U.S. Dollar Strength May Bode Poorly for Equities

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 |  Includes: ADE, ERO, EU, EUO, EWA, FXA, FXB, FXC, FXE, FXF, FXY, JYF, YCL, YCS
by: Ophir Chador

Overview

In anticipation of the Non-Farm Payrolls report issued Friday, equities markets were relatively quiet over the course of last week’s trading. Both the Dow and S&P 500 registered small gains on the trading week; however, in observance of Good Friday, trading was closed ahead of the jobs report.

The US dollar was mixed on the trading week, though a feeble yen propelled the greenback to new seven-month highs. By the Friday close, the dollar had gained 4.5 percent against the JPY, while the sterling gained in excess of 6 percent against the JPY.

Forex traders got a bit of a jolt on Thursday, when the Swiss National Bank is suspected of having intervened in the currencies market. In an effort to derail the Swiss franc’s natural upward trajectory, it is believed that the SNB loaded up on euros (and possibly US dollars as well) ahead of the holiday weekend. While the immediate effect of the SNB’s efforts managed to drive the Swiss franc lower, by the daily close the franc lost a modest 0.6 percent against the euro over the previous session.

The Friday jobs report showed the US economy adding 162,000 jobs in March. A closer look at the jobs numbers, however, indicates that 88,000 of the jobs added came in the form of temporary work -- 48,000 of which came from the decennial Census.

In the week ahead, expect US dollar strength to be the central theme, which may bode poorly for equities markets. A number of key reports out of the U.S. will kick off the trading week -- including Monday’s release of the Services PMI and Pending Home sales and Wednesday’s release of the FOMC meeting minutes.

Of particular interest, however, will be the Reserve Bank of Australia’s interest rate decision due for Tuesday release and is addressed below.

Currency Pairs of Interest

  • AUD/USD
  • USD/CAD
  • EUR/CAD
  • EUR/CHF

Analysis and Trade Ideas

Australian Dollar (AUD):

The RBA rate statement due for early Tuesday release -- 12:30 a.m. in New York -- promises a turbulent week ahead for the Australian dollar. While analysts are forecasting yet another 0.25 percent rate hike from the central bank, which is largely priced into the market, the forecast alone tells us very little.

Following an unexpected drop in retail sales numbers in February, to which recent rate hikes doubtless contributed, worries surrounding additional rate hikes have intensified. Among others, Australia’s National Retail Association has been extremely vocal about the negative impact that an April hike would have on the consumer. The retailers warn that the effective interest rate in Australia greatly exceeds the target rate set by the RBA; further rate hikes, meanwhile, would only broaden that disparity.

RBA policy members are certainly aware of the issues on the ground. As a result, a shift in policy may be on the horizon. While they may not forego a Tuesday rate hike, though it’s a real possibility, they could adopt more dovish language than that of past statements. Either way, the Aussie falls.

The AUD/USD has yet to break through its resistance levels, so preexisting short positions remain in safe territory. The pair closed at 0.9188 on Friday -- a great level to establish a new short position. A daily close above 0.9325 could signal additional upside risk. A close above the 0.94 handle confirms that the trade is done. On the other hand, should all the pieces come together -- resistance levels hold and the RBA takes a more dovish approach -- 0.8400 is the longer term target while the 0.87 handle could be visited by the Friday close.

Loonie (CAD):

The Canadian dollar, or loonie, has enjoyed tremendous strength against its major counterparts in recent weeks. Specifically, traders en masse have joined the USD/CAD Parity Parade that has seen the pair decline by over 6 percent since early February. While in the coming days, USD/CAD parity is a possibility, if not a likelihood, it’s what happens next that traders should be focusing on.

Last week’s Commitment of Trader report, which the CFTC issues each Tuesday, confirms what we already know: the parity trade has become extremely crowded. According to the latest release, the ratio of long to short positions among large traders exceeds 5 to 1 while among small traders the ratio is 2.75 to 1.

Not only are all those traders crammed into a single position, but they have also all but announced their exit point. USD/CAD parity, then, should set off some major fireworks, as traders scramble to cover their short positions.

Look to buy the USD/CAD slightly above parity -- 1.0020 would be a good price -- while simultaneously establishing a short EUR/CAD position. The latter trade should protect against USD declines beyond parity while taking advantage of euro weakness relative to the loonie; in other words, it is as much a standalone trade as it is a buffer.

Swiss Franc (CHF):

As the case for buying the Swiss franc against the euro was made just yesterday, here is a quick recap of the main points. First, despite numerous attempts, SNB interventions over the last year have failed to derail the EUR/CHF downtrend. Instead, history shows that the strength preceding an SNB intervention inevitably, if not immediately, resumes.

Second, there are systemic issues within the eurozone with which the SNB cannot compete. Buying euros in bulk will not begin to address the Greek debt crisis, the Irish banking fiasco, the Portuguese credit issues, the Spanish economic uncertainties and so on.

Third, the Swiss economic recovery has been both speedy and robust, which adds to the likelihood of a rate hike in the near future. In the words of SNB board member, Jean-Pierre Danthine, investors need to prepare for a “return to higher rates, with foreign exchange rates being set by market forces.”

Finally, the SNB is unlikely to scale up its war against the currencies market at this stage. After all, Treasury Secretary Timothy Geithner can easily award multiple merit badges at the upcoming Currency Manipulators Awards Ceremony -- and China would certainly welcome the company.

The trade, then, is simple: Short the EUR/CHF and add to the position on any euro strength.

Disclosure: Author is Short EUR/CHF and Short AUD/USD