The Dollar's Pullback is Technical Not Fundamental

The U.S. dollar's correction today is technical and not fundamental. The prospect of a rate hike in December has not been changed by news, economic data or comments from U.S. policymakers. In fact, yesterday's FOMC minutes and Fed speak tell us that U.S. policymakers are serious about raising interest rates next month. Today's jobless claims report, Philadelphia Fed Business Outlook index and leading indicators are all consistent with strength and recovery in the U.S. economy. Yet the dollar fell sharply against all of the major currencies, leading many investors to wonder if this pullback will turn into a crash. Some attribute the decline in the dollar to outsized expectations but after the past month's extensive rally, a correction is not unusual. Investors expected the FOMC minutes to send a stronger signal about December tightening but the Fed's guidance was about as specific as they could get after a series of weaker economic reports. Comments from Federal Reserve Presidents have been mostly hawkish, with Mester (non-voter) saying today the Fed has met its employment goal and the Paris attacks don't change the economic outlook. Treasury yields are down but the decline is small. Stocks are steady and commodities are mixed indicating that other investors have not adjusted their positions to reflect a change in their outlook for the Fed.

In the past 2 months, corrections in the dollar rally have been limited to a 2 to 3 day move averaging less than 150 pips in EUR/USD and USD/JPY. This means that while we could see a further decline in the greenback, losses should be limited. Another reason why we believe today's correction is purely technical is because the recent rise in the dollar has taken pairs like EUR/USD, USD/JPY and GBP/USD to key support and resistance levels and the Dollar Index just shy of $100. It would be a surprise if the Dollar Index managed to break $100 on its first try even if data and Fed speak supports it.

The rebound in EUR/USD will give investors the opportunity to sell euros at a higher level. The ECB minutes was the only release out of the Eurozone and they confirm that unless the economy suddenly improved after the last meeting, the central bank plans to increase stimulus. With the Paris Attacks, more QE or another rate cut is almost certain. Today's move is nothing more than a short squeeze and we believe that the path of least resistance for EUR/USD remains lower. Should the euro continue to bounce, the best place to sell the pair would be between 1.0830 and 1.0950.

The British pound traded higher versus the U.S. dollar despite weaker retail sales. Not only did consumer spending fall more than forecast but September's strong figures were also revised lower. Retail sales dropped 0.6% in October and excluding autos spending contracted by -0.9%. Food store sales dropped by the largest amount in 17 months on falling volume and prices. Discounting is a sign of lower inflation and this trend is one of the main motivations for last month's less hawkish monetary policy stance from the Bank of England. Fundamentally sterling should be trading lower and not higher but EUR/GBP flows continue to lend support to the currency.

The best performing currency today was the New Zealand dollar, which rose as much as 1.5% versus the greenback. Stronger than expected producer prices kicked off the rally but the primary catalyst was short covering. Of all the major currencies, NZD/USD experienced the steepest losses this year. Since January, the currency pair is down nearly 16% so its natural that on a day like today, it is up the most as well. Producer prices increased significantly but consumer price growth, which matters more to the RBNZ was far more muted in the third quarter. Additionally, the recent decline in dairy prices puts downward pressure on inflation and it is worth noting that job ads grew at a slower pace in October. There's still a lot for the RBNZ to be worried about and for this reason we believe that the path of least resistance for NZD/USD is still lower.

The second best performing currency today was the Australian dollar. Considering that there was no Australian data released today, the move was driven entirely by short-covering.

In contrast, USD/CAD ended the day unchanged. Oil prices dripped below $40 a barrel for the second day in a row but managed to settle the day above that rate. The Canadian dollar is in play tomorrow with retail sales scheduled for release. Based on the drop in wholesale sales and the overall weakness of the economy, spending growth should slow but economists are already looking for a contraction in spending ex autos so the downside surprise would need to be a big one to send USD/CAD above its September high of 1.3457.