Dollar Outlook - Will the Race to Ease Delay Fed Hike?

• Dollar Outlook - Will the Race to Ease Delay Fed Hike?
• EUR and the Prospect of Further Losses
• USD/CAD Nears 1.25
• AUD Crushed by Rate Cut Fears
• NZD: Chinese Manufacturing Activity Improves Per HSBC
• GBP: Retail Sales Surprise Helps GDP

Dollar Outlook - Will the Race to Ease Delay Fed Hike?

It has been a great week to be holding U.S. dollars with the greenback hitting multi-year highs against the euro, British pound, Canadian, Australian and New Zealand dollars. Since the beginning of the year, the Dollar Index is up more than 5%. While part of those gains can be attributed to the positive outlook for the U.S. economy, the main reason why the dollar is performing so well is because central banks around the world are in a race to ease. Between the Bank of Canada's 25bp rate hike, Quantitative Easing from the European Central Bank and dovish MPC minutes from the Bank of England, non-dollar currencies are becoming increasingly less attractive. The Reserve Bank of Australia meets in 2 weeks and the deep sell-off in AUD/USD signals that investors expect the RBA to join the ranks. However before the RBA meeting, we have monetary policy announcements from the 2 most hawkish central banks in the developed world - the Federal Reserve and Reserve Bank of New Zealand. Based on the performance of the New Zealand dollar, some investors believe that the RBNZ will temper their optimism and outlook for a more gradual rise in interest rates. We will discuss that in further detail next week but right now, the more interesting question to ask is whether the recent easing measures will delay a rate hike from the Fed.

It is no secret that the market is very long dollars. Everyone from hedge funds to institutional investors and speculators have piled into the trade. Since the December FOMC meeting, we have seen an improvement in consumer confidence and a drop in the unemployment rate but that's where the positive surprises end. Job growth slowed, average hourly earnings declined, retail sales plunged by the largest amount in 11 months and consumer prices declined. Unlike other central banks, the Fed views the oil driven decline in CPI as transitory as they believe that lower gas prices will help the economy but if they wanted a time to emphasize "patience," now would be it. Whether they choose to do so remains to be seen because this month's weakness in economic reports comes on the heels of many months of improvements. The Fed doesn't believe that problems abroad will affect U.S. growth and if anything easier monetary policy in other parts of the world is positive for global growth. So while we believe that the Fed will take this opportunity to emphasize the need for patience and the importance of watching incoming economic data, we don't believe that they have given up on raising interest rates in 2015.

EUR and the Prospect of Further Losses

Investors continued to sell euros on the back of the European Central Bank's historic Quantitative Easing announcement. The single currency broke through 2 big figures to fall to its weakest level against the U.S. dollar in 11 years. In yesterday's note, we talked about why we were looking for a 500-pip move off of the QE announcement and that target has been achieved with EUR/USD falling from a pre ECB high of 1.1650 to a low of 1.1115 today. While EUR/USD ended the day off its lows, this intraday recovery represents profit taking and not a shift in fundamentals. The first round of QE from the Fed led to a 900 pip decline in USD/JPY over the course of 3 weeks and the QE announcement from the BoJ last year drove USD/JPY from a low of 109 to a high just shy of 120 in 6 weeks time. This means there is additional room for the EUR/USD to fall. If 1.1200 is breached again, we could see the EUR/USD hit and mostly break 1.10. Even better than expected Eurozone PMI numbers failed to help the euro. A number of important economic reports are scheduled for release from Germany next week including IFO, CPI, unemployment and retail sales. Most of the data is expected to be weaker which could accelerate the slide in euro.

USD/CAD Nears 1.25

All three of the commodity currencies fell to fresh multiyear lows against the U.S. dollar today. The Canadian and Australian dollar are trading at their weakest levels in 5 years while the New Zealand dollar has not been this cheap since November 2011. USD/CAD came within 50 pips of 1.25 and would have probably tested that level today if not for a stronger retail sales report. Consumer spending grew 0.4% in the month of November but unfortunately that did not stop the Bank of Canada from cutting interest rates this week. Their decision to do so was most likely affected by the larger than anticipated decline in consumer prices. CPI has fallen for 2 months in a row with the annualized pace slowing to 1.5% from 2% in December. The Canadian dollar dropped 3% this week and another test of 1.25 is likely. Meanwhile the fear that ECB easing could mean looser monetary policies in other parts of the world drove AUD and NZD lower. The Australian dollar fell 1.3% despite an uptick in the HSBC Chinese manufacturing PMI index. The Chinese economy is stabilizing but investors do not believe that this will stop the RBA from lowering interest rates by 50bp this year. Next week's CPI report from Australia will be particularly important. Now that AUD/USD has fallen below 80 cents, the next stop for the currency pair should be the 2007 swing low of 0.7675. Yet the main focus will be on the New Zealand dollar and what the RBNZ will have to say about future tightening plans. With the recent decline in NZD and stabilization in dairy prices, we believe they will maintain a tightening bias.

GBP: Retail Sales Surprise Helps GDP

Better than expected retail sales data prevented sterling from incurring the steep losses experienced in other currencies. In fact GBP/USD actually ended the day in positive territory. The currency's outperformance reflects the difference between the market's attitude towards currencies of countries that are easing versus those keeping policies unchanged. The recent decline in gas prices helped to boost spending at the end of the year with retail sales rising 0.4%. This was a big surprise considering that the market was looking for sales to fall by 0.6%. This along with the improvement in trade activity should bode well for next week's Q4 GDP report. The disparity between UK and Eurozone growth drove EUR/GBP to its lowest level in 7 years and further losses are likely if U.K. data surprises to the upside next week.