Dollar Remains King

Despite their mixed fortunes, the equity class continues to reign supreme and dictate to both forex and most fixed income positions. Last week stateside, Investors managed to shift their attention to the increasing flow of earnings reports and found them mixed. A result that had equity prices ending the week where financials were hardest hit. This is in contrast to the Asia Pacific region, where most bourses are down for the first half of January. In Europe, equities have continued their last year’s climb and have been capable to shake off this year’s slow start, boosted by investor optimism over economic growth prospects in mainland Europe and the UK.

So far this morning, European markets have managed to open broadly lower in sympathy with Asian markets, which happened to sell off after confirmation of slowing Chinese growth (Q4 GDP +7.7%). The headline GDP print was a fraction ahead of forecasts, and certainly not enough to brighten the general mood of risk aversion. Other data released showed that industrial output grew an annual +9.7%; slightly below estimates while retail sales met expectations (+13.6%). With the US celebrating Martin Luther King Day, the forex market is expected to remain subdued, with liquidity again trading with a premium.

Now that China’s GDP growth has fallen to its slowest pace in 14-years last year, what’s next for the world’s second largest economy? For this year it seems that many are divided into two distinct camps: those who see a continued growth deceleration towards +7%, and those who expect a pickup to above +8%. The discrepancy comes from a number of factors; the biggest includes the extent to which reforms undertaken at the Third Plenum last November will impact their own domestic economic growth and the degree to which China will benefit from the pickup in global demand. No matter what, surprising data out of China will always bring market volatility and trading opportunities. This morning after the numbers, the Aussie managed to print a three and a half year low below $0.8760 before rebounding, while the Yen posted moderate gains and hit a 1-week dollar low below 103.90.

The mighty dollar starts this holiday shortened trading week sitting atop a two-month high, supported mostly by last weeks upbeat data having convinced investors that the Fed is to continue its gradual withdrawal of stimulus. It seems that the market is happy to buy into the theme that signs of an improving labor market (assuming last months NFP was a weather hindered anomaly) justifies further reductions in the Fed’s monthly bond purchases. Interest rate disparity favors a higher dollar, especially now that the ECB speaks a dulcet dovish tone. Later this week investors will get to see whether the BoC and BoJ get to change their respective monetary policies.

Governor Poloz at the BoC and his monetary policy has so far this year triggered a -6% decline in his own country’s currency against its largest trading partner the US. No one seems worried about the recent movement, apart from the CAD bulls, as long as the currency trades at “appropriate levels given the various economic realities.” Last October the BoC governor happened to remove their hawkish bias, a bias put in place by the previous Governor Carney 12-months prior. This has removed a market license to support the currency that has since printed a four-year low outright late last week.

For many analysts, shortening the CAD outright is considered one of the go-to trades for this calendar year. However, few expected the currency to have weakened so quickly so early this year. No matter, by mid-week the BoC is expected to put the loonie directly in the speculators crosshairs. The currency could come under further pressure if governor Poloz signals the need for lower interest rates by using rhetoric rather than action, an indirect approach to boost economic growth by devaluing the currency. Focusing on the downside risk to deflation and insisting that there is no housing bubble will again have the loonie on the back foot. The market remains a better buyer of USD on pullbacks.

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