Sterling Explodes as the USD Drops – Here's the reason
The value of the dollar has been on the rise since April. This rise has largely been the motivator for a stronger asset performance for the better part of the year. It is important to note that the stronger greenback has been as a result of, and impetus for a blend of divergence and tighter financial conditions.
Figure 1: 1-Years Dollar Index
Source: CNBC. As of Monday 8 October 2018
Note: Figure 1 show the rising value for the dollar since April 2018.
There are several other factors that are accelerating the dollar’s rally. Oil has been a strong rallying power considering that a stronger dollar, powers oil prices. I also attribute the rally to the ongoing US-China trade war and the global currency space is simply reacting to the war in a higher rate than what had been anticipated. On the other hand, investors are not looking forward to a disappointment with the ongoing Brexit negotiations and their optimism seems to be powering the sterling further.
After rising for the greater part of the year, the dollar’s rally recently lost force following mixed labor-market data. In spite of the fact that the USD broadened its gains against the commodity currencies, it went down compared to the Japanese yen, euro and the sterling pound. Recent job’s report missed the mark regarding expectations with the US economy, adding the least jobs in a half year but that was to a large extent attributed to the Hurricane Florence that put 299,000 individuals out of work. Reports indicates that the U.S. employment growth declined sharply in September as the Hurricane Florence lowered retail and restaurant payrolls.
On the one hand, the details of the job report were not so awful even with the joblessness rate tumbling to a 48-year low of 3.7% and employment growth for August revising up by 69 thousand, pointing a further contraction in the job-market conditions. On the other hand, earnings made up the main bad news by keeping up a consistent 0.3% pace of growth in September. The earlier number was revised slightly lower but because it was the strongest in over a year, the slight change followed by a consistent growth did not warrant any worry. The service sector is also extremely solid and employment growth ought to recoup in October. In lieu of the foregoing reasons, we can keep on trusting that the dollar is a buy-on-dips against the Euro, Sterling Pound, and most particularly the Yen.
The Federal Reserve has expressed its worry regarding the quickening inflation rate and very soon, financial reports ought to fortify their concern. Oil prices have also been topping since 2014 and have aggravated global imbalances for which we believe there's a decent shot that CPI and PPI might pop to the upside, which would recharge the dollar's momentum further. Investors on the other hand are already foreseeing three hikes in interest rates as opposed to the two hikes expected next year. Also, as the dollar remains low, 10-year Treasury yields will keep on making new 11-year highs.
In the meantime, USD/CAD pair has disregarded the high-yielding Canadian bonds and oil prices to exchange above 1.2950 even as the recent economic reports provided a reason to doubt possibilities of a rate riseany time soon.The trade balance ended positively in August but the manufacturing sector remained fundamentally sluggish in September. Despite recent job’s report indicating that Canada had the highest job growth this year and a superior unemployment rate, the fact that the Canadian job market is principally sustained by part-time employment is worrisome. Average hourly income growth is also weak raising more worries for consumer spending going forward. Report from the housing business sector in the coming week should not significantly affect the currency as investors take their prompt from the market's appetite for the greenbacks. In fact, USD/CAD pair could stretch out to 1.3000 prior to any significant resistance coming up.
The New Zealand and Australian dollars are the season’s worst performers. As recently noted by Kathy Lien (Managing Director of FX Strategy for BK Asset Management), poor economic performance prevented the AUD and NZD from rallying in the last few weeks. The selling pressure for the two currencies is overwhelming and according to Lien, we can anticipate a further decay before there is support in either of the two currencies. Nonetheless, data regarding retail sales from Australia has not been bad, it has indicated that retail sales expanded more than expected and the trade surplus and service-sector activity grew considerably. However, the ongoing rise in mortgage rates are already affecting the housing sector and according to investors, the US-China trade war will soon reach these two economies.
From the foregoing, it is foreseeable that the oncoming weeks’ business and consumer confidence reports may not revive AUD. Similarly, New Zealand's economy is failing to meet expectations with prices falling day by day and job ads going down as well. According to Lien, the most market-moving bit of information for the two economies could be China's trade balance and most particularly, its import activities.
The Sterling has been the best performer in the currency space during the last few weeks. Investors have not abandoned their expectation for a Brexit deal, and their hope was recharged by EU Chief Negotiator Barnier’s remarks that they were expecting to offer “the UK a supercharged free-trade deal that is more comprehensive than any other deal issued previously”. Unfortunately, this implies that they will dismiss Prime Minister May's interest in a frictionless trade so the Brits may not be content with the arrangement.
During the Tory Conference three weeks ago, Prime Minister May clarified that the UK was willing to leave the EU with no deal instead of going for an awful one. This implied that if the deal would fall short of her expectations, the Brexit negotiations could break down once more. Barnier presented the proposal on Wednesday and reactions from the UK are already coming out. The Irish border is also an uncertain issue and the UK would like to resolve it in the coming weeks. As a result, there is more to expect from the EU in the coming weeks.
According to Marc Chandler (Bannockburn Global Forex), we can expect the appreciating trend of the dollar to last longer despite its current overstretched position. Marc has reasons to believe that the recent deceleration of the dollar’s rally may not have necessarily captured all its underlying drivers and was puzzled why the dollar was not even stronger. Investors have already started seeing the reality of rate hikes coming soon and according to Marc, there is still more room for adjustments for the dollar to makeup and its incredible rally is set to last.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.