Will a Strong Dollar Stop Fed from Tightening?

• Will a Strong Dollar Stop Fed from Tightening?
• Short Euro Trades Paid Off Handsomely this Week
• USD/CAD Gives Up Gains after Labor Data
• AUD: Weaker Housing DataNZD: Oil and Gold Prices Increase
• GBP/USD Hits Fresh Multi-Year Lows 

Will a Strong Dollar Stop Fed from Tightening?

Investors bought U.S. dollars aggressively this week with the gains on Friday taking the greenback to its strongest level against the euro in 3 weeks and its highest level versus the British pound in nearly 5 years.  With 10 year Treasury yields moving lower and import prices falling 0.3%, its end of the week strength cannot be attributed to fresh data.  Instead, market participants are rushing to position for a June rate hike.  Everyone from the doves to the hawks are talking about the need for tightening with Fed President Lacker, a voting member of the FOMC this year saying that if it were up to him, the Fed would start selling assets now.  Like Dudley he downplayed the recent deterioration in data, attributing it to weather disruptions.  U.S. policymakers are clearly not worried about the latest slowdown in job growth and based upon the price action of the dollar this week, investors have also moved beyond the report.   

In light of the dollar's strength, many of our readers are wondering how it would affect the Fed's plans for tightening.  Unlike the Eurozone or Japan, the U.S. is not an export dependent economy and can therefore tolerate a strong dollar much better than other countries.  However a strong dollar has two important consequences - it lowers inflationary pressures and takes a bite out of earnings. The inflation impact is not a big deal now because the Fed views the decline in prices as "transitory" but the sell-off in stocks could become a bigger problem if it spreads to the broader market, triggers stops and leads to all out capitulation. Traders should heed IMF Managing Director Christine Lagarde's warning this week of a "bumpy ride" once the Fed starts raising rates.  While the stronger dollar will not affect the Fed's plan to raise rates in the next 5 months, it provides a stronger argument for a hike in September versus June.  For the central bank to reconsider raising interest rates this year, there would need to be a major crash in stocks.   A number of U.S. economic reports are scheduled for release next week and the most important will be retail sales. Based on the rise in earnings and the improvement in the labor market, we expect stronger numbers that will keep the dollar rally intact especially since the International Council of Shopping Centers and Johnson Redbook already reported a pickup in spending in March.

Short Euro Trades Paid Off Handsomely this Week

Being short euros paid off nicely this week as the currency traded lower against the U.S. dollar each of the last 5 trading days.  With no European economic reports released today, EUR/USD's move below 1.06 was driven by technical flows and more Greek headlines. Earlier this week we learned that the Eurogroup gave Greece 6 working days to provide a revised reform proposal and this morning, Bundesbank board member Dombret said further assistance to Greece can only be released if they provide sound finances.  In other words, Greece's creditors won't allow bailout funds to flow easily into Greece without something more concrete in return. Eurozone and U.S. monetary policy is drifting further apart and this dynamic is once again having a major impact on the currency. However after falling over 400 pips over the past week and coming close to the key 1.05 level with overstretched short positions, the EUR/USD is due for a relief rally. Of course, we will view this as an opportunity to sell at a higher level especially if the bounce occurs before the European Central Bank meeting on Wednesday.  The ECB has been buying bonds aggressively. Although they did not start buying bonds until March 9th, over the past month, they have already bought approximately 60 billion euros worth of bonds. They started with asset backed securities and covered bonds and then moved onto sovereign and supranational bonds.  When the ECB meets, we expect Mario Draghi to reassure investors that there are no issues with finding enough bonds to buy.  

USD/CAD Gives Up Gains after Labor Data
 
Contrary to Bank of Canada Governor Poloz's concerns about the Canadian economy and to the weakness in the labor market reported by IVEY PMI, Canada added 28,700 jobs in the month of March. Not only was this much stronger than the market expected but the unemployment rate also held steady at 6.8% versus a forecast for a rise to 6.9%. However the stronger headline numbers masked underlying weakness.  All of the job growth was in part time work with the economy losing 28k full time jobs.  The Bank of Canada meets next week and the big question is how today's jobs report impacts the central bank's monetary policy bias.  If Canada experienced job losses, the case could be made for a rate cut but the fact that there were jobs created means interest rates will remain unchanged.  We know that the central bank is dovish but with the U.S. economy recovering and oil prices finding support near $50 a barrel, the BoC will most likely refrain from easing, saving the bullet for a more desperate period in Canada's economy. USD/CAD pared its gains in response but still managed to end the day in positive territory.  Meanwhile the Australian and New Zealand dollars traded lower. Australian home loans and investment lending growth slowed while inflationary pressures in China increased. Commodity currencies will be in play next week with Chinese trade, retail sales and industrial production numbers scheduled for release along with an employment report from Australia. In addition to a monetary policy decision, we also have consumer prices and retail sales scheduled for release from Canada. 

GBP/USD Hits Fresh Multi-Year Lows
 
We have been looking for sterling to break the bottom of its recent range against the U.S. dollar but we did not anticipate the move happening this week. However now that a new 4.5 almost 5 year low has been set, bounces in the currency pair could be shallower.  Nonetheless, we believe investors should have the opportunity to sell sterling between 1.47 and 1.48 in the coming week for an eventual move below 1.45 on the back of the U.K. election.  Aside from U.S. data, U.K. inflation and employment numbers are also scheduled for release next week. While the PMIs reported mixed labor market activity with the rate of job creation accelerating in the service sector and slowing in manufacturing, inflationary pressures should remain weak.