Friday’s stronger than expected U.S.
economic reports failed to inspire new gains for USD/JPY but EUR/USD
dropped to fresh 2 month lows. Americans are spending more and
inflation is up but the greenback was trading strongly ahead of these
reports so the rally fizzled after the data. It was still a
good day for the dollar especially versus the euro, British pound,
Japanese Yen and Swiss Franc. Retail sales rose 0.6% in the month of
September, the strongest gain in 4 months. Excluding auto and gas
purchases spending rose by 0.5% – both reports were in line with
expectations. Producer prices increased 0.3%, which was stronger than
the market’s 0.2% forecast. Consumer sentiment pulled back in October
according to University of Michigan after strong gains in September.
The sentiment index dropped to its lowest level since September 2015
while the expectations component of the report dropped to the lowest
since September 2014. Despite the uptick in retail sales, the drop in
sentiment encouraged investors to take profits on long dollar positions
ahead of the weekend. Also, the contribution to GDP growth will be less
in Q3 than in Q2 because spending July and August were weak. Fed Chair
Janet Yellen spoke today and didn’t say anything market moving. She
indicated that maintaining accommodation too long could have its costs
which reaffirms her hawkish bias. This sentiment was shared by Fed
President Rosengren who said, that the market’s expectations for a
December rate hike sounds about right.
Looking ahead to the coming week the U.S. dollar could take a back seat to more important non-U.S. event risks on the calendar.
This includes the European Central Bank monetary policy announcement,
Bank of Canada Rate Decision, Australian and U.K. employment reports,
RBA Minutes, China’s Q3 GDP number along with U.K. and Canadian retail
sales. These are the most important releases amongst a long list of
other market moving events. From the U.S., the consumer price report,
housing data, Empire State and Philadelphia Fed indexes are the main
pieces of data on the U.S. calendar. CPI is an important input into Fed
policy but with inflation so low, it has become less market moving than
the jobs and spending reports. With that in mind, unless there is a
huge one way move in U.S. rates, we could see less consistency in the
performance of the majors next week. We are still bullish U.S. dollars
but it will be important to watch Treasury yields – if they fall, the
dollar could experience losses but if 10 year yields hit fresh 4 month
highs, we can expect strong gains in the greenback.
Next week’s European Central Bank meeting will be the real test for euro which dropped below 1.10 versus the U.S. dollar.
Whether this level holds or gives all depends on ECB President Mario
Draghi’s tone. 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. Interest
rates will be left unchanged but 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 the there’s been significantly more improvement in the
German and Eurozone economies since the last ECB meeting. The recent
weakness of the euro goes a long way in boosting the economy and
inflation so positive comments could make 1.0950/1.10 a near term bottom
for EUR/USD.
Sterling will also be in focus next week courtesy of an exceptionally busy economic calendar.
Not only will the British pound be responding to the outcome of the
British High Court who has a hearing on Parliamentary approval of
Brexit, but retail sales, inflation and employment numbers are also
scheduled for release. Previously most U.K. economic reports have been
strong, easing concerns about the impact of Brexit. We believe that
next week’s economic reports will show continued improvements as the
weakness of sterling boosts consumption and price pressures. The big
story this past week was Prime Minister May’s concession to allow
Parliament to vote on Brexit and Governor Mark Carney’s comments.
Carney said he is not indifferent to GBP weakness but they could
tolerate higher prices, which means there’s no urgency to intervene in
the currency. Hearings before the British High Court began on Thursday
and will continue until Monday. May argues that she has the sole right
to determine when Article 50 is invoked but if the court finds that
Parliamentary approval is needed, it would delay the process beyond the
first quarter of 2017. This outcome could be enough to drive GBP/USD to
1.2450. It would also suggest that there would be a softer exit.
However if the high court decides that it does not want to interfere
with the Lisbon Treaty, then GBP/USD will reverse its gains quickly and
aggressively. Either way, the decision will be appealed and sent to the
Supreme Court who may hear the case before year-end.
The Canadian dollar traded higher this week as oil prices hovered near 4-month highs. No
major economic reports were released but continued pushback from OPEC
nations along with a rise in oil inventories remains a problem for the
loonie because once again there doesn’t seem to be much teeth to the
OPEC deal. Next week the focus will return to Canada and its economy
with a Bank of Canada rate decision on the calendar along with retail
sales and consumer prices. The rate decision will set the tone for the
CAD while the economic reports will likely validate the BoC’s bias as
rates will remain unchanged. Outside of inflation, there’s been
significantly more improvement than deterioration in Canada’s economy
since their last meeting. CPI is a big problem but oil prices have been
on the rise which should alleviate some of those concerns.
The Australian and New Zealand dollars recovered from losses incurred at
the start of the week. AUD/USD managed to turn positive, NZD/USD did
not. Chinese trade numbers were terrible so their rallies were
driven primarily by U.S. dollar weakness although contrary to the
Reserve Bank’s concerns, New Zealand data continued to surprise to the
upside with manufacturing activity accelerating. In the coming week,
New Zealand’s CPI report is due. Just this week the RBNZ said inflation
is low and monetary policy accommodative but food prices are on the
rise so a soft CPI report is not a given. From Australia we have the
minutes from the last RBA meeting on tap along with the September
employment report. Unlike the RBNZ, the RBA has been relatively
optimistic about the economy and the labor data is likely to confirm
that with the PMI reports showing stronger employment conditions in the
manufacturing, service and construction sectors. Aside from these
individual reports, Chinese Q3 GDP, retail sales and industrial
production numbers will be released. Two of the big stories last week
was China’s aggressive devaluation of its currency and its terrible
trade numbers. The former is most likely in reaction to the latter.
Both developments are negative for Australia and New Zealand who count
on Chinese demand. The only reason why AUD and NZD are not trading
lower is because of carry trade demand.
