Dollar Ends Strong Month — Possible Correction Ahead

01/10/2017 08:36 AST

By all counts September was a strong month for the U.S. dollar. The greenback appreciated more than 2% against the Japanese yen, over 1% versus the Swiss franc and Australian dollar and about the same amount against the euro. The only currency that saw meaningful gains against the dollar was sterling, which caught a strong bid after the Bank of England turned hawkish this month. But as we look ahead to October, the greenback’s momentum is fading and the odds of a correction outweigh the chance of continuation. Part of this has to do with the outlook for U.S. data and part has to do with the prospect of other central banks tightening policy over the next 2 months. We’ll dissect each of these in future detail but we fear October will not be as kind to the greenback.

For the U.S. dollar, October is when we will begin to see the negative impact of hurricanes Harvey and Irma on the U.S. economy. Everyone from economists to Federal Reserve officials have warned that data will be distorted temporarily but based on the performance of the dollar and U.S. stocks, investors may not be prepared for the extent of potential weakness in these reports. Yes, the data will recover the following month but nonfarm payrolls are due for release in the coming week and economists are only looking for payrolls to rise by 75K, which would be the weakest pace of growth in 6 months. This follows a steady trend of slower job growth in July and August that questions the hawkishness of the Federal Reserve. When the Fed met in mid September, it made it clear that tightening will continue. Its dot-plot forecast showed a majority of policymakers favoring 1 more hike in 2017 followed by 3 hikes in 2018. However a number of the Federal Reserve officials who spoke this past week did not sound as enthusiastic about raising interest rates and data, including the latest personal income, spending and PCE deflators were softer. We’ll hear from more Fed Presidents in the coming week and perhaps their views will be different. Yet even Yellen’s hawkish comments failed to lift the currency. Part of the problem is that while the Fed plans to raise interest rates, the market doesn’t expect it to do so until December — and a lot can change between now and then. U.S. data may not recover as strongly or it may, but either way there’s plenty of time for investors to position for hike as December nears. For now the focus will be on the prospect of softer data and the promise of tighter policy in Europe, which is negative for USD/JPY and USD/CHF and positive for EUR/USD and GBP/USD.

One of our favorite currencies in the weeks ahead is the euro. On a fundamental basis the outlook for the Eurozone is positive. According to the most recent economic reports, inflation and retail sales activity improved in Germany, the Eurozone’s largest economy. The uptick in activity hardens the central bank’s resolve to normalize monetary policy in October. ECB President Mario Draghi made it clear this past week that the bulk of QE decisions will be made in this month. Although he also added that they have to be sensitive about not halting the recovery and careful about hasty moves, if data continues to improve, their announcement to taper will be accompanied by plans for more changes in the coming months. The week started with election uncertainty but the euro has finally stabilized as investors realize that at the end of the day, Angela Merkel will still be leading the country. It won’t be long before a coalition government is formed and EUR/USD traders could celebrate the announcement by driving the currency higher on the elimination of election uncertainty. Technically, EUR/USD found support this past week right at 1.1720. This level is significant and a prime place for a bottom as it is where the 200-week SMA converges with the 23.6% Fibonacci retracement of the 2008 to 2016 sell-off as well as the 38.2% Fib retracement of the 2014 to 2016 decline. No major Eurozone economic

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