Kathy Lien | Feb 04, 2019 15:38
Between the strong US nonfarm payrolls report and a less hawkish Federal Reserve monetary policy statement, the equity markets are on fire. This improvement in risk appetite lifted many currency pairs with the exception of sterling, which continues to be haunted by Brexit.
The Fed joined the chorus of central bankers worried about growth and global market uncertainty, which should remain the case until Brexit, the US funding crisis and US-China trade risks are lifted. The greenback sold off against all of the major currencies except for sterling. The best performer was the New Zealand dollar, which soared on stronger data and better risk appetite. Looking ahead, there’s very little US data on the calendar (although some delayed data could be released), so the downtrend that we saw last week could continue. There are also two important monetary policy announcements from Australia and the UK along with employment reports from New Zealand and Canada.
Fed Says No To Rate Hikes (For Now)
The US dollar sold off aggressively last week after the Federal Reserve made it clear that they have no immediate plans to raise interest rates. Since last year, they’ve been talking about the need for patience but made it official at their most recent central bank meeting by removing the reference to further gradual rate increases from their monetary policy statement. USD/JPY broke below 109 in response but found support after a better than expected nonfarm payrolls report. More than 300k jobs were created in January, which was significantly better than the 165K forecast and matched last month’s +300k rise. Not only does this report tell us that the government shutdown had a limited impact on the labor market, but after revisions, job gains averaged 241K over the past three months.
Even though the labor market is on fire, wage growth is slowing, and there’s a very good chance of downward revisions next month. More importantly, the change in the Federal Reserve’s monetary policy statement was significant enough to keep the US dollar under pressure. Having just raised interest rates in December and released a dot plot that showed two more rate hikes in 2019, they said they “will be patient”, which is a big shift from last month when their statement said, “some further gradual increases” were coming. With that in mind, the central bank still feels that the economy is growing at a “solid rate” with inflation hovering near their target. To clarify, Fed Chair Powell said in his press conference that the economy is in a good place, but the case for raising interest rates has receded. So in some ways, the Fed’s baseline economic outlook has not changed, and they're only saying no to rate hikes for now. A lot of their concerns stem from events like Brexit, funding for the US government and US-China trade issues that could be resolved over the next few months. The economy is still slowing, but if Congress passes a permanent spending increase, the UK reaches a withdrawal agreement with the EU and the US forgoes further tariffs on China, two rate hikes this year could still be justified. With that in mind, any one of these discussions could go south, sending the markets into turmoil. Press conferences after every meeting this year gives the Fed the flexibility to change policy as needed and so far, domestic and global uncertainty justifies the need for patience. There’s not much in the way of US data, so for the time being, the path of least resistance for USD/JPY should be lower.
Euro Rally Cut Short By Data
Unlike many of the major other major currencies, weaker economic data has made it difficult for the euro to rally. It broke through 1.15 briefly last week on the back of US dollar weakness but failed to extend beyond this level as disappointing economic reports and dovish central bank comments reminded investors that the risks are skewed to the downside for the single currency. Inflation is falling according to the latest German CPI report, retail sales in Germany fell by the largest amount in 11 years and confidence is down across the region. ECB President Draghi feels that the risks have moved to the downside and last week ECB member Weidmann said growth in 2019 could be well below 1.5% and inflation could be noticeably lower. He expects bad news from the economy to continue for a while as uncertainty remains high. There are potential downside surprises to all of this week’s economic reports from Eurozone PPI to retail sales and GDP. US dollar weakness is the only reason why EUR/USD rallied over the past week and the lack of US data in the week ahead makes 1.15 a difficult resistance level to break.
