Fed-fueled momentum to keep dollar higher

Report prepared by Ahmed Shibley

What a week for the US Dollar. The outlook that the Federal Reserve pushed the US Dollar within a handful of ticks from the 2015 high. The US Dollar is set to end the week higher against all G10 currencies except the New Zealand Dollar, which is currently the strongest currency within the G10 on the week. The big surprise from the Federal Reserve on December 16th was not the rate hike, but rather the view that the Fed could hike four times in 2016. Should this happen, an increasingly large divergence between the United States and other economies would continue to emerge, which would likely push the US Dollar even higher. As we’ve seen in USDCAD, even if a currency looks to be “topping,” that “final” move can result in a strong move that wipes out traders fighting the trend.

For now, the clean support on the US Dollar remains the 100-DMA at 12,040. While tactical/ short-term traders may find opportunities selling the US Dollar above the 100-dma, the strength of the US Dollar along with stable yields and weakness elsewhere make the higher probability move higher. Conservative or patient traders who want confirmation of a move higher before jumping in the trade may want to wait for a break above the post-Fed higher near 12,204/6. 12,204/6 combines the closing high of the extreme day high for US Dollar in 2015 on November 6th and Wednesday’s Bull Run high. Traders that are more attracted to a good risk: reward may prefer to enter now with targets beyond the current 2016 high at 12,219, and a stop below the pre-Fed low of 12,040.

Supporting markets could continue to provide a base under the US Dollar. The easiest market to point to be US 2Yr. Yields, which broke above 1% for the first time since 2011 on the Fed’s announcement this week. However, given the larger pattern of a multi-year bullish falling wedge for yields, we could target a return to the start of the pattern near 1.40%. Given the strong divergence we’ve already seen from the spread of US short-term yields to other major countries, the strong dollar/ pain trade could well continue into 2016. We may see January, which is seasonally bullish the US Dollar, bring more pain to US Dollar shorts.

The Canadian Dollar is definitively the weakest currency within the G10 as pressures mount on the Bank of Canada to potentially ease again. Oil is causing further pressure on the economy and another January rate hike may be in the cards should the price of Oil, which the Canadian economy relies heavily upon, fall below the 2008 intraday low of $32.40. That fear, along with the market’s favor of the US Dollar after Wednesday’s FOMC decision to raise rates and project four hikes in 2016 cased The Canadian dollar to fall to C$1.40 per US Dollar for the first time since 2004.

in Canada has been rather steady even though economists’ expectations proved too optimistic on Friday. Canada CPI rose to 1.4% Y/y in Nov. vs. Est. 1.5%. Aside from the CPI data,

Wholesale Sales fell 0.6% m/m vs. est. 0.1%. Both the CPI & Wholesales trade data miss pushed USD/ CAD to 1.4001, was also 2004 high. Next week, data schedule will be expectedly light. We have Retail Sales & GDP on Monday. GDP looks to improve from the September print of -0.5% to market expectations of +0.2%,

retail sales look similarly for improvement from the September read of -0.5% to +0.5%. A miss on these data points, GDP, could continue to put further downward pressure on the Canadian Dollar.

The government bond market is also worth focusing on when looking at the value of the Canadian Dollar. In short, the spread between two-year government yields in US & Canada continue to widen. There has been a significantly positive correlation historically between widening government yield spreads, and strong currency pair moves and USDCAD toward 1.4001 is no exception. The current spread displayed below is ~-48bps. You would get the spread if you were to buy the Canadian 2yr Government Notes, and sell United States 2yr Notes and take the difference between the two yields. In this example, the US spread is +48 bps. Should the spread continue to widen, the CAD could continue to weaken. Unfortunately, we’ve seen traders fight this move aggressively per our Trading Sentiment Tool, SSI. This fight has been costly, but the message here is that strong moves with multiple forces should not be fought. The onshore yuan exchange rate (USD/CNY) ended 10-days of declines before it closed at 6.4800 on Friday. The offshore yuan rate (USD/CNH) fell for 0.4% during the Fed-rate-hike week less significant compared to the 1.3% loss one week ahead. One on hand, the Fed’s decision has already been priced-in to the yuan pairs before the official announcement, similar as to other dollar pairs. On the other hand, China’s central bank was closely managing yuan’s volatility through the mid-point rate and trading band. Looking forward, as the big decision is over and the US and European markets enter the holiday season, for the yuan, it will have some time to take a breath for corrections; the domestic policies will be key drivers.

