FX News

FX Update, The USD Finds Ground

Market Overview:

US equity markets continued to fall on Friday, in-spite of the crucial Non-farm payrolls figure coming in above expectations. Wall Street had its worst week since June 2016 with the Dow Jones Industrial Average and the S&P both dropping over 4%. Both the Dow and S&P500 were sharply lower, over 2.5% and 2.12% as the worsening bond rout heightened concerns that the Federal Reserve will accelerate its rate-hike schedule. Comments from Dallas Fed President Robert Kaplan suggesting that Fed officials may need to hike interest rates more than three times this year to moderate the economic advance, further exacerbated the selling tone. Selling was broad based across all 11 sectors of the S&P500, with energy shares sinking 4.1% as earnings disappointed and the crude price slumped. The tech selloff worsened, pushing the Nasdaq 100 Index lower by 2.1 %. Not even a record rally at Amazon could halt the decline, as shares in the world’s biggest company, Apple Inc hit their lowest level since October. The US Nonfarm Payrolls report released earlier in the day were very positive, showing that the economy added 200,000 new jobs in January, (beating forecasts of 180K) while the unemployment rate remained steady at 4.1% for the 4th consecutive month. Wages growth was up 2.9% from previous 2.5% its fastest pace of growth in eight years, a sign that inflation may finally be on the increase. This was stirring concerns that, if inflation grows too fast, it could affect companies’ profits and at the same time force the Fed to raise rates at a faster pace. On currency markets, the better than expected NFP data saw the USD gain across the board. Locally, this week will be dominated by Australia’s RBA interest rate announcement and statement tomorrow. The rate is expected to remain unchanged. For New Zealand, there will be another Global Dairy auction on Tuesday night and then the RBNZ statement and rate decision on Thursday.

Australia (AUD)

The main news out this week from Australia will be around the first RBA meeting for 2018 tomorrow. The RBA usually uses the first meeting of the year to re-set the policy discussion with an overhaul of the wording in the Governor’s statement accompanying the decision, and the Statement on Monetary Policy (SoMP) released this coming Friday. This will provide an opportunity to present revised forecasts and a fuller elaboration of its views. There is not expected to be a major shift this time around. It is expected that the Bank will acknowledge the more positive tone from offshore economies and emerging stronger domestic data. It may also alter its commentary, particularly around the AUD. However, its central view from late last year – that “continuing spare capacity in the economy and the subdued outlook for inflation means that there is not a strong case for a near-term adjustment in monetary policy” – is likely to remain in place. Expect rates to remain on hold along with some commentary around the strength of the AUD. Although inflation is continuing to run below the RBA’s target 2-3% band, currently at 1.9%, we expect little comment on this as the RBA will see this as a relatively minor problem. Prior to the RBA statement trade balance figures will be released along with import/export data.

New Zealand (NZD)

It is a shortened week for New Zealand markets with the Waitangi Day holiday tomorrow. Markets should see light trading ahead of the RBNZ rate announcement and Monetary Policy statement on Thursday. We believe that there is virtually zero chance of any rate increase on Thursday or anytime soon. Given inflation and inflation expectations remain below levels desired by the RBNZ – low wage growth being part of the problem. Tomorrow night brings another Global Dairy auction, futures markets are pricing in a 7% gain for Wholesale milk prices, however it should be noted that over the last few auctions this indicator has been very unreliable, having seen GD auction prices tip the other way. On the better than expected NFP figures on Friday the USD is back in play and the continued thumping the equity markets are taking does not add to the lustre of risk assets like the New Zealand and Australian dollars. The last two weeks may have been the high watermark for the NZD for the year.

United States (USD)

NFP jobs data on Friday came in above expectations at 200K (180k expected). Along with the unemployment rate remaining constant for the 4th month at 4.1% proved positive for the USD, although equity markets continued to be aggressively sold off. Of note in the jobs data was the increase in wages of 2.9% against the previous 2.5%, the fastest pace of growth in eight years. This may be a sign that inflation may be starting to stir. Market concern is that although 3 Fed rate hikes for the calendar year have been more-or-less allowed for, continued stronger than forecast data may see the Fed increasing the pace of rate hikes to 4 for the year. This has previously seen the bond market rally and equity markets sharply lower.  Given the strong labour data we believe that next month’s rate hike is “a done deal” and that ongoing solid data releases will raise rate hike expectations, keeping equity valuations under pressure. The US dollar rallied on Friday immediately after the NFP release, as negative sentiment toward the greenback began to fade after it plummeted last week to multi-month lows across the board. However, the USD later in the day gave back most of its gains against the EUR as the equity market continued to be sold down.

