The Next 48 USD Hours: Watch Tax Reform

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

The U.S. dollar went on a rollercoaster ride on Wednesday as investors tried to make sense of the latest economic reports. Initially, the dollar responded poorly with USD/JPY slipping below 112.50. However by the end of the North American trading session, the greenback found its way back above 113 and is slowly trying to stabilize around that level. In the month of October, retail sales growth slowed to 0.2%, which was slightly stronger than expected but significantly weaker than the previous month when spending rose by 1.9%. Excluding autos and gas, sales were a bit stronger at 0.3%. Consumer price growth also slowed to 0.1% but excluding food and energy costs, price pressures accelerated to 0.2%. Lastly, manufacturing activity in the NY region expanded at its slowest pace in 4 months in November. At one point shortly after these releases, 10-year Treasury yields were down more than 5bp and the chance of a rate hike in December according to Fed fund futures dropped to 87%. By the end of the day, however, yields bounced off their lows and rate hike odds rose back to 92%, which was exactly where they were on Tuesday. This tells us that while none of these reports are reflective of a strong economy, investors felt they were strong enough to keep the Federal Reserve on track to raise interest rates in mid December. President Trump delivered a speech today where he discussed his trip to Asia and repeated that all options are open on North Korea.

As for tax reform, the House is set to vote on its tax plan on Thursday, which is a formality at this stage as the market focuses on the Senate bill. The Senate is expected to finish marking up their bill this week but last minute changes have led to clashes between Republicans and Democrats over the repeal of the Affordable Care Act's individual mandate. The Senate is also looking to make the individual tax cuts temporary (good till only 2025) and the corporate tax cuts permanent. An initial vote on the Senate bill is expected on Friday followed by a full Senate vote after Thanksgiving. If the Senate vote ends up being pushed past Friday, the delay drive the dollar sharply lower whereas a passing of the House bill and a yes vote from the Senate Finance Committee (which is different from the full Senate) would trigger a strong end of week rally.

While EUR/USD rose to its highest level in 3 weeks on the back of stronger Eurozone trade data and a falling dollar, it ended the day flat, just under 1.18. This sharp intraday reversal is a sign of weakness for the currency but whether these losses continue hinges entirely on the market's appetite for U.S. dollars as there's been very little market-moving data on the Eurozone calendar. Long term, a hawkish Fed and dovish ECB means EUR/USD should be trading well below 1.18. Thursday's Eurozone consumer price report could add further pressure on the currency with price growth expected to have slowed significantly in October.

Sterling has been surprisingly resilient in the face of mediocre data. On Wednesday morning we learned that while fewer people filed for unemployment claims in October, average weekly earnings growth slowed in September. This follows Tuesday's weaker consumer price report. Retail sales are due for release Thursday and while a rebound is expected after September's soft reading, lower shop prices and a lower BRC retail sales monitor suggest that we could see another contraction. GBP/USD has been trading in a very tight range over the past 2 weeks and if retail sales miss, it could be the straw that breaks the camel's back, taking the pair below 1.3100 and possibly as low as 1.3050. Bank of England Governor Carney and Monetary Policy Committee members Broadbent, Cunliffe, Place and Ramsden are also scheduled to speak on Thursday and their comments may affect how sterling trades.

Wednesday night was a big night for Australia with the country's latest labor-market report scheduled for release. The Australian dollar is trading at 4-month lows ahead of the report on the back of softer wage data but stronger manufacturing and service sector employment suggests that we could see steady job growth. At its last meeting, the RBA highlighted the strength of the labor market and Wednesday's data could reinforce that view. Stronger data would take AUD/USD back above 76 cents. The Canadian dollar is under pressure as NAFTA talks begin. Bank of Canada Deputy Governor Wilkins' positive comments on the economy did not have much impact on the currency. She described the economy as progressing strongly and said less monetary stimulus will likely be appropriate although BoC will be cautious about tightening due to slack in the labor market and slower wage rises. USD/CAD still appears to be headed higher for an eventual move above 1.28. Unlike the Canadian and Australian dollars, the New Zealand dollar ended the day unchanged against the greenback after 4 straight days of losses.