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Are we moving to a period of uncertainty for the dollar?


KEY THEMES

  • It looks as though we are moving from a phase of dollar strength into a far more uncertain period for the greenback. There are a number of political factors increasingly playing a role which will create volatility, however it also looks as though the Fed will be only above to complete a maximum of two hikes this year (and possibly once again maybe just the one). Volatility will come from the increased political risk from the Eurozone as the run to the French Presidential election ramps up, taken alongside Trump’s protectionist rhetoric will help to generate volatility, but the expectation of Fed tightening will determine how strong the dollar is in 2017. The recent FOMC statement and subsequent lack of earnings growth suggest that there is likely to be little appetite for a sharp tightening on the FOMC (especially with any perception of a negative impact of Trump’s protectionism).

dollar up and down

  • Marine Le Pen (or should that now be just “Marine”) is marginally ahead in the preliminary polls and should mean that she is likely to go into the second round of voting for the final run-off for French President. Le Pen kicked off her election campaign at the weekend with an protectionist, anti-immigration theme running through her speech. She is anti-euro and pledges to hold a “Frexit” referendum within six months of being President. This means that the market is having to factor in the risk of a Le Pen victory. French government bond yields are rising, as is the spread over the Bund. This is putting pressure on the euro. As the chart below shows, France is not the only major country in the Eurozone whose bond yield s have pushed strongly higher in 2017.

French yield

  • The safe haven plays are also reacting with this recent increase in political risk within the Eurozone and Trump’s protectionism. Gold and the yen have broken out (USD/JPY and EUR/JPY have both broken key supports), whilst Treasury yields are also tracking lower. Traders are buying Treasuries because of both the safe haven appetite and also a perception that the market pricing of just two hikes in 2017 (June and December) may even be on the hawkish side. Treasury yields could now move into more of a consolidation phase as the post-Trump rally has petered out. The correlation between the dollar and Treasury yields may have weakened recently but that has tended to be because the dollar has been under corrective pressure and now the Treasury yields could be playing catch up. I see this as playing out with higher volatility but a lack of trend on the dollar now. The caveat to this would be a large corrective move on the euro which drives the dollar higher. Whilst I see the euro as potentially back towards parity, unless the unlikely drive of a Le Pen victory in the second Presidential vote, a move below parity would be unlikely without three or even four hikes in 2017.

yen strength

  • Brexit will remain an issue for UK assets in the coming months, with sterling hamstrung and this should maintain in the least the range between $1.2000/$1.2775. The various Parliamentary exchanges and votes on Brexit will be a drag on sentiment. A vote (on Wednesday) on the first amendments to the Brexit bill is expected this week. The rise in input prices is beginning to be reflected in retailer pricing and this will begin to hit retail sales as the initial positive impact of the weaker sterling finally filters through towards inflation. Could it be that with the services PMI disappointing, the economic data will begin to miss to the downside as Brexit bites? Sterling weakness tend to lead to FTSE 100 outperformance and this could be a them to watch going forward.
  • There is not much economic data of note this week, with Chinese trade balance on Friday a factor for risk appetite.
  • Watch for: Brexit vote, Trump (as ever) and China Trade Balance

 

MARKETS

EUR/USD – A break below $1.0577 re-opens the lows again

  • Political risk is driving interest differentials (i.e. French OAT yields moving higher and is now the highest spread with the Bund since September 2012) and is a drag on the euro near term. The French election begins in late March and this could remain a drag on the euro
  • Support at $1.0577 to $1.0617 has been key but with the recent uptrend broken this now opens support again. A breach would be a key bear move.
  • Watch for: French yields, Trump rhetoric

GBP/USD – Outlook is deteriorating within the range low once more back in focus

  • Sterling is pulling lower with concerns over Brexit impact on UK economy.
  • Breaking below $1.2430 is a key move and opens $1.2250 but if that failed then the low at $1.1980 is under pressure. Near to medium term deterioration in momentum indicators points towards a correction.
  • Watch for: Parliamentary Brexit vote, Trump rhetoric.

USD/JPY – Safe haven flow is pulling the pair lower

  • Although the BoJ is trying to keep JGB yields low with its bond purchases within its yield curve control program, the moves on the dollar could be a driving factor lower. If Treasury yields continue to fall this could also play into the move lower.
  • A breakdown below 112.50 implies 310 pips and rallies are now seen as a change to sell.
  • Watch for: Moves on Treasury yields, Trump

Gold – Corrections to $1215/$1225 are a chance to buy   

  • The safe haven appeal of gold is helping to support demand, whilst any dollar weakness would also be a key driver .
  • The breakout above $1220 has opened $1241/$1250. A trend higher comes in $1215/$1225 breakout and corrective moves are a chance to buy.
  • Watch for: Moves on Treasury yields, Trump

Oil – Compliance with OPEC deal is key for support of the recent range plays

  • The OPEC production deal needs to be complied to in order to hold recent support. With Russia playing ball, this is a positive, however will US supplies begin to ramp up instead to pick up the slack? This would put the brakes on a rally.
  • Both WTI and Brent Crude are in $5 ranges and show little appetite for a breakout. WTI: $50/$55.25; with Brent Crude $53/$58.35
  • Watch for: News on OPEC production levels, EIA Oil Inventories

Indices – S&P 500 is an outperformer, with the DAX struggling    

  • S&P 500 – A positive earnings season has been tempered by Trump’s protectionist rhetoric, however with so many companies citing dollar strength as a concern, will any weakness n the dollar now be supportive? The Fed seeming having a March hike off the table is also supportive. Support at 2267 and 2254 with 2234 now key.
  • DAX Xetra – With the breach of 11,535 is the DAX at risk of topping out? The momentum indicators are corrective and the resistance at 11,700 is building. The key support is 11,400/11,425.
  • FTSE 100 – With sterling again starting to come off, the FTSE 100 is again performing well. Holding on to a breakout at 7205 is key near term in a move that has momentum indicators now beginning to pick up in strong confirmation.

 

WATCH OUT FOR THIS WEEK

Tuesday 7th February

  • US – Trade Balance
  • US – JOLTS jobs openings

Wednesday 8th February

  • US – EIA Crude Oil Inventories
  • New Zealand – RBNZ monetary policy

Thursday 9th February

  • US – Weekly Jobless Claims

Friday 10th February

  • China – Trade Balance
  • UK – Industrial Production
  • US – Michigan Sentiment (prelim)

 

NEXT WEEK

Tuesday 14th February

  • China – CPI & PPI
  • UK – CPI
  • Eurozone – German ZEW Economic Sentiment
  • Eurozone – Flash GDP
  • US – Fed chair Yellen speaking before Congress

Wednesday 15th February

  • UK – Unemployment and Average Weekly Earnings
  • US – CPI
  • US – Retail Sales
  • US – Empire State Manufacturing
  • US – EIA Crude Oil Inventories

Thursday 16th February

  • Australia – Unemployment
  • US – Building Permits & Housing Starts
  • US – Philly Fed Manufacturing

Friday 17th February

  • UK – Retail Sales

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