US Dollar Extends Gains after Strong Business Investment Data but Strategists are Now Scoping Out a USD Reversal

-US durable goods orders fall -1.7%, but core orders rise 0.9%

-Reversion of aircraft orders to normal levels masks positive trend.

-But US Dollar has had its time in the sun, strategists eye reversal.

© RCP, Adobe Stock

The US Dollar rose broadly in the final session of the week as traders' appetite for risk faltered across the globe and markets responded to the latest volley of US economic data, which showed many categories of American business investment recovering strongly from a March slowdown.

US core durable goods orders, a measure of business investment which excludes large ticket items like aircraft from the data because of their distortive impact on underlying trends, rose by 0.9% during April according to Census Bureau data. This was a much faster increase than the 0.5% gain that economists had forecast. 

Meanwile, the measure of overall durable goods orders that includes aircraft orders and other transportation items fell by -1.7% during the recent month, which is down from the 2.6% growth seen back in March. Economists had forecast a lesser contraction of -1.3%.

"In a reversal of fortunes compared with the prior month, the volatile aircraft segment weighed on headline durable goods orders in April, but the detail was much more solid," says Andrew Grantham, an economist at CIBC Capital Markets. "The 3-month annualized rate of core capital orders firmed to 6.3% (strongest since November), in a sign that the underlying trend is improving again. That's a good sign for business investment, which we expect to support growth a little more going forward than it did in Q1 particularly given new tax incentives."

Markets care about the data not only because rising business investment can support economic growth and job creation in the here and now, but also because of the signal it sends about the corporate world's view of future US economic growth. Typically, companies will only commit to large orders of capital equipment where they expect economic conditions to facilitate a return on investment.

"The strong rise in underlying durable goods orders in April suggests that the slowdown in business equipment investment in the first quarter is being reversed in the second quarter, providing further evidence that economic growth is picking up," says Andrew Hunter, an economist at Capital Economics. "With industrial capacity utilisation at a three-year high and firms still benefiting from the recent tax cuts, business equipment investment should expand at a solid pace over the coming quarters."

Above: Pound-to-Dollar rate shown at daily intervals.

The US Dollar index was quoted 0.37% higher at 94.13 following the release Friday, after extending an earlier 0.17% gain from the morning session, while the USD/JPY rate was 0.11% higher at 109.44 after having fallen sharply on Thursday.

The Pound-to-Dollar rate was 0.32% lower at 1.3340 and the Euro-to-Dollar rate was 0.38% lower at 1.1677 after having fallen below the technically important 1.17 handle.

Above: Euro-to-Dollar rate shown at daily intervals.

Friday's data comes amid an eight week-long rally that has seen the US Dollar convert convert a 4% 2018 loss into a 1.7% gain. However, after reaching its highest level since late 2017 earlier this week, the Dollar index appears to have stalled around the 94 level and some strategists have observed that momentum behind the greenback is now waning.

"We think now is an opportune time to start fading the USD and we are short USDJPY. Risk sentiment appears fragile with renewed trade and geopolitical tensions. Treasury yields also appear poised to settle lower - at least for the time being," says Mark McCormick, North American head of FX strategy at TD Securities. 

Above: USD/JPY rate shown at hourly intervals.

Global Risk Appetite Dented by North Korea Setback

Risk appetites were dented in the latter half after the White House said it has cancelled a landmark summit between President Trump and North Korean leader Kim Jong-Un, citing "tremendous anger and open hostility" displayed by the regime in some of its most recent statements.

Both US and North Korean leaders were due to meet in Singapore on June 12 to discuss the winding down of North Korea's weapons programme in what was a landmark event for geopolitics and a diplomatic coup for President Donald Trump. But statements reported to have been made by the North Korean regime during recent days prompted the White House to think again.

June's now-cancelled summit had been seen as the White House's best chance of shuttering North Korea's nuclear weapons programme and dealing with its arsenal, which the hermit nation has repeatedly threatened to turn against the US, in a peaceful manner.

"We continue to see clear signs of a concerted effort now being under way at the Federal Reserve to emphasise to the financial markets that the FOMC sees little reason for changing guidance on monetary policy just because the 2.0% inflation goal is about to be achieved. We believe this will be important in limiting the upside for the dollar from here," says Lee Hardman, a currency analyst at MUFG.

The Fed's Gallic Shrug to the USD

Driving broader moves in exchange rates over the last eight weeks has been a sudden shift in global bond markets, which saw yields on American bonds of all tenures rise to multi-year highs which, pushing interest rate differentials favouring the Dollar to near record levels.

Multiple factors have been behind this shift, including an inflation-boosting rise in oil prices, superior levels of US economic growth and rising issuance of new bonds at the US Treasury in order to finance President Trump's budget-busting tax cuts.

Those more favourable yield differentials have seen international investors, particularly so called carry traders, incentivised to sell lower yielding currencies and buy the Dollar in order to invest in the US bond market. But increasingly, strategists are calling a top for bond yields and the US currency.

"We think EUR/USD may well be close to bottoming. One factor is FOMC caution from here. The minutes from the meeting on 2nd May, released on Wednesday, illustrates this caution. The word “symmetric” was cited 10 times in the minutes – in March (excluding the SEP portion) and in January, the word was mentioned just once," MUFG's Hardman adds.

Market hopes of a pickup in the pace at which the Federal Reserve raises interest rates have been an important contributing factor in recent bond and currency market price action. But the minutes of the latest monetary policy meeting, released Wednesday, place a question mark over whether any such pickup will ever be forthcoming.

Wednesday's minutes showed a majority of Federal Open Market Committee members agree another interest rate rise will be appropriate "soon". But they otherwise appeared to overlook the current level of US inflation, as well as the prospect of US consumer price growth continuing to exceed the Fed's 2% target in the months ahead, leaving the meeting record devoid of the hawkish tones that would have been necessary to ensure continued support for an extended Dollar rally.

"Overnight we saw further evidence of this with Atlanta Fed President Bostic (voter)stating that he was comfortable with sticking with three rate hikes in 2018 while Philadelphia Fed President Harker stated that he hadn’t moved far from his view of three rate hikes this year either," Hardman notes. "We maintain our view of two more rate increases this year."

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