Which Currencies are Investors Buying and Why?

The best performing currencies this week were the Australian and New Zealand dollars and while their quiet strength may come as a surprise, here are 5 reasons why investors are buying these commodity currencies. Most importantly, the U.S. dollar lost its luster this week. The greenback traded lower against all of the major currencies and this played a key role in driving A$ and NZ$ higher. AUD and NZD were also two of the worst performing currencies this year (even with recent recoveries they are down more than 11%) so what has fallen the hardest is bouncing back the strongest on short covering flows. At the beginning of the week investors feared that stocks would crash and risk appetite would sour after the Paris attacks but instead markets proved to be resilient with European and U.S. equities ending the week higher. A$ also benefitted from the end of the week recovery in gold and copper prices and optimistic comments from RBA officials. Despite the problems in China and depressed commodity prices, many Australian policymakers feel that the prospects for the economy have improved. NZ$ fell hard at the beginning of the week but recovered strongly on the back of hotter producer prices. In the coming week, the question of whether these rallies will continue hinges on the market's appetite for dollars and RBA speak. We don't have much on the calendar for New Zealand (only trade numbers on Thursday evening) and while there are no major Australian economic reports due, RBA Governor Stevens will be speaking on Tuesday.

5 Reasons Why Investors are Buying A$ and NZ$

1. Dollar Weakness
2. Short Covering
3. Risk Appetite
4. Commodity Price Recovery
5. NZ Data, RBA Speak

What is interesting is that the Canadian dollar failed to participate in the commodity currency rally. The loonie is this year's second worst performer behind AUD but the price of oil did not recover like gold and copper and there were no improvements in Canadian data. Oil prices dropped below $40 a barrel to its lowest level in 2 months while Canadian retail sales growth slowed in September. Retail sales dropped 0.5% but losses in CAD were nominal because consumer prices growth accelerated.

The cleanest trade these days remains the EUR/USD. After the 2-day rally, euro resumed its slide as ECB officials continue to talk down the currency. Mario Draghi spoke this morning and according to the ECB head, "the central bank will do what it must to raise inflation quickly." He confirmed that the downside risks have increased in recent months and said the central bank cannot be relaxed about low core inflation. Although Bundesbank head Weidmann continues to resist the notion of weak German growth and low inflation - he called the oil price drop stimulus and not a deflation harbinger and said there's no reason to paint gloomy economic picture - investors recognize that Draghi is running out of patience. According to yesterday's ECB minutes, unless there was a sudden improvement in the economy after the last meeting, the central bank planned to increase stimulus. With the Paris attacks and today's comments from Draghi, more stimulus is next month is certain. EUR/USD has begun to move lower again and we are looking for a test of 1.0520 on the back of next week's Eurozone PMI and German IFO reports.

Even with today's mixed performance, this has been a tough week for the U.S. dollar but we believe that the correction 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. Comments from Federal Reserve Presidents have been mostly hawkish, with Vice Chair Fischer saying overnight that the "Fed has done everything it can to avoid surprising the market." This plays off FOMC voter Dudley's comments earlier in the week that "when liftoff happens it won't be a big surprise and it will signal the Fed's confidence in the economy." The bottom line is that the Fed's views have not changed after the Paris attacks and if anything, we've only heard stronger support for tightening and as such we expect a recovery in the dollar. Next week is a shortened holiday trading week in the U.S. but there are a number of important economic reports scheduled for release including Markit PMI numbers, revisions to GDP, consumer confidence, personal income, personal spending and the University of Michigan Consumer Sentiment Survey.

Sterling also moved lower like the euro on the back of weaker public sector finances. Today's report was the worst in 6 years and shows that the government is significantly behind their 2015-2016 borrowing projections. Lower tax receipts and higher government spending are to blame. After this week's reports including retail sales, Fundamentally sterling should be trading lower and not higher but sterling traders need to watch EUR/GBP because the flows have been keeping GBP supported.