USD/JPY Hits 115, Catch-up Begins

Dollar bulls are back in control and they have taken the buck higher against all of the major currencies.  In yesterday's note we said the greenback was lagging and not diverging from U.S. equities and rates but that divergence came to an end today with the currency breaking sharply higher.  USD/JPY rose within 20 pips of 115 as EUR/USD sank close to 1.0650.  This strength comes despite a series of mixed U.S. economic reports.  While the December trade balance narrowed slightly and economic activity accelerated this month according to Markit Economics, jobless claims rose more than expected and new home sales dropped sharply.  The market was looking for a modest 0.7% decline but the 10.4% drop was the largest since March 2015.  The rise in U.S. rates since Trump's victory has driven the cost of mortgages up more than 75bp from 3.54% before the election to a high of 4.32% at the end of December.  Fourth quarter GDP numbers are scheduled for release on Friday along with durable goods and the University of Michigan Consumer Sentiment index.  Slower growth is anticipated and if that is the case, we could see an end of week pullback in the dollar.   While we are still looking for further dollar strength in the coming week, the recent rally has taken USD/JPY to the 20 and 50-day SMA, an area that invites profit taking. 

After struggling to break 1.08, the recent stretch of lower highs and lower lows in the EUR/USD indicates that we have seen a near term top.  No economic reports were released from the Eurozone outside of German consumer confidence, which was slightly firmer than the previous month.  However we heard from a number of Eurozone policymakers and their comments were conflicting.  ECB member Villeroy said while their growth forecast confirms the European recovery, it is not yet satisfactory and the fears of inflation resurgence are "very exaggerated." ECB member Knot believes that the tail risk of a deflationary spiral is no longer imminent while Rajoy expressed concern over premature tightening.  The euro's previous weakness has gone a long way in supporting the economy but the central bank's persistently dovish monetary policy and the positive outlook for the dollar should cap gains.  We now look for the currency pair to pullback to 1.06 and possibly even 1.0550 in the near term. 

Although sterling also traded lower against the U.S. dollar today, it extended its gains against other major currencies.  Fourth quarter GDP growth was stronger than expected at 0.6%.  Economists had been looking for slower growth but instead the U.K. economy maintained the same pace as the third quarter.  This healthier report sent GBP/USD sharply higher and within a few pips of 1.27.  With that in mind, we found the steep drop in the CBI distributive trade survey disconcerting. This report has a strong correlation with the broader retail sales measure and signals a potential slowdown in consumer spending.  Sterling is still poised for stronger gains especially as Prime Minister May embarks on her trip to Washington.  In contrast to the twitter spat with Mexico, the U.K. and U.S. should enjoy a stronger relationship given President Trump's support for Brexit.  We would not be surprised if May walked away with a promise for a healthy bilateral trade deal. If the two leaders were to talk of progress on this front, it could be wildly positive for sterling.  If the U.S. becomes one of the first countries to announce a bilateral trade deal with Britain, it would be a vote of confidence for Brexit and force other countries to fall in line.  Will it shield the U.K. economy from slower growth or recession? No but it will be years before the U.K. formally exits from the E.U. and that is when they will feel the brunt of the pain. For the time being, the weaker currency and a friendlier relationship with the U.S. should continue to support the economy.

Meanwhile all 3 of the commodity currencies traded lower taken as the greenback turned upwards. The New Zealand Dollar was the biggest loser and its slide came in spite of stronger inflation data. New Zealand CPI increased by 0.4% for the fourth quarter, a slight rise from the 0.3% expected. When the report came out NZD jumped nearly 50 pips but peaked shortly thereafter, giving up all of its losses and then some as the day progressed.  The Canadian dollar also moved lower but the decline could have been worse had it not been for the sharp nearly 2% rise in oil prices today. With the improvement in risk appetite today, gold prices ticked lower and with it, the Australian dollar. The Aussie continues to stay in focus as PPI number is scheduled for released later this evening and with the miss in CPI earlier in the week, the risk is to the downside for the report.