Here's Why Dollar is On Back Foot Before Jackson Hole

For the past month, it has been one step forward and 2 steps back for the U.S. dollar. This performance can be partially attributed to the unevenness of U.S. data but what is really hurting the greenback are growing political tensions at home and abroad between the U.S. and other nations.  On Tuesday, the greenback soared on the lack of inflammatory comments from North Korea and Donald Trump but that changed completely last night when the President went back to threatening Congress and the U.S.' trade partners.  In his rally last night, Trump said, "If we have to close down our government, we're building that wall. One way or the other, we're going to get that (Mexico) wall." On NAFTA he said, "I personally don't think you can make a deal without a termination but we're going to see what happens."  His threat to pressure Congress to fund the U.S.-Mexico wall and terminate the NAFTA agreement did not sit well with investors who sold the U.S. dollar and U.S. stocks.  A sharp unexpected decline in new home sales also contributed to the greenback's weakness.  Purchases of new homes dropped 9.4% in July, the largest one month decline in 11 months.  According to Markit Economics, manufacturing activity slowed in August but service sector activity accelerated, leading to a higher composite PMI index.  But ultimately the drop in Treasury yields and the ongoing anxiety created by President Trump played the biggest role in the dollar's decline. Even rating agency Fitch is nervous - they said they may review the U.S.' rating outlook if the debt ceiling is not increased.  Looking ahead, we still think the greenback will benefit from the speeches at Jackson Hole with the Fed preparing the market for balance sheet reduction. For this reason, we don't expect USD/JPY to experience a material decline below 109.00.  At worst we think USD/JPY will probably see 108.50 before Yellen's speech on Friday.

Aside from the Japanese Yen, the best performing currency today was the euro, which found its way back above 1.18.  Just as there were no less than 4 reasons why the euro sold off yesterday, there are at least 3 reasons for today's strength. The most obvious one is the decline in the dollar but Eurozone data also helped propel the currency higher.  Manufacturing and service sector activity in Germany accelerated this month, pushing the country's composite PMI index to 55.7 from 54.7.  Although we could point out that a slowdown in other parts of the region prevented the Eurozone composite index from experiencing similar gains, the stronger regional report was enough to satisfy the bulls.  ECB member Weidmann also said he sees no acute need to extend QE into 2018 as inflation is on the path to reaching their target.  These hawkish comments confirm that the central bank plans to reduce asset purchases next month but the recent strength of the euro also makes it more likely that the central bank will maintain a dovish tone.  ECB President Draghi spoke today and outside of saying that QE, forward guidance are a success, he refrained from touching on next month's plans. 

Meanwhile the New Zealand dollar continues to be the worst performing currency and unlike yesterday, the latest move was driven by local factors.  Last night, the New Zealand government provided its latest economic update ahead of next month's election and while they forecast a significantly larger budget surplus this year, they expect growth for the year to June to be 2.6%, down from a previous estimate of 3.2% and for fiscal year 2018, they now expect 3.5% growth instead of 3.7%.  These lower growth projections combined with the Reserve Bank's unease about the currency and talk of intervention puts NZDUSD on track to test 71 and possibly even 70 cents.  At the same time, it should only be a matter of time before AUD/NZD hits 1.10.  Tonight's New Zealand trade balance report should add further pressure on the currency as the strong NZD and weaker manufacturing activity signals lower trade activity.  The Australian dollar also followed the New Zealand dollar lower despite higher gold prices.  No major Australian economic reports were released overnight so the move today was driven purely by risk aversion. 

For the third day in a row, USD/CAD ended the day virtually unchanged.  Although this consolidation may suggest that the pair is bottoming after a deep sell-off, fundamentals and technicals still favor further weakness. Oil prices are up sharply today following the 8th straight week of crude draw.  Recent data from Canada supports the case for further tightening and on a technical basis, the pair is still holding below the 20-day SMA, which currently hovers near 1.2615.  Although we continue to believe that USD/CAD will decline, we should see more material loonie strength versus other currencies like GBP, AUD and NZD.

No U.K. economic reports were released today but sterling remains under pressure. As we mentioned in Tuesday's note, between the central bank's ongoing concerns about Brexit, uneven data and the prospect of a stronger U.S. dollar, there are many forces driving GBP lower.  GBP/USD fell to its lowest level since June 27th and is eyeing 1.2750 while EUR/GBP climbed to its strongest level since October 2009. If EUR/GBP clears 0.9250 in a meaningful way, the next stop could be 94 cents. Revisions to second quarter GDP are due for release tomorrow and the initial forecasts are usually accurate but if changes are made, they will definitely have a short term impact on sterling.  For the time being we don't see the downtrend in the pair changing.