Dollar gains most in 15 mths as mkts eye US data
The US Dollar scored its best week in 15 months as the aftermath of January’s explosive labor-market data continued to play out. That report showed that wage inflation surged to an 8-year high of 2.9 percent. That stoked speculation about an unexpectedly aggressive Fed tightening cycle, sending the greenback higher and punishing risky assets that had been buoyed by nearly a decade of ultraloose monetary policy.
Equity markets offered the most obvious display of weakness. The MSCI World Stock index shed 5.75 percent, the most in over two years. Close to 80 percent of all monetary transactions involve the US Dollar, so when the Fed pushes up the cost of borrowing in the benchmark currency, it makes credit broadly more expensive on a global scale.
The week ahead is likely to see this narrative remain at the forefront as the spotlight turns to January’s US CPI report. It is expected to show that headline and core inflation rates ticked down last month. An upside surprise echoing the jump in wage costs seems likely to offer the greenback a further lift, all the while triggering another bout of violent selling across stock exchanges the rest of the risky asset spectrum.
The likelihood of such an outcome seems significant. Survey data from Markit Economics pointed to the continued acceleration in services-sector inflation in January, putting its pace above the trend average. Services account for close to 80 percent of the overall economy, so a slight downtick in still-elevated manufacturing-sector price growth is probably not enough of an offset.
Elsewhere on the docket, retail sales statistics and the University of Michigan consumer confidence gauge are due to cross the wires. These are probably not potent enough to have stand-alone impact on par with the CPI release however. Cleveland Fed President Loretta Mester is also scheduled to speak on the outlook for the economy and monetary policy. Her hawkish lean is well established, so a surprise seems unlikely.
The Euro has been a freight train for much of the time since last year’s open, constantly chugging-higher even in light of bearish drivers. Since setting a 14year low on just the second trading day of last year, bulls took over and have largely been in-control ever since. This happened while the European Central Bank was seemingly talking the currency-lower throughout 2017, continually saying that they weren’t quite ready to begin plotting for the end of QE. Nevertheless, markets continued to anticipate some inevitable move off of uber-loose monetary policy, and in January we finally heard some recognition from the ECB on the matter.
But, in a bizarre twist of events, that warning, which should be a Euro-positive given the potential for stronger rates in the economy, may actually be helping to bring some weakness into the single currency. We have yet to test the highs that came in on the morning of ECB, and since then we’ve seen a build of lower-highs coupled with fresh lower-lows; giving the price action appearance of a deeper short-side move. The relationship here would be one of global implications, where the European Central Bank starting to pull back on stimulus creates a bit of fear in risk markets around the world as we have another major Central Bank moving towards tighter policy. This has brought upon higher yields in US Treasuries, and those higher yields are creating fears around elevated valuations in the equity space. The ECB would join the Fed in their path of tightening policy, leaving only the Bank of Japan amongst the major Central Banks actively pushing QE into global markets without some type of taper or wind-down planned.
For risk markets, this implication can be big as the backdrop for corporates in the United States and Europe gets less friendly and a bit more unforgiving with higher rates and tighter policy. The relationship between Central Banks pulling back liquidity and tightening policy should not be dismissed as a negative for global equities that have ridden Central Bank easy-money policies for more than eight years to fresh all-time-highs.
We have been reasonably positive on Sterling’s fortunes in the past few weeks but change our stance to neutral now, despite the latest Bank of England commentary that UK interest rates will rise ‘somewhat earlier and to a greater extent’ than previously anticipated. The first rate hike of 2018 has been pushed forward to May with some of the more hawkish commentators now predicting two hikes this year, May and November.
With the path of UK monetary policy now slightly more evident, the short-term direction of GBP should be clear but the ongoing post-Brexit trade discussions have reared their head again, and like the first round of negotiations, these look likely to become more entrenched and acrimonious ahead of the European Council Summit on March 22-23. It was hoped by this date that the EU and the UK would have agreed a transition deal that would allow trade negotiations to begin in earnest. However the latest commentary from EU Brexit negotiator Michel Barnier seems to highlight that both sides are sticking with their ‘red lines’ with Barnier warning that a transition deal is ‘not a given’ unless the UK agrees to the EU rulebook.
GBP/USD has trimmed its recent gains after the US dollar came back into fashion after a weak first month of 2018. A Bank of England ‘bounce’ on Thursday was quickly reversed when Barnier’s Brexit headlines hit the screens on Friday. Initial support lies between the current 50-day EMA at 1.37830 and the Jan12-15 high/low cluster around 1.37350 while upside moves should find resistance at 1.3850 ahead of 1.4000.
This sell-off is not like other selloffs we’ve recently seen, and the reason is simple. Underlying global demand is as strong as it has been in at least eight years. Data from China General Administration of Customs showed that China’s oil imports in January were the most in the world since 2010, and that’s putting institutions and individuals that are long crude oil in a difficult spot.
The surge in volatility across multiple asset classes means that assets with strong fundamentals are being sold. The selling takes place either to free up liquidity or due to algorithms that look for sell-offs in correlated assets as a heads up to get out while the getting’ is good.
However, if you look to other markets like bonds and equities, commodities like crude oil are likely the envy and seem to be supportive of the price rise since mid-2017. While production in the US is aggressively high, it’s being met with similar demand, which could mean that the weakness in assets could be shortest-lived in crude oil.
Options data is showing only mild bearish exposure building, with WTI puts toward March $60-57. However, longer-dated Brent calls continue to focus on a move to and through $70, and up to $80 by mid-year.
The overall message being here that the drop in the price of oil is likely more collateral damage to the global risk-off move as opposed to the historical reason of oil weakness that was driven by obscene over-supply relative to demand.
Recently, the price of WTI Crude (US oil) broke below the 55 (Fibonacci sequence)-DMA at $60.90/bbl. However, given the aggressive rise since August from $45.62/bbl, traders should note that a healthy technical pullback of 38.2% of the impulsive move would still take the price of Crude to $58.60/bbl. A move to this level would also have the price sitting in the Ichimoku Cloud (bullish price support), as well as the price zone of the prior correction.
A break below the 50% level of the move from August to late-January at $56.13 would begin to concern bulls (including me) as it could show that fundamentals are taking a backseat to aggressive selling mentioned early by institutions. It would not signal to me that the trend is over, but rather, we’d have to likely wait longer before its resumptions.
Gold prices are fell for the second consecutive week with the precious metal off by more than 1.5% to trade at 1312 ahead of the New York close on Friday. The losses come amid a tumultuous week in equity markets with all three major US stock indices trading lower by nearly 8%. The total declines off the January record highs takes us into correction territory with the indices now trading lower yearto-date. For gold, the panic offered little support with bullion continuing to target the 2018 open just lower.
Headlines continue to be dominated by speculation that last Friday’s strong Non-Farm Payrolls figures (specifically wage growth) have spooked market participants over fears of rising inflation which could stoke the Federal Reserve to tighten
at a faster pace. Gold is caught in a tug-of-war from a fundamental standpoint. An increase in inflation expectations would typically be supportive but the focus on how this may impact the path for monetary policy continues to outweigh sentiment.
Continued strength in the U.S. Dollar has also weighed on Gold prices with the DXY building on last week’s reversal with a 1.6% rally. Next week traders will be closely eyeing more inflation data with the release of the January U.S. Consumer Price Index (CPI) and Retail Sales on tap for Wednesday. From a technical standpoint, there’s a little more room for further losses near-term, but we’re generally on the lookout for a near-term low heading deeper into February trade.