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.
Here are my Main Takeaways from the June ECB Announcement and Mario Draghi’s Press Conference – will update if needed.
Top Takeaways from ECB
- ECB Hikes 2016 GDP and Inflation Forecasts
- More Stimulus on the way – Corporate Bond Purchases Begin June 8, TLTRO Begins June 22
- ECB Expects Extra Impetus from Stimulus Yet to Hit
- Low Oil Prices are Helping but Q2 Growth May be Slower than Q1
- Not Seeing Significant Wage Pressures of Second Round Inflation Effects
- ECB Still in Wait and See Mode – Needs to See Full Impact of Stimulus, Maintains Dovish Bias
- BUT If Financial Conditions Tighten Significantly, they Stand Ready to Act
- Global Economy and Brexit Main Risks for EZ
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.
The main focus tonight will be on Australia and the Reserve Bank’s monetary policy announcement. At their last meeting the RBA left rates unchanged and said, “Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy.” Investors interpreted these comments to mean discomfort with the current level of the currency and sent AUD tumbling lower as a result. There’s a small subset of investors looking for the RBA to ease this month because CPI declined in the first quarter and activity slowed according to the PMIs. However according to the following table, consumer spending rebounded, business confidence improved, the unemployment rate declined and market indicators ticked upwards. So like many of their peers, the RBA may opt to wait and see how the economy performs in the next month before taking additional action.
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.