Europe (EUR)

The tortuous negotiations around the formation of a new German government continue with a Sunday deadline. Talks between Chancellor Merkel’s conservatives and the Social Democrats coming and going without any coalition agreement being reached. This continues to weigh on the EUR and talks will continue this week. Eurozone weak wage growth remains an important factor in the subdued Eurozone inflation outlook. Wages have failed to pick up recently despite increasing labour shortages. With unemployment in December at 8.7%, stable at the lowest rate since January 2009, some recovery in wage growth would seem imminent. German unions are pushing for higher wage increases in collective bargaining negotiations for example, but it will likely take at least until 2019 for wage growth to be back at pre GFC crisis levels. Don’t hold your breath for any swift return of inflation to the Eurozone anytime soon.

United Kingdom (GBP)

With little in the way of major releases over the week, Thursday/Friday saw manufacturing and construction PMI data figures both falling lower in January below market expectations. However the UK pound remained well supported by the ongoing fundamental weakness of the US Dollar.  We expect UK markets to consolidate ahead of major releases on Thursday for quarterly inflation and the BoE rate decision along with the accompanying Monetary Policy statement. Data on Friday for Industrial production and the trade balance will also provide further gauges of the state of the UK economy. Expectations are for the Monetary Policy Committee expected to stay unchanged on both asset purchasing program as well as the interest rates that have just been lifted to 0.5% after a decade of lower rates. The Bank of England is expected to remain traditionally conservative in its inflation report, seeing only modest economic growth rate in the UK for the upcoming three years. Although it may be a little more optimistic than the International Monetary Fund with its 1.5% y/y prediction for both 2018 and 2019. BoE Governor Carney is expected to be cautiously pragmatic and has already pointed out that the Bank’s forecast of the UK GDP differs from the one issued by the IMF two weeks ago in Davos. The UK has been the only G7 country with the GDP forecast downgraded in the newest version of the World economic Outlook. While growth outlook for the UK might be a bit more optimistic, the inflation outlook is the main determinant of the policy and there should be little change on that front, even after the current strength of GBP playing in favour of inflation falling faster towards the 2% inflation target. The latest inflation numbers showed the UK CPI rising less than expected by 3.0% y/y in December. Although the Bank of England may opt for tentative optimism in terms of inflation forecast, it is highly unlikely to alter its outlook of maximum two rate hikes until 2019.

Japan (JPY)

Light economic releases to end the week from Japan, with nothing much this week until trade data and current account figures on Wednesday. The monetary stimulus continues in Japan with the BoJ on Friday buying JPY 450 bln of 5 to 10 year Japanese Government bonds. The USD/JPY rose on Friday completing three days of gains. After the release of the NFP, it peaked at 110.47, the highest level in a week. It has now pulled back modestly finding support around 110.00- 110.25 level.

Canada (CAD)

Canadian GDP came in as expected at 0.4% m-o-m for November, not changing the bigger positive picture for the economy. Markit’s manufacturing PMI also suggested that Canada is doing well, with a score of 55.9, better than expectations. The upcoming week features a Canadian publication almost every day. Trade data and the Ivey PMI will shape trading of CAD on Tuesday, building permits on Wednesday and more housing starts on ThursdayThursday also sees a speech by BOC Deputy Governor Carolyn Wilkins. She provided the first hint for the first BOC hike in 2017, so her speech on Thursday could be a market mover. The most important publication is Canada’s jobs report on Friday with high expectations for a good report around 44K after two stellar job reports for November and December, both were around 79K, smashing all expectations. The publication will get full attention as the US Non-Farm Payrolls is already out, and we may see a stark difference between the two neighbours’ publications. The USD/CAD enjoyed solid gains, breaking over the 1.2400 resistance level to a high around 1.2435. Immediate support is at 1.2400 with topside at 1.2480.

Major Announcements last week:

• Australian CPI m/m 0.6% vs 0.7% expected
• European Flash CPI y/y 1.3% as expected
• Canadian GDP 0.4% as expected
• FOMC leaves interest rates unchanged at 1.5%
• UK Manufacturing PMI 55.3 vs 56.5 expected
• US ISM Manufacturing PMI 59.1 vs 58.7 expected
• US Non-Farm Employment Change 200k vs 181k expected
• US Average Hourly Earnings 0.3% vs 0.2% expected

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