It was a quiet start to a busy week in the foreign exchange market. The U.S. dollar traded lower against most of the major currencies on the back of a softer manufacturing sector report. The Empire State index dropped for the third month in a row, reflecting a deeper contraction in manufacturing activity in the NY region. At -6.8, the index reached its lowest level since May 2016. Economists looked for an improvement but the recent strength of the dollar poses a major risk to manufacturing activity and this drag is likely to be felt in Philadelphia as well, signaling potential weakness in Thursday’s report. There’s not much in the way of market moving U.S. data this week so the focus will be on Treasury yields and comments from Federal Reserve officials. We heard from Fed Vice Chair Fischer today and he said the central bank is close to reaching its goals. He also warned that we can’t expect wages to rise without inflation. His comments weren’t overly hawkish which could explain USD/JPY’s under-performance today. U.S. consumer prices are scheduled for release tomorrow and while CPI is important inflation is very low and the small uptick that we expect will harden the Fed’s desire to raise interest rates only slightly – what matters more now is job and wages growth.
Instead, the economic calendar abroad is heavy with major market moving event risks from other parts of the world. Of those, the five most important events this week will be the following in order of potential currency impact:
1. European Central Bank monetary policy announcement
2. Bank of Canada rate decision
3. Chinese Q3 GDP
4. New Zealand CPI
5. Australian employment
Other releases such as U.K. CPI, retail sales, employment and
Canada’s consumer spending reports will also have a significant impact
on their respective currencies but we are looking for greater volatility
from the five events listed above because they have direct implications
for future monetary policy actions.
The first of these 5 events will be tonight’s New Zealand’s consumer price report.
The New Zealand dollar has been surprisingly strong despite weaker
service sector activity and dovish comments from the Reserve Bank of New
Zealand. Last Monday RBNZ Assistant Governor McDermott said inflation
is expected to be low and therefore further policy easing will be
required. Yet NZD was the strongest performing currency today because
investors are skeptical about the central bank’s willingness to lower
rates at a time when manufacturing activity is growing at its fastest
pace since January. In other words the CPI report could reshape
expectations for RBNZ easing. If CPI growth slows to 0.1% from 0.4% like
economists expect, the central bank’s concerns will be justified and
NZD/USD will give up its recent gains quickly. However if CPI grows by
0.2% or more, we may only see a modest decline in NZD and if year over
year growth holds steady at 0.4% or better yet accelerates, NZD/USD
could make a run for 72 cents.
The Reserve Bank of Australia will also release the minutes from its
October RBA meeting this evening, which we feel is less important than
Australian employment because the minutes will echo this month’s
statement. If you recall the central bank expressed optimism
about the economy and the labor market. They only raised concerns about
the strength of the currency. However looking ahead, they should be
adding China to their worries as recent trade data showed a significant
slowdown in demand. Thankfully job growth is expected to have increased
according to the manufacturing, service and construction sector PMI
reports. We are worried that Chinese growth and retail sales slowed
because in addition to the softer Chinese trade data, the PBoC felt that
it was necessary to significantly devalue the currency but whether they
allow it to show up in the data is a separate question. AUD and NZD
have been surprisingly strong but outside of carry, their gains aren’t
warranted in light of a rising U.S. dollar, Fed policy and weaker
economic activity in China, one of their most important trading
partners.
The Canadian dollar traded slightly higher today despite a pullback in oil prices. This
was prompted by talk that Iran is looking to produce 5 million barrels
of oil a day, which is higher than the pre-sanctions level of 4 million
barrels. Oil prices is important for Canada and the recent increase
will play a role in the Bank of Canada’s outlook this week. Interest
rates are expected to remain unchanged so the question for the BoC is
whether the improvements in manufacturing and trade activity can
overshadow the drop in spending and consumer prices. USD/CAD is trading
near the bottom of its 2 week long range and whether it breaks the low
or bounces from here will be determined by the tone of the BoC.
Sterling remained under pressure as the British High Court held its second day of hearings on Brexit.
There’s been no official announcement on Parliament’s right to approve
the terms of Brexit and no news has been bad news for the British pound
because it means that Parliament may not have the power to push for a
soft Brexit and/or slow the process of exit. Instead the market latched
on to comments from Bank of England monetary policy committee member
Broadbent who said hiking UK rates to meet their inflation target could
lead to “undesirable comments.” U.K. inflation data is scheduled for
release tomorrow and while the U.K. has many important economic reports
scheduled for release, these numbers should continue to take a back seat
to Brexit talk. With that in mind, since we are looking for mostly
stronger reports, they may give investors the opportunity to sell
sterling at a higher level. Between the decline in the currency and the
sharp increase in prices reported in the PMIs, we expect consumer and
producer prices to tick higher in the month of September.
Finally EUR/USD is trying to claw its way back above 1.10. Eurozone
consumer prices rose 0.4% in the month of September, which was higher
than the previous month and right in line with expectations. The
European Central Bank’s monetary policy announcement is the main focus
for EUR/USD this week. Since the central bank is not expected to change
rates, President Draghi’s tone and the central bank’s latest economic
projections will determine how EUR/USD trades.
We’ve seen a lot of conflicting headlines about the central bank’s thinking. Two weeks ago the big story was on tapering asset purchases and this week there was talk about extending / tweaking QE. Everything that we’ve heard from policymakers tell us they are comfortable with the current level of stimulus but stand ready and willing to increase it if the economy weakens. The last time the ECB met, President Draghi expressed more confidence about the outlook for the Eurozone economy, using the word resilience on numerous occasions. However they also lowered their growth forecasts and announced Eurosystem committees to further evaluate stimulus options. So if Mario Draghi reinforces his concerns about the economy and puts greater emphasis on the need for more stimulus, further losses are likely. If he’s optimistic and we think he will be because there’s been significantly more improvement in the German and Eurozone economies since the last ECB meeting and the recent weakness of the euro goes a long way in boosting the economy, EUR/USD could find its way back to 1.11.
