Will the Dollar Stand Up to the Test? Busy Week Ahead

• Will the Dollar Stand Up to the Test? Busy Week Ahead
• Euro Sinks After Greece Rejects Troika
• Why USD/CAD Could Reach 1.30
• NZD Hits 4 Year Lows
• AUD: Big Week Ahead
• Will Sterling Hold 1.50?

Will the Dollar Stand Up to the Test? Busy Week Ahead

The first month of the year is always expected to be busy but few market participants anticipated this January's big moves. The euro, Swiss Franc, Australia and New Zealand dollars saw changes in excess of 5%, which is typically a fluctuation that you would expect over 3 to 6 months and not 1 month.  Compared to last year for example, the average change in the major currencies during the month of January was approximately 1.5% whereas this year it is closer to 5%.  Between the Swiss National Bank's decision to abandon their 1.20 EUR/CHF peg to Quantitative Easing from the European Central Bank and unexpected rate cuts around the world, investors were caught off guard by monetary policy surprises.  Traders cannot expect the volatility to subside in the coming week with employment reports and more monetary policy announcements on the calendar. The two most important and potentially market moving event risks are the US nonfarm payrolls report and Reserve Bank of Australia's rate decision. In addition, manufacturing and service sector ISM numbers are also scheduled for release from the U.S. along with personal income, spending and trade numbers.  The big question on everyone's minds is whether the dollar will stand up to the test and while we are long-term dollar bulls, there's more downside than upside risk for the greenback.  The ISM service and manufacturing reports could beat expectations but personal income/spending is expected to be weak and the strong dollar may hurt exports, widening the trade deficit. More importantly, non-farm payrolls may fail to impress.  Job growth around 250k is expected but having fallen so significantly over the past few months, we may not see further unemployment rate improvement in the month of January.  Will this stop the Federal Reserve from tightening? No but softer reports could give traders an opportunity to buy dollars at a lower level.  

In the meantime, the underperformance of USD/JPY is tied to the decline in Treasury yields. Ten-year rates fell to its lowest level since May 2013 on the back of softer Q4 GDP numbers. However with personal consumption rising more than expected, the larger trend is foreign capital inflow into the U.S. that is positive for the dollar.  GDP growth slowed to 2.6% in the fourth quarter from 5% while personal consumption grew 4.3%, up from 3.2%. Manufacturing activity in Chicago accelerated while the University of Michigan consumer sentiment index was revised slightly lower.

Euro Sinks After Greece Rejects Troika

The euro resumed its slide on Friday after the Greek government indicated they would not welcome the return of EU and IMF inspectors (Troika).  According to Reuters, there are also reports of no plans to seek an extension to the EU portion of the aid program expiring at the end of February. In doing so, Greece is clearly creating more headaches for the Eurozone because if they do not allow the Troika into the country, they may not receive the next aid disbursement that they desperately need to avoid default.  Prime Minister Alexis Tsipras wants to start discussions from scratch and in all likelihood, the ECB, EC and IMF will mostly likely concede to revising the terms of their loan because a default could plunge the entire region into crisis. European policymakers have no interest in creating more volatility in the financial markets. Of course, the Greek government would have to make concessions as well since loan forgiveness is very unpalatable. Meanwhile Italy should have a new President by the weekend. There is a lot of political maneuvering happening at the moment but at the end of the day, the Prime Minister has more power than the President and the impact on the markets should be nominal.  We have seen the euro repeatedly survive Berlusconi driven political drama and the upcoming elections should be no different.  Anemic retail sales growth in Germany and falling consumer prices in the Eurozone reinforces our belief that the EUR/USD is headed to 1.10. Final Eurozone PMI numbers are scheduled for release next week along with German industrial production and retail sales. Barring significantly weak U.S. data, we expect EUR/USD to remain under pressure. 

Why USD/CAD Could Reach 1.30

A surprise contraction in Canadian GDP growth drove USD/CAD to a high of 1.28.  Over the past month, the currency pair soared over 1000 pips or 8% to its strongest level in 5 years. The initial slide was triggered by a decline in oil prices with the move extending on the back of the Bank of Canada's surprise rate cut and the move is now exacerbated by weaker economic reports.  Each of these goes hand in hand of course because the BoC would not have lowered rates if oil prices had not fallen and the economy had not weakened. Nonetheless, the 0.2% contraction in the month of November drove annualized GDP down to 1.9%, the slowest growth since March.  The problem was manufacturing and oil production - which saw its biggest drop in 6 years.  Unfortunately next week's IVEY PMI and employment reports could highlight the same areas of vulnerability in Canada's economy. If the data is soft like we anticipate, USD/CAD could make a run for 1.30.  The only saving grace is oil, which seems to be finding support above $40 a barrel.  Meanwhile the New Zealand dollar dropped to a 4 year low following a report that building permits dropped 2.1% in December. NZD/USD will remain in focus in the coming week with RBNZ Governor Wheeler scheduled to speak and the Q4 employment report set for release.  The main focus however will be on the Australian dollar and the prospect of a rate cut by the RBA.  Chinese manufacturing and non-manufacturing PMI reports are also scheduled for release in the coming week.

Will Sterling Hold 1.50?

Compared to many other major currencies, sterling has been holding up well.  Hawkish comments from policymakers along with some modest surprises in economic data helped.  This morning we learned that mortgage approvals increased in December even as net consumer credit declined. The 1.50 level has been extremely important for the currency and whether this level holds will in large part hinge on next week's economic reports.  We know that the decision to keep policy unchanged at the most recent meeting was unanimous but certain members such as BoE Governor Carney and MPC member Foster are still talking about tightening, leaving the market confused about where the central bank stands.  That confusion should be clarified by next week's PMI reports. Stronger numbers will help GBP/USD hold 1.50 whereas weaker data will send it to fresh 1 year lows.