Chinese regulators published new rules to loosen capital outflows last Thursday. State Administration of Foreign Exchange now gives more freedom to business in Shanghai’s free trade zone on foreign exchange settlement. That means it is easier for them to take out non-yuan funds out of China under current half-controlled regulation system. Remember, the new rules come out at a time that China’s foreign reserves are declining and more capital tends to flow out to US for a higher return. Thus, it is a strong signal that China is not turning back from opening up its capital markets. This is good news for the traders because yuan’s rate formation regime will become more market driven.

In addition to loosened controls, China’s central bank continues to promote the cross-border use of yuan. In the past three days, PBOC approved new quota for investors from two new countries to purchase yuan-denominated assets in China and signed deals with three new countries regarding yuan settlement in trade. Also, in the coming week, Korean will issue yuan-denominated bonds in China’s domestic bond market. It will be the first time that a foreign government issues sovereign bonds in China. If we say yuan joining SDR has more symbolic meaning, all the above actions China did leads to more real effects, to make yuan one step closer to serve as an international currency. For traders and investors, it means that more yuan-denominated products will be available and they will also have more access to participate in yuan’s trading through the increasing onshore and offshore centers. In summary, the yuan trading in the next week is expected to be less active under a quite global environment. But at this resting period, traders will want to keep an eye on the development of yuan policies in China, as it will pave the way for the yuan to become a real global currency.

Gold prices are down for the second consecutive week with the precious metal off by 0.84% to trade at 1065 ahead of the New York close on Friday. A historic week saw the Federal Reserve move to the raise the benchmark interest rate for the first time since 2006, fueling a rally in the USDOLLAR which tested the 2015 close high on the heels of the release. Gold saw the largest single day drop in five months on Thursday but pared a bulk of the declines into the close of the week.

The FOMC’s decision to hike rates marks the end of the seven-year zero interest rate policy (ZIRP) and the beginning of the central bank’s normalizations cycle. Rising interest rates increase the holding costs for gold, which does not pay a dividend, and as such is likely to keep the metal under pressure. With that in mind, markets have already been pricing in this hike and moving forward the focus will be on both the timing & scope of future rate hikes. For gold, this alleviates some of the immediate bearishness heading into the start of the 2016 calendar year. Looking to the week ahead, traders will be closely eyeing the third and final read on 3Q GDP with consensus estimates calling for a downward revision to an annualized 1.9%, down from the previous 2.1% print. With the FOMC continuing to suggest that the committee remains ‘data dependent’, look for US economic data to drive price action in gold as investors adjust interest rate expectations. We’ll also be closely eyeing the greenback after the U.S. Dollar Index failed to breach the 2015 high-day close at 12204.

From a technical standpoint, gold completed a 100% extension from the decline off the monthly high at 1047 before reversing sharply on Friday. Ongoing momentum divergence on both daily & weekly timeframes suggests that prices may be at risk for a near-term correction higher while above this region. Prices have continued to hold within confines of the December opening range (1046-1088) and we’ll be looking for a break of this region heading into next week. A breach targets key resistance & near-term bearish invalidation at 10981101. A move sub-1047 keeps the shortside bias in focus targeting more significant support at the 975/80 Fibonacci confluence. Bottom line: look for a break of the monthly opening range to offer guidance on our near-term directional bias with broader outlook weighted to the downside sub-1101.

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