Over the past week forex traders were focused on divergences in monetary policy. We learned that the Bank of Canada is actively thinking about easing, that the European Central Bank is still open to more stimulus in December and that the Australian economy may not be doing as well as the Reserve Bank suggests. The momentum in the U.K. economy is also slowing at a time when U.S. Fed districts have a generally positive economic outlook thanks to a tighter labor market, uptick in spending and housing. The steady hawkishness of the Federal Reserve stands in stark contrast to dovish leanings of other central banks and this has helped the U.S. dollar outperform most of the major currencies. Considering that there wasn’t much market moving U.S. data, the dollar’s gains were modest and the Australian and New Zealand dollars still managed to rack up modest gains against the currency albeit both ended the week off their highs and are vulnerable to a deeper correction.
Yet with consumer price growth remaining slow and year over year CPI ex food and energy dropping to 2.2% from 2.3%, investors still need to be convinced that a rate hike is coming in December. Treasury yields have fallen off their highs while the odds of a year end hike has only increased modestly from 65.9% to 69.2%. There are a number of U.S. economic reports scheduled for release in the coming week the most important of which will be the third quarter GDP report on Friday. Consumer confidence, new home sales, durable goods and Market Economics’ reports on U.S. activity are all interesting but not game changers for Fed policy. GDP is old data but a big increase is expected and that would be encouraging but a disappointment could renew the decline in the dollar. The big question in the week ahead is whether carry or divergences matter more – particularly for the Australian and New Zealand dollars. If U.S. data beats, divergences could be highlighted but if they miss the market will be focused on carry as they pare their expectations for Fed tightening.
While the euro was not the week’s biggest market mover, it dropped to its lowest level in nearly 7 months. The single currency was under pressure all week but the breakdown occurred after the European Central Bank meeting. We were a bit surprised by the move because they did not discuss extending Quantitative Easing, tapering and further rate cuts. They briefly talked about negative rates and options related to the scarcity of bonds available for purchase but no decisions on expanding the pool of purchases were announced. In other words there was nothing exceedingly dovish Draghi’s comments and yet the lack of emphasis on the positive gave investors the green light to continue driving the currency lower. While we can’t rule out a final flush to 1.08, we believe that EUR/USD is a near a bottom and expect it to find its way back to 1.10. Next week’s economic reports could help. At the start of the week, Eurozone PMIs and the German IFO reports are scheduled for release. We are looking for firmer numbers given the weakness of sterling, uptick in investor confidence, industrial production and factory orders. Draghi will also be speaking again and investors will be listening closely for any fresh insight into their plans for the end of the year.
This past week’s U.K. economic reports failed to help sterling. There was a brief short squeeze but the gains did not last. The latest U.K. data was mixed with wage growth slowing and jobless claims rising slightly. Inflation ticked up but the increase was modest and consumer spending stagnated. The momentum that we saw last month is clearly fading and the weakness of sterling has failed to lend support to the economy. The focus remains on Brexit. The London High Court held hearings on this very issue earlier this week and said they would rule “as quickly as possible.” We don’t know exactly when that announcement will be made and this uncertainty could limit big moves in the currency. We know that the High Court does not believe that Brexit can be reversed but there’s a good chance that they will give Parliament the right to vote on the terms of exit from the European Union rather than let Prime Minister May maintain 100% of that power. The only U.K. economic report worth watching next week will be GDP. It is not released until the end of the week, which means that sterling will take its cue from risk appetite, the dollar and any Brexit headlines.
Of the 3 commodity currencies, the worst performer was the Canadian dollar. Retail sales continued to decline while consumer prices grew less than expected, validating the Bank of Canada’s strongly worded dovish bias. After cutting their 2016 growth and inflation forecasts, Bank of Canada Governor Poloz took to the podium, expressed his frustration with exports and said the central bank actively discussed more stimulus and indicated that housing measures won’t stop them from easing further. USD/CAD shot to a 7 month high with the pair now eyeing 1.35. While this dovish monetary policy bias will limit losses for the currency pair, the lack of Canadian data next week means oil will continue to be a key driver of the currency’s flows.
For the Australian and New Zealand dollars the big question is whether these currencies have peaked, particularly AUD/USD, which traded within arms reach of its 5 month high before reversing sharply. Even though the RBA minutes were relatively benign the Australian dollar was hit hard by weak labor data. Full time employment dropped by the largest amount since February 2009. The increase in part time work kept the net decline small but the overall report was very disappointing. The unemployment rate dropped to 5.6% from 5.7%, the lowest level in 3 years but due primarily to the drop in the participation rate. There have been recent adjustments to the calculation methodology but regardless of the volatility the numbers show a slowdown in the Australian job market that will be compounded by the slowdown in China. Australian inflation data is scheduled for release next week and unfortunately we are not optimistic that these reports will help the currency. The New Zealand dollar also traded lower against the greenback but outperformed AUD thanks in part to higher inflation and consumer prices. New Zealand’s trade balance is scheduled for release next week and the rise in the business PMI index points to a smaller trade deficit that could help NZD extend its gains versus AUD. However at most we expect AUD/NZD to drop to 1.05 because ultimately the RBNZ is much closer to cutting interest rates than the RBA.