It is understandable. China’s move on Tuesday caught the market off-guard. After seemingly re-pegging the yuan to the dollar, it pushed it reset the yuan to the lower end of its 2% band and announced a new mechanism that seems still to be largely a “black box”, in the sense of lacking much transparency.
The US dollar posted gains against all the major currencies last week save the Australian and New Zealand dollars. The Reserve Bank of Australia appears to have moved to a more neutral stance on rates, relying on the currency to provide the necessary adjustment.
A strong July auto sales, a jump in the service sector ISM, and a jobs report that was consistent with recent trends helped the dollar’s gains. Over the course of the week, the September Fed funds futures contract priced in a greater risk of a September hike.
The unexpectedly record low increase in Q2 US Employment Cost Index unwound the some of the dollar’s weekly gains and neutralized the near-term technical outlook. Next week’s nonfarm payrolls are still critical, and the weakness may put even greater burden on the jobs data to demonstrate that slack is indeed being absorbed.
From a technical perspective, the US dollar looked vulnerable to start the week, but the 8.5% drop in Chinese shares in Shanghai provided additional fuel. The linkage between the two is that global headwinds may intensify and keep the Fed from raising rates in September. This seems like a premature judgment, but market pricing was never as convinced of a Fed hike than as surveys suggested.
The overextended technical condition of the dollar we highlighted previously came with a mixed performance last week. Against the top ten currencies, that dollar fell against five. The drop in oil prices and other commodity prices encouraged rate cut expectations in Australia and Canada, sending those currencies to new multi-year lows.
The US dollar rose against nearly all the major and emerging market currencies in the past week. The notable exception among the majors is sterling, where hawkish BOE comments and another rise in average earnings goaded the bulls. Among the emerging market currencies, only three rose against the greenback, South Africa rand, the Turkish lira, and the Chilean peso.
The Pacific developing member countries (DMCs) of the Asian Development Bank are a heterogeneous group of economies with different levels of economic development and economic size. However, when it comes to choosing an optimal exchange rate, the Pacific DMCs face similar challenges.
The US dollar has begun the new week on firm footing. It remains, though, largely in the ranges seen in the second half of last week. Sterling is the notable exception. Last week’s sharp downside momentum has continued, pushing the sterling to $1.52. The softer than expected manufacturing PMI gave the bears cover, even though it improved from 51.8 to 52.0, the market had expected a 52.5 reading.
The Peoples’ Bank of China (PBoC) has maintained a close relationship between the renminbi (RMB) and the US dollar since the RMB was first pegged in 1994. Twenty years on, after the PBoC has made the RMB somewhat more flexible, pegging it to a genuine broad trade-weighted basket would promote stability for China and its trading partners.
Sterling has fallen out of favor. It was the market’s darling, rallying from $1.4565 in mid-April to $1.5815 in mid-May. From a technical point of view, it was correcting the slide from last July’s test on $1.7200. The fundamental trigger for the correction was the weaker US dollar environment, which was partly spurred by disappointing Q1 data. The unexpected majority victory by the Tories also helped fuel sterling gains.
