordinated). Since then we have seen USDJPY fall as low as 76 and average around 102.25 over the past 4 years. So Japan has and can tolerate a stronger yen although they have less flexibility with monetary and fiscal policy because extensive action has already been taken through these years.
While we believe the Japanese government should intervene given the weakness of the currency, there are a number of reasons why they won’t:
- They could be waiting for the G7 meeting
- They could be waiting for fresh fiscal stimulus
- They could be waiting for the markets to capitulate first.
- They could also be looking into monetary stimulus rather than direct intervention to avoid being singled out for competitive devaluation of their currency at the G7 meeting in late May – because the host never wants to be embarrassed.
On a fundamental basis, it is becoming clear that the BoJ could allow USD/JPY to fall to 105 and maybe even 100 before taking action. In early February they let USD/JPY fall close to 1100 pips before there was also indication of intervention. While it has not been confirmed on February 11th, after dropping to a low of 110.98, USD/JPY jumped 200 pips in 20 minutes – price action that is indicative of intervention. USD/JPY still has 500 pips to go before this capitulation point, which would put the pair right between the 100 and 105 level. However we would be surprised if the BoJ let USD/JPY fall 1000 pips from its March 29th high of 113.80 without checking rates near 105.
On a technical basis, there’s no support in USD/JPY until 106.63, the 38.2% Fibonacci retracement of the 2011 to 2015 rally. We expect USD/JPY to test and bounce off this level. However if the Fib is broken then it should be smooth sailing down to 105.85, the 200-month SMA. So while the Bank of Japan could allow USD/JPY to drop 1000 pips from its recent high, there are enough key technical and psychological support levels between now and then to make it a choppy and not one-way move.
Top Forex Themes for 2016
Since the next two weeks are generally the quietest periods in the financial markets, we want to take this opportunity to think longer term and share with you our currency forecasts for 2016. We’ll start with an initial review of the top themes and explore them in further detail as the week progresses in our outlook for each of the major currencies.
But first – 2015 has been a big year for the foreign exchange market. Divergences in monetary policies led to strong moves in currencies with the U.S. dollar as the best performer. The U.S. saw its first rate hike in nearly a decade while other major central banks in the Eurozone, China, Canada, Australia, New Zealand and Japan eased. In response, the greenback climbed to multiyear highs and this strength translated into significant weakness for many major currencies along with a collapse for commodities. These are some of the milestones reached in currencies this year:
The greatest risk for the financial markets and the global economy in the coming year is the feedback loop from the dollar and Fed policy.
While the quarter point hike in December represents only a nominal increase in U.S. rates, the Federal Reserve expects to tighten 4 additional times next year which will have broad ramifications for currencies, equities and commodities. In mid-December, we published a piece outlining the Consequences of a Strong Dollar and a lot of these issues will return to focus in 2016.
The first few months of the year should be good for the dollar as long as Fed officials don’t backtrack on their hawkish views.
There will be more hawks voting on the FOMC in 2016 than 2015 so the balance swings in favor of continued tightening. Between the warm El Nino weather and gas prices below $2.00 a gallon in some states, consumer spending should also rise in the first quarter. So while the dollar is rich, the path of least resistance is still in higher. However our outlook changes in the second half of 2016 as we believe rate hikes and the strong dollar will force the Fed to slow tightening makring the top for the greenback and the bottom for other major currencies.
Here are some of the themes that we are looking for in 2016: