Last week failed to provide any fresh catalysts to jolt the foreign exchange market from its current state, and as such we continued to see a softening in US interest rates which pressured the greenback lower against the bulk of the majors. The DXY is ebbing towards the lower-end of the consolidative trend channel which has confined the index for the past year, while the yen freight train continues to gather momentum and has pushed USDJPY to lows not seen since late 2014. The softness in the dollar index will be key to watch in the week ahead, as there is little from a technical perspective that would suggest we’re nearing a turning point in the short-term.
The minutes from the last Federal Reserve monetary policy meeting that were released last week failed to entice any USD bulls from hibernation, and even with the minutes being littered with hawkish undertones from regional voting and non-voting members, the dovish power base of the FOMC continues to influence market direction. As such, the knee-jerk firming in bond yields was quickly faded, and the trend of USD consolidation continued unperturbed. Also aiding in the deterioration of the short-term outlook for the big dollar is that the Atlanta Fed’s GDPNOW tracker has rolled over, with growth estimates for Q1 being slashed to 0.1% on an annualized basis after February wholesale inventories were reported at the end of last week. Retail sales for the month of March will be releasedon Wednesday, and will be one of the pivotal data releases for the American buck this week, as headline retail sales to start the year have been weaker than anticipated, one of the main catalysts contributing to easing of economic activity in the first quarter. Consumer demand is expected to have firmed up slightly after the sluggish start to 2016, and a stronger than expected print would help the DXY plug some of the holes that have been punched in the index since Fed ratcheted back their optimism for the global economic landscape.
Consequently, the deluge of economic data hitting the wires from China this week could in fact have a greater influence on the American buck rather than domestic data, given the Fed’s increased vigilance into global variables. The use of the word “global” in the FOMC communique has steadily increased since the December meeting, and as such, it is likely to assume these global variables will have an increase importance in the influence of the direction of the USD. Near the end of the week when the flood of Chinese data hits the wires, which includes first quarter GDP figures, a robust set of economic prints may help the American dollar find some support as concern about those international variables eases. Because of the importance the Fed places on international developments, we would opine that to better determine the longer term direction of the dollar, the Chinese GDP figures will likely be of more importance then domestic retail sales. While there are pundits suggesting the leading indicators pointing to slow first quarter growth in the US are indicative of a deeper trouble, with some uttering the dreaded ‘R’ word (hint: Recession), we are slightly more sanguine knowing the seasonality associated with economic activity in the United States. Given that GDP traditionally comes in far below trend growth the first quarter of the year, the bigger risk in our opinion is how the Fed’s overall tone towards international variables will develop in the coming months, so for those participants expecting the overall weak technical tone in the big dollar to vanish, Yellen will first need to feel more confident there are signs of stabilization overseas.
Turning to Canada, while the developments pertaining to interest rates south of the border will continue to influence price action for the loonie, the Bank of Canada meeting this week will be in the forefront of traders’ minds. Expectations are that Governor Poloz and the BoC will be holding interest rates firm on Wednesday, with only a 5% probability the central bank will reduce the overnight lending rate by an additional 25 basis points. The Federal Government’s new fiscal stimulus plans will likely help Poloz refrain from reducing the lending rate further from current levels, though we would caution the rate statement has the potential to take on a slightly more dovish tone than we’ve seen from Poloz previously.
While we do acknowledge the data to begin 2016 has been far more robust than anticipated given the effects of lingering low commodity prices, the recent rapid appreciation of the loonie may spook Poloz into trying to guide the loonie to lower levels in an effort to guard against choking off the positive developments in the non-energy export sector. The trade balance data that was released last week was overlooked by market participants in favour of the overall bearish tone towards the American dollar; however, the larger than expected trade deficit in February was a direct result of a 5.4% fall in exports, namely a drastic 14.3% drop in consumer goods exports. The Canadian dollar strengthened roughly 3% against the American dollar during the month of February, but that was on the heels of a previous gain of 5% from the lows witness in the middle of January. While it may be too early for Poloz to panic about the strength of the loonie, the recent appreciation could throw a wrench in the works of the rebalancing act Poloz and the Bank of Canada are trying to engineer. Optimists will point towards the constructive labour market report in March to suggest the wheels aren’t falling off a recovery post collapse in commodity prices just yet; however, the gain of 35k new full time jobs in March is roughly just over half of the nearly 52k that were shed in February, and still a ways from getting back to a ‘net gain’ position for 2016.
So while we’re not arguing the validity of the March employment numbers, we are highlighting the risks to having a long CAD position heading intoWednesday’s interest rate announcement. From the commitment of traders report released at the end of last week, speculative positioning on the CAD has turned net long for the first time since last May, illustrating short-covering has brought the speculative market back into balance. The overall positioning is neutral in terms of direction for the currency, but has room for the gross long position to build should Poloz continue with his rosy assessment of the international landscape and how the Canadian economy has managed to shake-off the effects of low commodity prices early in 2016. Now that the speculative shorts have been flushed from the market, a lot will be riding on Wednesday’sannouncement to see whether the CAD bulls use this as an opportunity to strengthen their stronghold on USDCAD, or if a nervous Poloz keeps any further bullish sentiment in check.