The Reserve Bank of Australia also has a monetary policy announcement and the majority of economists surveyed expect the RBA to cut interest rates by 25bp but we feel that a rate cut is not a done deal. The last time we heard from the RBA they sounded open to the idea of easing if data supports it but since the last meeting in July, manufacturing activity accelerated, consumer prices increased, full time job growth rebounded, business confidence improved and the participation rate is up as shown in the table below. Granted consumer confidence is down and the unemployment rate ticked up, we’re not sure if this is enough for the RBA to pull the trigger on easing in August. The AiG Performance of Manufacturing Index rose to 56.4 vs. 51.8 previous. Chinese PMI numbers were mixed. The official manufacturing PMI showed a decline from 50 to 49.9. The Caixin Manufacturing PMI reading registered an increase in activity, coming in at 50.6 vs. 48.9 expected. Australia’s trade balance and building approvals report will be released pre-RBA but the rate decision will be key. If the RBA cuts, AUD/USD will drop below 0.75 cents quickly but if they hold rates steady, we should see Monday’s high of 0.7615 recaptured.
Taking a look at the day to day change in the U.S. dollar, it may seem that there was very little consistency in the performance of the greenback ahead of Wednesday’s monetary policy announcement. However if we isolate the price action to the U.S. session, the dollar moved higher against most of the major currencies. This morning’s U.S. economic reports were mostly better than expected with consumer confidence beating expectations and new home sales rising sharply. Service sector activity slowed according to Markit Economics and house prices dropped slightly but that was not enough to deter investors from buying dollars pre-FOMC. During a time when central banks around the world are actively talking about and planning for easing, the Federal Reserve’s hawkish bias will shine a bright light on the dollar. Many feared that the Fed would give up on the idea of tightening after Brexit but as we have seen U.S. markets and the U.S. economy have proven to be fairly resilient.
The following table shows more improvements than deterioration in the U.S. economy since the June Fed meeting. Retail sales increased, non-farm payrolls rebounded strongly with job growth rising 287k in June, the housing market is chugging along, manufacturing and service sector activity are on the rise. U.S. stocks also hit record highs while plunging U.S. yields provide support to the economy. The currency has strengthened across the board but the strongest gains were against the British pound. We’ve also heard from a number of FOMC voters since Brexit and they still seemed to support the idea of tightening. The FOMC statement generally reflects the views of the Fed leadership (Yellen, Fischer and Dudley) and it is likely to recognize the improvements in the economy since June. Of course, there will still be notes of caution and everything will be “data dependent” but we expect the main takeaway to be that a 2016 rate hike remains on the table. The Fed needs to move forward with policy normalization and they can’t wait around for the U.K. to invoke Article 50 which could take up to 2 years. So we expect the dollar to trade higher into and after FOMC. There won’t be fireworks but there could still be some quick trading opportunities.
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.
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:
Is Buying Dollars in 2016 a Smart or Foolish Trade?
2015 has been a great year for the U.S. dollar but with only 5 trading days left many investors are wondering if being long dollars in 2016 is still a smart trade. December has been a difficult month for the greenback with dollar bulls struggling to maintain control. The Federal Reserve raised interest rates for the first time since June 2006 but instead of appreciating, the dollar erased nearly all of November’s gains. Now many investors are wondering that if a rate hike and hawkish forward guidance can’t lift the dollar, is it foolish to be buying greenbacks in 2016.
To answer that question we have to understand why investors sold dollars in December. The bet that the dollar would rise in 2015 was one of the world’s most crowded trades and according to the CFTC’s Commitment of Traders report, forex futures traders were busy adjusting positions ahead of the December 16 FOMC meeting. The biggest changes were in euro and yen where investors aggressively cut their short euro and short yen positions. This means that investors started to unwind their long dollar trades ahead of FOMC and based on the price action after the meeting, liquidated further after the rate hike. Buying dollars became a very crowded trade in 2015 and a lot of money moved to the sidelines at the end of the year.
This means there’s money to put back into play in 2016.
Yet positioning was not the only reason why investors bailed out of the greenback. According to the following chart past tightening cycles have not been good for the dollar and this scared many investors. While USD/JPY generally appreciated leading up to the rate hike, on a number of occasions it reversed course after tightening but this cycle is different because the first few months of the year will be good for the U.S. economy and the dollar. The warm El Nino weather and low gas prices will boost consumer consumption, which is already supported by steady job creation, wage growth and consumer borrowing. The Fed also welcomes new hawks to their roster of FOMC voters.