Great Unwind-‘Long’ Dollar Positions Recalibrate

The mighty dollar has been the darling of the forex market for 18-months now, mostly on rate differentials. But has the Fed got it right?

So far this year, and after the first Fed rate hike in nine-years last December, the U.S fixed income market continues to price in a Fed policy error. Dealers see one, maybe two Fed rate hikes, and not the four that U.S policy makers are leading the market to believe. Weak U.S data is key, as the U.S is being considered the consumer of last resort.

The USD has come under immense pressure this week, down just under -2% against its major counterparties in Wednesday trading alone. The unwinding of ‘long’ dollar positions ahead of Friday’s non-farm payroll (NFP) is giving some significant support to GBP, AUD, NZD and CAD, but to varying degrees.

This coupled with some relatively upbeat U.K data this week has sterling printing three-week outright highs (£1.4655). Wednesday’s stronger than expected UK services PMI is currently sparking talk that the market is overpricing Bank of England (BoE) rate cut risks.

Sterling (£1.4650) has been supported by some upbeat economic data; Aussie (A$0.7225) is finding some rate differential appeal, the Kiwi (N$0.6712) seems to have dismissed this weeks disappointing GTD price action and jumped as New Zealand jobless rate tumbles (-0.9% to +5.3%), while Canada’s loonie (C$1.3683) remains handcuffed to the price of a barrel of crude and some M&A activity interest south of the 49th parallel.

Oil price volatility and concerns over global economic growth continues to be the most dominant of market focus. U.S data this week (ISM and Markit services ISM data has undershot expectations) is raising real fears the economic slowdown is spreading. The Feds normalization rate path is becoming more complicated by the actions of other central banks (ECB’s and BoJ NIRP) and this alone will lend support to currencies whose economies show some or any traction.

Wednesday’s massive USD unwinding has seen GBP (old resistance – £1.4450-1.45), AUD (A$0.7050-0.7100), NZD (N$0.6550) and CAD (C$1.3900) blow right through key resistance levels.

Not making it any easier for investors is that February is an “air pocket” for central bankers.

Investors will have to go it alone this month. Despite February being the shortest calendar month of the year it could feel a rather long one with no directional guide from any of the major central bankers (the BoE do meet this Thursday morning).

The next five weeks lacks a single scheduled opportunity for the Fed, ECB or Bank of Japan to reset monetary policy. Yen is now stronger than when Governor Kuroda introduced his NIRP last Friday. With the lack of direction, investors could be exposed to even more volatile moves especially if there is any further slide in commodities and evidence supporting China’s economic slowdown-data already this week indicates that China’s manufacturing remains in contraction.

Friday’s non-farm payroll (NFP) number will be big, not the number itself (consensus is looking for +180k print), but the significance and impact that it could have on the market.

A weak number will encourage further unwinding of the 18-month one directional “long” dollar trade. Now that significant resistance levels have been broken for sterling and its commonwealth counterparties, there remains room for a further “long” dollar squeeze across the board short-term, at least until investors can get some central bank monetary guidance.

For the pound, at £1.4810 sees some interest to sell GBP. Despite Australia’s strong trade ties with China, and the RBA’s efforts in talking its own currency value down, the AUD has an outside potential of revisiting the A$0.7300 handle. It certainly feels a stretch, but with some of the moves that the forex market has seen thus far in 2016, and especially so this week, any further U.S negativity, the market will quickly gravitate towards such levels.

For the other two commodity sensitive currency pairs, NZD and CAD, both again will be relying heavily on dairy and oil prices respectively. The loonie has been instep, high correlated, with the price of crude. If one believes crude has found a temporary bottom ($30/bl), this will only benefit CAD. Through C$1.3850 there is some significant market interest to want to own U.S dollars on pullbacks near C$1.3650. However, if oil fails to find any traction then the CAD will easily give up some of the recent significant gains. For many, at N$0.6780 looks considerably toppish for the Kiwi dollar. But with the breath and depth of some of the currency moves this week it’s been near impossible to make a USD stand without feeling wrong.

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