Stocks sold off sharply on Tuesday with the Dow Jones Industrial Average dropping more than 1% and the NASDAQ losing 2%. As this was the biggest one day decline since February, it should have coincided with big moves in currencies. There was some action around the NY open but by the end of the day, most of the major currency pairs stabilized and recovered prior losses. USD/JPY for example settled above 108.60 after trading as low as 108.34. EUR/USD settled around 1.2150 after trading down to 1.2123. The slide in stocks should have kept Yen crosses at the day’s lows and prevented any meaningful gains in euro. However none of these were big moves, there’s no panic in the market and no flight to safety in currencies. The rise at Treasury yields confirms the relative calmness in other markets.
Stocks are overbought and due for a correction. Concerns for inflation kicked off the decline but fundamentally, growth in the U.S. economy and the global economy are accelerating with plenty of room for stronger recoveries. We are just beginning to see good data out of the Eurozone with the German ZEW survey rising sharply in May. Business sentiment in the U.S. is up, job ads are up and there’s a reasonable chance for an upside surprise in Friday’s U.S. retail sales report. Policymakers around the world are upgrading their economic forecasts including Fed President Harker who now sees the economy expanding 7% in 2021 from a previous forecast of 5 to 6%. Central banks will make these brighter outlooks official when they meet in June even if they refrain from reducing asset purchases immediately.
While forex traders looked past the sell-off in stocks to the summer recovery, high beta currencies are still at risk for profit taking if the selling continues. For now, the U.S. dollar traded lower against all of the major currencies except for the Swiss Franc. The U.S.’ consumer price index is scheduled for release on Wednesday. Economists are looking for CPI growth to slow but on an annualized basis a sharp increase is anticipated. The Federal Reserve cautioned on many occasions that the increase in inflation is temporary but with stocks correcting on inflation fears, a stronger than expected increase could accelerate selling.
Sterling continues to be the best performer with GBP/USD closing in on 1.5 year highs. Wednesday is a busy day for the U.K. with Q1 GDP, industrial production and the trade balance due for release. Healthy numbers are expected all around as widespread vaccinations and relaxed restrictions allow the recovery to gain traction. The Australian and Canadian dollar continue to outperform with oil prices supporting CAD.
In the weeks ahead, monetary policy divergence should play a bigger role in currency flows. This means the currencies of countries whose central banks are more eager to reduce stimulus will outperform whereas the currencies of countries who will lag behind will underperform. This can pave the way for stronger moves in crosses such as EURGBP to the downside, EURAUD and EURCAD to the upside.
Kathy Lien Managing Director of FX Strategy BK Asset Management