Gaps Left Unfilled but Dollar Still Vulnerable

After all of the excitement from the French election, Donald Trump's "big" tax reform announcement and the prospect of another U.S. government shutdown, there was very little consistency in the performance of the dollar.  The gaps after the election were left unfilled but the gains also did not continue. However next week, the U.S. dollar should experience a more uniform performance ahead of and following the upcoming Federal Reserve's monetary policy announcement. Despite Friday's rally, U.S. data has been terrible.  GDP growth slowed to 0.7% in the first quarter the worst level in 3 years. Personal consumption was the weakest since 2009. Investors were excited about the rise in prices but higher inflation won't be enough for the Federal Reserve to raise interest rates in June.  There's currently a major misalignment between the performance of the U.S. economy and the market's expectations for Fed tightening. Fed fund futures are pricing in a 69% chance of a rate hike in June. This jump occurred after the election in France and in spite of consistently softer U.S. data.  Over the past month, job growth slowed to 98K, inflation declined, manufacturing and service sector activity slowed and spending turned negative.  The only "good" news was in the unemployment rate, which notched lower and in the housing market which continued to benefit from low interest rates.  There's not enough here for the Fed to be convinced that rates should increase in June instead of September and for this reason, we think the dollar will trade lower into FOMC. The May meeting does not include updated forecasts or a press conference but it is the last meeting before June when a good part of the market thinks the Fed will deliver its next rate hike.  With no additional clarity on the President's fiscal spending program since the last monetary policy meeting, the central bank has little reason to use this upcoming meeting to signal that a hike is coming in June.  For this reason we think USD/JPY is a sell going into Wednesday's FOMC meeting.  Aside from the Fed, ISM manufacturing and non-manufacturing numbers are also scheduled for release along with the latest non-farm payrolls report.  Given the weakness of the February report, a major rebound is expected in April. 

Without the post election breakout last Sunday, the euro would not have been this week's best performing currency and politics should continue to provide the single currency with support going into the final round of the French election. At this stage Emmanuel Macron is a shoe-in to become the next President of France and that reality will be a huge relief for the euro.  Italy is the next battleground but the Italian elections will not be held until 2018.  Meanwhile, the European Central Bank is worried about inflation even though consumer price growth rebounded to 1.9% from 1.5% in April. This increase was stronger than expected and should ease part of the ECB's concerns.  However spending in Germany and France remain weak according to the latest retail sales reports and even though EZ CPI increased, price pressures in France eased. As a result, French GDP growth slowed to 0.3% from 0.5% in the first quarter.  It was no surprise that the ECB left interest rates unchanged this past week. Although Mario Draghi recognized the improvements in the economy, he also emphasized the need to keep monetary policy extremely accommodative because he's not sure that the rise in inflation is durable.  Aside from the final round of the French Presidential election, German unemployment and first quarter Eurozone GDP numbers will be in focus next week.  Between these events and those in the U.S., we expect EUR/USD to break out of its 1.0850-1.0950 trading range. 

The commodity currencies continued to underperform with the Canadian dollar falling to a 1 year low, the New Zealand dollar hit a 10 month low and the Australian dollar reached its weakest level in 3 months.  Aside from the weakness in Canadian data (retail sales and GDP both fell short of expectations), plunging yields and falling oil prices also contributed to the relentless downtrend in Canada's currency.  Canada is also under attack with the U.S. looking to impose 20% tariffs on Canadian lumber imports.  NAFTA negotiations will begin soon and it is still not clear whether the U.S. will be pulling out or simply renegotiating the terms.  The Australian dollar was hit by lower consumer prices while the New Zealand dollar fell in sympathy with its neighboring currency. 

AUD will be in focus at the start of the new week with the Reserve Bank of Australia's monetary policy announcement.  Afterwards, the focus will shift to the Canadian dollar with trade, employment and IVEY PMI scheduled for release.  The last time the RBA met they expressed caution about the economy and the labor market specifically.  They have less to worry about in March with labor market activity rebounding, consumer price growth steady (despite this past week's miss) and trade activity improving.  Chinese data however has been soft so there's very little reason for the central bank to alter its current bias.  Aside from the RBA rate decision Australia's PMI reports and trade balance are also due for release. New Zealand on the other hand has labor data on tap. The Canadian and New Zealand dollars are oversold but AUD has plenty of room to fall.  Whether that happens will hinge on the RBA and the FOMC. 

While the Canadian dollar has been on a relentless downtrend, the British pound has been experiencing a relentless uptrend.  The currency only lost value one out of the last four trading days and pushed to a 6 month high on the back of stronger annualized GDP growth.  Although the U.K. economy expanded by only 0.3% in the first quarter, compared to 0.7% in Q4, the year over year rate accelerated to 2.1% from 1.9%. Brexit has faded yfrom the minds of sterling traders but whether that attitude is justified will hinge upon next week's PMI reports.  1.3000 is the obvious resistance level for GBP/USD with 1.2600 as support.  While sterling previously benefitted form anti-euro flows, the prospect of a Macron victory should ease those flows.