Theresa May survived her no confidence vote, the UK Parliament rejected the Brexit withdrawal agreement and gave her the mandate to renegotiate the backstop. She refuses to extend Article 50 or officially rule out a no-deal Brexit. None of this hurt the British pound, but the UK is no closer to a mitigating Brexit uncertainty today than three or even six months ago. With less than 60 days before the UK exits the European Union, the fate of sterling, the economy and millions of EU and UK citizens rests on whether the European Union agrees to open the withdrawal agreement for renegotiation. The EU, Ireland and several other countries said on countless occasions this past week that the agreement, which was 18 months in the making is not open renegotiation. Having promised Parliament the opportunity to take control of Brexit on February 13th if she fails to make meaningful progress on a revised agreement, May has two weeks to come up with a better alternative for the Irish backstop. But having seen her backed into a corner by her peers, the EU is playing hardball and forcing the UK to choose between a no deal Brexit, the current agreement or a second referendum. If the EU refuses to budge, May’s only option is to get Parliament to support a gently revised version of the current Withdrawal agreement. Until there’s meaningful progress and a clear path forward, the risk is to the downside for sterling.
Brexit uncertainty will also be a problem for the Bank of England who meets this week. The risk of a disorderly no deal Brexit increases with each passing day and Governor Mark Carney will reassure investors that they are ready to increase stimulus if it causes a major disruption in the markets. When the central bank last met in December, they said Brexit risks intensified significantly. Earlier this month, Carney said future rate hikes would be limited and gradual. The BoE won’t even consider changing interest rates until the terms to leaving the EU becomes clear. If Article 50 is extended by a few months or to the end of the year, they will stand pat until the government settles on a solution and for this reason, the outcome of the meeting should be sterling negative. The performance of the economy allows for patience as weaker service and manufacturing activity is offset by a strong labor market and wage gains. In addition to the monetary policy announcement, the BoE will also release its Quarterly Inflation report, which includes updated economic forecasts and is followed by a press conference with Governor Carney.
AUD Could Rally Even If RBA Is Neutral
All three of the commodity currencies benefitted from a weaker US dollar this past week, but stronger local data also supported their moves. In Australia, consumer prices rose more than expected, and manufacturing activity accelerated, but these improvements will not alter the Reserve Bank’s monetary policy position. When they meet this week, the RBA will say that while the next move in rates will be up, a change is some ways off so for their time being a steady and neutral stance is warranted. Taking a look at the table below, there’s been more weakness than strength in Australia’s economy since December. Labor market activity weakened, business and consumer confidence is down, building approvals plummeted, and consumer inflation expectations declined. There was also widespread deterioration in Chinese imports, GDP, industrial production and retail sales. So even if manufacturing and service sector activity improved, the RBA won’t alter their cautious outlook especially after NAB raised interest rates. With that in mind, neutral policy may not be negative for AUD because the Fed just shifted to a less hawkish stance. Technically the pair is bid and could hit a two month high above 74 cents.
The Canadian dollar also ended the week unchanged after hitting 2-week lows and then recovered strongly on Friday despite a steep fall retail sales. Consumer spending dropped -0.9% in November, the most in 7 months as gas prices fell and automobile purchases declined. November GDP numbers are due for release this week and given the latest retail sales and trade balance reports a contraction is expected. USDCAD is poised to extend its slide below 1.32.
The New Zealand dollar rose to its strongest level in 7 weeks on the back of a stronger trade balance. NZD has been one of the best performers as the combination of risk appetite, stronger data and a weaker US dollar lent support to the currency. We expect that outperformance to continue in the week ahead as Q4 labor market numbers will most likely surprise to the upside. According to the Manpower index, hiring intentions improved in Q4 and Q1 and this positive sentiment was further validated by consistent increases in the employment component of the business PMI index. The Canadian dollar rallied on the back of higher oil prices and a slightly better than expected GDP report. Oil prices hit a 2-month high after the US imposed sanctions on Venezuela’s oil industry. Crude oil inventories also rose less than expected and gas stockpiles declined. We’ve seen a near term bottom in oil but if US-China trade talks break down, we could see renewed declines in the price of crude.
Written By: Kathy Lien
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