DXY Slammed into Support, Yields Will Determine Next Move
- Even as DXY Index fell back into the former highs of the 2015-2016 range, US yields were able to maintain elevation.
- Further US Dollar weakness requires yields to break down, otherwise near-term selling may be done.
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The US Dollar had a tough day yesterday, with GBP/USD posting its best day since 2008, amid a combination of US President-elect Donald Trump talking down the 'strong dollar policy' and UK Prime Minister Theresa May's Brexit speech. Yet despite the US Dollar's near-term weakness, it finds itself having landed at an important support level in DXY, back to the former highs from the 2015-2016 range.
Absent in the move lower in DXY Index was a breakdown in US yields. In fact, both the US 2-year and 10-year yield have maintained their elevation at key support levels for the past week. From this point forward, if DXY Index is going to break back down into its 2015-2016, US yields will need to follow suit.
The data due out today is exactly the kind that will test the backbone of the US Dollar rally. The upcoming December US Consumer Price Index report is expected to see headline inflation tick higher to +2.1% from +1.7% (y/y), exceeding the Fed's medium-term target. A strong base effect from energy prices is the main reason why; the core reading is only expected to tick higher by +0.1% to +2.2% (y/y). Higher inflation necessitates higher interest rates; which given the context in which today's report is being released, the data has the chance to be profoundly important for the US Dollar and its yield backdrop.
Later on today, the Bank of Canada meets for the first time this year. With the BOC taking a neutral stance at its December meeting, some analysts were questioning whether or not policymakers were not dovish enough. However, after weeks of better than expected trade and investment data, as well as a sustained turn higher in energy prices since November, it now seems that the BOC’s more neutral tone is appropriate, and should be reflected as much in the policy statement.
While the BOC will likely speak poorly of the recent rise in short-term rates – a knock-on financial tightening effect thanks to the jump in US yields after the US elections in November – the BOC isn’t likely to take any substantive action. Concerns linger about energy-related investment, and labor market growth was anything but steady over the course of 2016. Governor Stephen Poloz’s conference should try to balance out what may be seen as a hawkish policy statement due to its optimism over near-term developments. Volatility, if not direction, should result for CAD-crosses. USD/CAD long against 1.3000 remains appealing given the risk-reward of near-term US Dollar selling being finished, assuming US yields don't breakdown further.
--- Written by Christopher Vecchio, Senior Currency Strategist
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