4 Reasons for the Dollar Collapse

The U.S. dollar traded lower against all of the major currencies today with the steepest losses seen against the euro, Canadian and New Zealand dollars. Each of these currencies rose over 1% versus the greenback on a day devoid of any Tier 1 U.S. economic reports. Instead the dollar’s collapse was driven by 4 main factors – a surge in oil prices, concerns about U.S. data, comments from Fed President Kocherlakota and a short squeeze in non-dollar currencies – in that order. Over the past few months, falling oil prices have weighed heavily on market sentiment but over the past 48 hours, crude prices rose as much as 14%, shifting risk appetite in the process. The recovery in risk appetite, decline in oil prices and concerns that this week’s U.S. economic reports may not live up to expectations triggered profit taking on short EUR/USD, GBP/USD and long USD/CAD positions. Comments from Fed President Kocherlakota accelerated the dollar’s decline, causing it to spread to the AUD/USD and NZD/USD. At some point during the North American trading session, AUD/USD even turned positive for the day, erasing all of its post-RBA losses. Kocherlakota said the Fed should not raise rates in 2015, which would be important if he was a voting member of the FOMC this year but he is not. Nonetheless, his words pushed the dollar even higher, triggering stops in many major currency pairs in the process. By the end of the North American trading session, the dollar managed to bounce off its lows but still ended the day in negative territory against all of the major currencies. We expect bargain hunters to start swooping in to buy dollars at these levels especially after the sharp rise in 10 year Treasury yields. The focus will shift to the labor market on Wednesday with the release of ADP Employment Change and Non-Manufacturing ISM. If these reports surprise to the upside, dollar bulls will regain control but if the data is weak, we would recommend holding off on buying dollars until after Friday’s non-farm payrolls report.

Fade the EURO Rally?

New proposals from the Greek government to restructure the country’s debt sent the euro sharply higher against the U.S. dollar. Since the elections, investors have been worried about the new government’s resistance to cooperating with the Troika and their demands for partial debt forgiveness. Today’s “creative” proposal to exchange its current bonds for new growth-linked bonds and perpetual bonds for the ECB reflects their willingness to come up with a plan that is both palatable to their creditors and to the market. The first part is debatable as there’s talk that the ECB won’t accept a bond swap but investors are simply happy that progress is being made towards a resolution. We’ll still have to see how the German government and the ECB officially respond especially since the proposal includes a request for a 4-month bridge loan and the promise to provide Greece with favorable term liquidity. At the end of the day, we expect concessions to be made by Greece and its creditors but today’s proposal is a step in the right direction. With this in mind, many traders are wondering whether the EUR/USD rally should be faded and we continue to believe that the answer is yes. The uncertainty created by Greece is only part of the reason for the euro’s recent decline. Monetary policy divergence is still the main story. Even if Greece reaches a deal with the Troika to restructure its debt, it does not resolve the problem of low inflation and slow growth. The rally in EUR/USD could extend if this week’s US non-farm payrolls report surprises to the downside but we don’t expect the gains to last. The next resistance level in EUR/USD is the November 2005 low of 1.1640.

USD/CAD Crushed by Oil Recovery

What a day it has been for the commodity currencies! The big story of the night was the Reserve Bank of Australia’s rate cut but the big story of the day was the more than 8% intraday rebound in oil prices. In the past 48 hours alone, oil prices have risen over 14% and in the past 3 trading days, the price of WTI increased more than 20%. In reaction, USD/CAD dropped from a high of 1.2800 on Friday to a low of 1.2352 today. We are weary of the currency pair’s recovery because we expect this week’s economic reports to highlight the weakness in Canada’s economy. The decline in oil has taken a big toll on the economy and we are only beginning to see the impact on data. Tomorrow’s Canadian IVEY PMI report for example, could be exceptionally weak. Nonetheless we recognize that the bottom in oil prices has gone a long way in shifting sentiment and that cannot be underestimated. Meanwhile, it was remarkable how the Australian dollar recovered nearly all of its post RBA losses even though the central bank’s rate cut caught the market by surprise. Not only did the RBA cut interest rates by 25bp to a record low of 2.25% but their shift in bias suggests that more easing could be in the pipeline. The market had been pricing in 2 rate cuts by the RBA this year and cuts by the central bank are rarely one-off moves. The New Zealand dollar also benefitted from the decline in the dollar but its outperformance was driven primarily by the sharp 9% rise in dairy prices. This was the largest increase in prices since at least August. NZD/USD remains in play with New Zealand employment numbers scheduled for release this evening.

GBP: Boosted by Dollar Weakness and PMI

While the rally in the British pound could be easily attributed to the stronger than expected Construction PMI report, it was the sell-off in the U.S. dollar that took GBP/USD away from the 1.50 level. The PMI number helped to reverse an earlier decline in sterling but the rally did not gain momentum until the North American session. So far we have seen improvements in both the manufacturing and construction sectors but the most important release will be tomorrow’s PMI services index. If all 3 reports show stronger economic activity, talk of a 2015 rate hike will return. Regardless of whether the BoE chooses to tighten this year, these recent reports refute the need for easing which alone helps the BoE stand apart from all of the other central banks that have recently taken steps to increase stimulus. In terms of our outlook, this means we are looking for additional strength in GBP/AUD, GBP/CAD and a reversal in EUR/GBP.