It may not be long before we see more significant profit-taking in equities and currencies. The signs are there – stocks hover near record highs but are struggling to extend their gains. Equities consolidated for the fifth straight day, but currencies and Treasury yields are beginning to sell-off. In fact, the decline in the euro and Japanese Yen crosses at the beginning of the week could foreshadow a deeper pullback in stocks. We’re not looking for a 5% correction, but with the Dow Jones Industrial Average hitting a record high almost every day since November, a pullback is long overdue.
President-elect Joe Biden is expected to share his long-awaited stimulus plan on Thursday, and it could be trillions of dollars. There’s no doubt that it will include funds to speed up vaccine distribution, funding for unemployment insurance will increase, larger direct payments, extension to the eviction moratorium and more government aid. The bigger the stimulus package, the stronger FX risk rally. However, another sizable check for households may not be easy to pass, so an initial rally could also fade quickly. If Biden opts for a smaller package that is easier to pass, stocks could sell-off in disappointment. Currencies take their cue from equities, so a sell-off in stocks will drive yen and Swiss crosses lower.
Concerns about violence on inauguration day and worries about Biden’s new policies would also be reasons for profit-taking in equities, but both effects will be short-lived. Senator Mitch McConnell said he will not bring the Senate back early, which means the impeachment of President Donald Trump will be left until he leaves office. So, at minimum, that uncertainty won’t be an issue for stocks.
Consumer prices in the U.S. rose 0.4% in the month of December. The monthly increase was in line with expectations, but the year-over-year rate was slightly higher at 1.4%. Rising inflation is one of the main concerns this year and fuelled quite a bit of speculation about earlier Fed tapering. As we noted in yesterday’s piece}}, it is far too early to talk about tapering, but this is one of the main reasons why the {{942611|U.S. dollar is trading higher against all of the of the major currencies.
EUR/USD spent its third straight day below the 20-day SMA. If it breaks below 1.2130, we could see a swift decline to the Dec. 9 low of 1.2060. Aside from stricter restrictions in Germany and the government’s warning that lockdown restrictions could remain in place for another eight to 10 weeks, ECB President Christine Lagarde said they are monitoring exchange rate movements very closely. ECB member François Villeroy was more specific, saying they are watching the negative effects. With restrictions expected to remain throughout January and February in the Eurozone’s biggest economy, it is hard to see EUR/USD hovering near 2.5-year highs for much longer. We continue to look for a near-term correction that should take the pair to 1.20.
The Australian and New Zealand dollars extended their losses as China slammed Australia for politicizing an M&A deal on national security grounds. New coronavirus cases in China also hit a five-month high, raising concerns that the virus is resurfacing in the region. The Canadian dollar saw modest losses thanks, in part, to stronger inflation data.