Dollar and Stocks - Its All Up to Powell Next Week

Friday's Federal Reserve monetary policy report failed to have a significant impact on the dollar. Many hoped that it would be a blueprint for Fed Chair Jerome Powell's testimony on the economy and monetary policy next week but it provided very little fresh insight. We fear that this lack of new information will also be the main takeaway from the Fed Chair's speech next week. The monetary policy report was slightly more cautious than the FOMC minutes, which focused on stronger growth and the likelihood of further hikes. On Friday, the Fed said wage gains were held down by low productivity and there's limited evidence of emerging supply constraints. We know that Powell will strive for continuity, especially at the beginning of his term but market dynamics have changed significantly since Janet Yellen stepped down and investors will be eager to see if Powell's views have shifted as well. 3 main things that will affect how the market responds to Powell's testimony:

#1 Powell's Take on Recent Market Developments - The Dow is down 6% since its peak in January as 10 year Treasury yields close in on 3%. Most U.S. policymakers are not concerned about these moves, especially given the recent recovery. If Powell shares these views and downplays the February correction, we should see stocks and risk currencies rally.

#2 Outlook on Growth and Inflation - Powell's emphasis on wage gains, growth and inflation will also be very important. Wage gains have been on the rise and if he says it could push inflation higher, necessitating faster more aggressive moves on rates, it would be disastrous for stocks and risk appetite. In this case, the dollar would rise against most of the major currencies.

#3 Position on More Rate Hikes - Last but certainly not least is how much transparency Powell provides on rate hikes. It is widely believed that he will emphasize the need for gradual tightening but if he gets specific and confirms that 3 to 4 hikes may be necessary this year, it would be the most disruptive to currencies as the dollar would propel higher. However if his comments are relatively benign in that he refrains from talking about the specific number of hikes, investors could see this as a green light for further gains in equities and risk currencies.

At the end of the day, we don't expect much in the ways of specifics from Powell outside of optimism and a vague plan to raise interest rates. Yet this may be enough to sustain the rally in stocks and renew the gains in risk currencies. Powell doesn't want to see stocks crash, yields spike and the dollar soar so he'll strive to maintain continuity and limit market volatility. There's still a decent amount of time to shape expectations ahead of the March meeting where he's expected to deliver this year's first Fed hike. In the meantime, there's not much in the way of market moving data on next week's calendar although investors will be watching the housing, confidence, personal spending and personal income reports to verify their rate hike views.

While EUR/USD extended its losses this past week on the back of softer economic data and U.S. dollar strength, it is still one of the most resilient currencies. There's rock solid support at 1.22 and decent buying underneath 1.23. Investor and business confidence took a hit as manufacturing and service sector activity slowed in Germany and across the region. It is also important to realize that activity and confidence receded from multi-year highs so instead of weakness, these reports reflected normalization in the Eurozone. The economy is still performing very well and everything we've heard from the central bank indicates that they are preparing to adjust their guidance in March. The upcoming Eurozone confidence, inflation and employment numbers won't change that outlook although February Eurozone CPI will be worth watching as inflation guides ECB policy. The market's response to the Fed Chair's testimony will have a significant impact on EUR/USD's direction but the euro itself could outperform other major currencies. Barring any major surprises, we expect EUR/USD to hold 1.22 and find its way back up to 1.24.

Sterling spent the entirety of this past week testing and rejecting 1.40. Although Q4 GDP was revised downwards, data in general wasn't terrible with jobless claims falling and average weekly earnings rising. Monetary policy committee members are also optimistic with Bank of England Governor Carney and his colleagues talking about the reduction in spare capacity, the firming of inflationary pressures, positive global momentum and the tight labor market. Carney left most of the positive assessments to his colleagues, but there's no doubt that while Brexit is a risk, U.K. policymakers are more hawkish than dovish. This attitude helped GBP/USD avoid steep losses and allowed sterling to outperform other major currencies. Looking ahead, the most important piece of data on next week's calendar will be the manufacturing PMI report towards the end of the week and between now and then, we expect sterling to maintain its resiliency.

All three of the commodity currencies fell victim to U.S. dollar strength this with NZD/USD experiencing the steepest losses as it sold off 5 out of the last 6 trading days. The initial decline was triggered by weaker service sector activity and lower dairy prices but NZD also shrugged off an unexpectedly significant increase in retail sales ex inflation last quarter as the U.S. dollar extended its gains. After reaching 74 cents, NZD/USD was hit by a wave of profit taking that exacerbated on the back of U.S. dollar strength. Looking ahead, New Zealand's latest trade balance, business and consumer confidence reports are scheduled for release but these second tier numbers will take a backseat to the market's appetite for U.S. dollars and risk. Technically, NZD/USD has support between .7200 and .7250. It was also a tough week for the Australian dollar although unlike New Zealand, there was very little on the calendar. We only saw the RBA minutes, which did not say anything new. While the central bank sees a positive course for the domestic and global economy, they are in no rush to raise interest rates because they believe that inflation will only rise gradually. The calendar is also quiet in the coming week with only manufacturing PMI scheduled for release. The main level to watch for AUD/USD is .7750 as the February low and 100 / 200-day simple moving averages hover right above this rate. If it breaks, we could see a stronger move down to .7600 and if it holds, we could see a recovery back to .7900.

USD/CAD tested and rejected 1.2700 following stronger than expected consumer prices. Over the past month, we've seen mostly softer Canadian data including retail sales which dropped -0.8% at the end of the year. Economists were looking for softer demand but they did not anticipate sales falling by the largest amount in a one month period since March 2016. However like the Eurozone, Canada's economy is coming from a strong base and the CPI report suggests that the healthy labor market is driving up price pressures. Core consumer prices, which are less volatile increased for the fourth month in a row and is now at its highest level since September 2016. This will keep pressure on the Bank of Canada to tighten. In the week ahead, Canada's current account balance and GDP reports are scheduled for release. We are looking for stronger growth so on a technical and fundamental basis, we see USD/CAD dropping back down to 1.25.