What currency wars? Dollar Breaks Support
By Ric Spooner, Chief Market Analyst CMC Markets Australia
On one level the currency wars are an attempt by other central banks to import some much needed growth from the US. The flip side is that a strong Dollar is importing economic weakness and low inflation into the US economy from elsewhere.
Markets are coming progressively to the view that signs of slowing growth in the US economy have got to the stage of delaying Fed rate increases. This saw the US Dollar Index break chart support this week in what could be a significant move.
2016 has been a volatile year for markets so far. For foreign exchange markets, this had mainly been about moves in other currencies. The Yen weakened after Bank of Japan introduced negative rates; the Pound reversed on changing views about the UK economy and commodity currencies have been buffeted by large moves in the oil price. Until Wednesday, there had not been a clear directional move in $US itself.
If this Dollar decline can extend, it will continue to impact other markets. Among other things such a move might be very handy for the People’s Bank of China. It would help depreciate the Yuan via its loose peg to the $US.
Wednesday night’s fall in the US Dollar was triggered by further weakness in the Markit Services PMI. While still showing expansion, this indicator which covers the crucial US services sector has been trending down for some months. The January reading of 53.2 was down from 56.1 in August. Worryingly, slower growth in new orders for service businesses was the biggest negative in January.
In a sense, this figure was the “straw that broke the camel’s back” as far as Dollar support was concerned. The table below shows a snapshot of US economic statistics that provides a window into patchiness in the overall economy
Source: Bloomberg; CMC Markets
From this we can see:
The strong dollar; falling capital expenditure on oil and weak global demand have all been taking a toll on US manufacturing. Warm weather in December may have disrupted utilities production. However, the overall trend is weak and getting weaker for Industrial production; and the manufacturing PMI’s. Trend growth in durable goods orders has improved a little but remains very weak.
Growth in personal spending which is the main engine room of the US economy has softened recently. Wage growth remains subdued and consumers have become cautious mode. The savings rate is back up to 5.5% after getting as low as 4.5% in late 2014. Consumers appear to be saving the benefits of lower fuel and energy costs.
Housing construction is holding up well. The improving jobs market; low interest rates and population growth are ongoing tailwinds
The Non-Manufacturing PMI accounts for 90% of the economy. Although softening a little, the trend had been holding up well indicating solid conditions in construction, health and domestic retail. The concern is that the weaker services PMI is pointing to further softening.
Through all this, job growth continues to be good and this is the bottom line for the Fed
In summary manufacturing is weak and growth in consumer spending has been sluggish. The concern is that weakening growth in services could see all this flow through to a softer job market. As usual, market is going to be very focussed on these numbers, especially tonight’s jobs data.
US Dollar Index Chart
This index tracks the US Dollar against a basket of 6 currencies. The Euro has the biggest weighting and currently makes up 58% of the index. The Yen, Pound and Canadian Dollar make up most of the rest; accounting for 35%
In the big picture, this index has traded within a broad sideways range since March last year. It neatly respected the top of the range when it peaked in December. Having done that, typical trading range behaviour could see it return to the bottom of the range, around 3% below current levels.
The break below short term support sees the Index back in the vicinity of the 200 day moving average and an AB = CD level. It’s possible this could provide support. A good Non-Farm Payroll number might do the trick.
That said, there is plenty of downward momentum at the moment. The last 2 days have produced large red candles. Unless the index starts to reject this support it’s a falling knife that may not want to try and catch. A clear move below current support the Dollar could see it on track for a test of the major support. In that scenario a break below the major support is by no means out of the question.
At this stage, near term rallies are probably best viewed as minor corrections in the big picture. That would only change if the Dollar Index can get above its March and December 2015 highs.