Loonieviews August 25, 2014

US dollar consolidation likely

Michael O’Neill

FX Consultant / IFXA Ltd


  • US employment measurement drives rate-hike speculation
  • US Dollar Index suggests period of consolidation
  • Geopolitical risks increase, but are ignored

By Michael O’Neill

The bank holiday in the UK today has put a dampener on FX trading activity in the European session, even though European Central Bank president Mario Draghi’s Jackson Hole comments have increased speculation of additional ECB stimulus.

USDJPY rallied on dovish comments from the Bank of Japan’s governor, Haruhiko Kuroda, but have since retraced all its gains. Tomorrow’s US durable goods data and the UK holiday are likely to ensure a fairly quiet North American session.

A riddle, wrapped in a mystery, inside an enigma

Winston Churchill famously said Russia was "a riddle, wrapped in a mystery, inside an enigma". This also succinctly describes the US employment measurement dilemma. Fed chair Janet Yellen’s Jackson Hole speech and the Federal Open Market Committee failed to provide any new information or direction to support the hawks or doves with respect to the timing of a US interest rate hike.

If there is one clear message, it is that the committee members have been unable to quantify their assessments of the degree of slack in labour markets. And until they do, US rates are not moving anywhere. The FX market is chomping at the bit for a "hard target" measurement of the labour market, while all the FOMC can deliver is vague references to variables shrouded in a fog of "degrees of slack".

Reality check

Global markets believe US interest rates will rise, with the first move sometime in 2015. Therefore, a rate hike in 0.0025 point increments should not surprise anyone. The current federal funds rate target is 0-0.25%. The rationale for not raising rates is that a rate hike would undermine a fragile economic recovery, yet no one is explaining how a quarter point hike in an interest rate from a level never seen before will stymie economic growth.

There is no rule or law that mandates consecutive meeting rate hikes. The current federal funds rate has been around since December 2008. A 1% hike would still leave interest rates at historical lows. If a mere 1% rate increase means the difference between solvency or insolvency for US corporations, they probably should not be in business in the first place. In fact, an argument could be made that a rate hike would stimulate the economy as corporations realise that the era of cheap money is coming to an end and activate dormant borrowing or expansion plans.

Effective federal funds rate

Source: Federal Reserve Bank of St. Louis

USDX suggests US dollar consolidation

The USDX broke through strong resistance in the 81.70-76 area last week, which is a level that contained rallies since November 2013. It is now running into a similar obstacle in the 82.70-76 zone, which suggests a period of consolidation may be in order. The July uptrend line from 79.78 comes into play at 89.12, which should contain any retracement. A move above 82.70 targets 83.60.

USDX daily

Source: Saxo Bank

Geopolitical tensions – who cares?

FX traders seem hardened to the unrelenting headlines of missile strikes, artillery barrages and fire fights in the Middle East and elsewhere around the world.

Israel has adopted a nastier tactic in Gaza, leveling entire apartment blocks where suspected Hamas military bosses are hiding among civilians. Iran claims to have shot down an Israeli drone.

Islamic State militants have reportedly captured a Syrian airbase. Will President Obama ally the US with President Bashar al-Assad to combat the group? Libya’s capital Tripoli also finds itself under Islamist control.

Meanwhile, Russia is sending another aid convoy to Ukraine, much to the dismay of officials in the country.

Japan is increasing its defence budget by 3% in the face of a worsening security environment in the region, much to the dismay of China.

China and the US are also exchanging pleasantries over military aircraft intercepts. US spy planes have had close calls with Chinese fighter planes, which has inexplicably irritated the former. One has to wonder how the US would react if Chinese were sight-seeing around San Diego.

The geopolitical risks are real, but as long as they remain localised then risk aversion trades are on the back burner.

China angered the US last week after one its fighter jets barrel rolled "very, very close" to an American Navy plane, but geopolitical risks are not crucial to investor calls. Photo: rypson Thinkstock.com

Key US data releases

Tuesday: July’s durable goods orders (forecast: 7.0%, ex-transportation 0.5%). This data is expected to surprise to the upside on the back of aircraft orders, which will add to the positive US dollar sentiment. A big miss would hurt the US dollar as the market is long dollars across the board.

Tuesday: Consumer confidence (forecast: 89.1 vs. previous 90.9).

Thursday: GDP (forecast: 2.0% quarter-on-quarter). The surprise would be if GDP is below consensus, which would also squeeze the existing long US dollar positions.

Friday: July’s personal income and spending (forecast: income 0.3%, spending 0.1% month-on-month).

Key Canadian data releases

Thursday: Q2 current account (forecast deficit: CAD11.4 billion). A big drop in the deficit would be a boon to the Canadian dollar, which is an unlikely outcome. The current account deficit is a key macroeconomic data supporting predictions of a weaker Canadian dollar.

Friday: GDP (Q2 forecast: 2.6% year-on-year, June 0.2% month-on-month). The proof is in the pudding, and the slew of better-than-expected Canadian data releases risk an upward surprise to the data and provide support to the Canadian dollar.

Categories FX, Foreign Exchange, Currency, Canadian Dollar

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