With U.S. markets closed for Martin Luther King Day, it has been a quiet start to another busy week in the foreign exchange market but this week – it will not be about the U.S. dollar. There are no major U.S. economic reports scheduled for release until Wednesday and even then, CPI, the Philadelphia Fed index or housing market numbers are not game changers for the Fed at this stage of monetary policy. We are in the quiet period pre-FOMC, which means there will be no speeches from Federal Reserve officials. So it is no surprise that we saw zero consistency in the performance of the greenback today which strengthened versus the euro, Japanese Yen, Swiss Franc and New Zealand dollar but weakened against the British pound, Canadian and Australian dollars. There’s enough going on in other parts of the world for the U.S. dollar to take a backseat to other currencies this week.
China’s fourth quarter GDP report is scheduled for release this evening and the pace of growth will have a significant impact on equities and currencies. There’s no question that the Chinese economy slowed at the end of the year but the question mark is on whether the government will print a number that could risk sending the Shanghai Composite and the Yuan spiraling lower. While a number of big name economists believe that Chinese growth slowed from 6.9% to between 6.4% and 6.8%, the consensus forecast is for growth to remain steady. Given recent industrial activity reports, steady growth is almost hard to believe but then again, China has every reason to prevent tonight’s reports from reigniting volatility in local markets. They could do this through the GDP numbers and/or the industrial production and retail sales figures, both of which could increase slightly in the month of December. If GDP growth slows to 6.8% and the other reports are stronger, we expect a limited decline in currencies and equities. However if GDP growth slows to 6.7% or worse, investors should brace for a messy week of trading.
Our focus will shift to the British pound after Chinese data. With U.K. CPI, retail sales and employment numbers scheduled for release, sterling is in play this week. Tomorrow, Bank of England Governor Mark Carney will be delivering his first speech on the economy this year. Given the recent slowdown in manufacturing and service sector activity along with the drop in commodity prices, we are looking for inflationary pressures to ease, which should lead to more caution from Carney. At the last central bank meeting, we learned that U.K. policymakers were concerned about market volatility and low oil prices. According to the central bank “Recent volatility in financial markets has underlined the downside risks to global growth” and recent declines in oil “will depress global inflation in the near term.” While they also mentioned that lower commodity prices could boost spending, wage growth will curtail it. Dovish comments from Carney and/or lower CPI could drive sterling to fresh lows versus the U.S. dollar.
Euro is also in play with an ECB meeting on the calendar. No changes are expected from the European Central Bank but given how much oil prices have fallen since the beginning of the year, Mario Draghi has many reasons to remind investors that it is within the central bank’s mandate to increase QE because the drop in oil makes it more difficult for the central bank to meet its 2% inflation target. If there’s no recovery in oil prices before the March meeting, their inflation projections will have to be lowered in March. The question at this month’s meeting is whether the will to change monetary policy increased since the last meeting and while we certainly believe that it has, Draghi could say that it is premature to draw any conclusions. With that in mind, we still expect him to be dovish. The ECB meets on Thursday. The German ZEW survey is scheduled for release tomorrow.
Meanwhile there has not been a down day for USD/CAD since the beginning of the year. This is the longest stretch of strength for the currency pair since October 2008. USD/CAD climbed to a fresh 12 year high as oil prices dropped to fresh 12 year lows. Over the weekend international sanctions on Iran were lifted, sending crude prices sharply lower. It is estimated that this groundbreaking decision could increase crude exports by an average of 500,000 barrels a day this year. The return of Iranian oil to the markets will make life even worse for oil producers like Canada. The Canadian dollar is in focus this week because the Bank of Canada has a monetary policy meeting and based on oil trends and recent economic reports, we believe the economy needs a 25bp rate cut. However the Canadian dollar is falling too far too fast and that could deter the central bank from lowering rates and risking an even deeper slide in the currency.
Between the Australian and New Zealand dollars, NZD should see a bigger move than AUD this week. Both currencies will be affected by Chinese data but there are no major Australian economic reports on the calendar whereas New Zealand has a dairy auction tomorrow followed by consumer prices. Dairy prices fell at the start of the year and if they do not rebound on Tuesday, we could see renewed losses in the currency as investors start to wonder if the prior downtrend has returned. The recent decline in food prices also means that inflation eased in the fourth quarter. Weaker economic reports would validate the double top formation in NZD/USD.