Trading the Dollar Requires Precision & Patience

Trading the U.S. dollar requires patience and precision because for the past few weeks the greenback struggled to break its range versus the euro and Japanese Yen.  Even Janet Yellen's unambiguous support for a 2015 rate hike failed to give the dollar the lift that it needed to hit 1-month highs.  Today, the dollar traded lower against both of these currencies, testing the patience of anyone who bought dollars after Yellen's speech last week.  The sharp sell-off in stocks, decline in Treasury yields and mixed U.S. economic reports contributed to the weakness in the greenback but none of these reasons including data is damaging enough to halt the uptrend in the greenback.  However patience and precision is important because while it may be tempting to buy dollars on every hint of hawkishness from the Fed, the best place to buy USD/JPY is towards the bottom of the range around between 119.75 and 119.25 and the best place to sell EUR/USD is between 1.1350 and 1.1400.  There are enough Federal Reserve officials talking about 2015 liftoff that the losses in the dollar will be limited but there's also enough uncertainty surrounding Friday's non-farm payrolls report that we could see profit taking in the dollar if it rises to the upper end of the range before the release.  

We heard from 3 FOMC members today - Tarullo, Dudley and Evans.  All 3 are dovish voting members of the FOMC this year. Tarullo did not touch on monetary policy, Dudley says he expects the Fed to raise rates this year and indicated that there is a strong case for liftoff if the economy stays on track. Like Yellen, he warned that October is a live meeting. Evans on the other hand wants the Fed to raise rates later because he is worried about the costs to premature liftoff.  While he believes that "we're not far" from the first increase, he would prefer that the Fed forgo raising rates in 2015 and instead move three times in 2016. Fed President Williams who is also a voter speaks this afternoon and we doubt that his views will differ significantly from Yellen.  The surprise decline in pending home sales and earlier weakness in personal income growth drove USD/JPY below 120 but the increase in personal spending is enough to keep us optimistic about demand and growth.  The S&P Caseshiller house price index and consumer confidence numbers are scheduled for release tomorrow. 

The tides are shifting in Europe as the Euro was the only "high beta," non-safe haven currency to trade higher against the U.S. dollar. No economic reports were released from the Eurozone but more ECB officials are coming forward to downplay the possibility of further Quantitative Easing.  In early September, the sell-off in EUR/USD was driven by growing speculation that low inflation, weakness in the Eurozone and the global economy could drive the ECB to add stimulus. Comments from policymakers at the time fanned the fire.  However in the past week we have seen a complete U-turn in the rhetoric with nearly all ECB members saying there is no reason to act and it is too early to talk about expanding QE. This includes ECB members Vasiliauskas and Lautenschlaeger who spoke this morning. German consumer prices and Eurozone confidence numbers are scheduled for release on Tuesday. 

Seven trading days have now past without a rally for the British pound versus the U.S. dollar. Long stretches of weakness or strength for the currency pair are not unusual.  In late August for example, GBP/USD fell for 9 days straight before bottoming.  In mid June, it rallied for the same number of days before reversing strongly.  When GBP/USD turns, the move is strong and can range from 200 to 800 pips. There are a handful of U.K. economic reports scheduled for release this week. The most important will be Thursday's UK PMI manufacturing report.  Revision to Q2 GDP is also significant but changes are not often made. 

The New Zealand dollar was the day's worst performing currency, falling approximately 1% versus the U.S. dollar, euro, and Japanese Yen.  We are a bit surprised by the weakness because no economic data was released from New Zealand overnight and the latest comments from RBNZ Governor Wheeler was positive.  He said NZ's economy performed better than others and while he is concerned about financial stability risks, he is also worried about soaring house prices.  After their last rate hike, Wheeler said further easing may be necessary but between his concerns about housing, the recent increase in dairy prices and the increase in payout by Fonterra, there is less pressure on the RBNZ to lower rates.  

The sharp decline in Chinese industrial profits is the only legitimate reason for the weakness in not only the New Zealand dollar but other commodity currencies as well.  Both the Australian and Canadian dollars fell sharply today as profits fell by the largest amount in 4 years.  Earnings in the resource sector have been hit particularly hard and this put additional pressure on commodity prices. There are major economic headwinds in China and this will limit growth in countries that rely on Chinese demand.  Canadian raw material and industrial product prices are scheduled for release on Tuesday but the impact on CAD should be limited.