By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Consolidation was the theme of the day after Wednesday’s big moves in currencies. The only action was in the Australian dollar, which crashed on the back of the Reserve Bank’s laissez faire attitude about rate hikes and rating agency Standard & Poor’s decision to lower China’s credit rating from A+ to AA-. Unlike the Federal Reserve, European Central Bank, Bank of England and the Bank of Canada, the RBA is in no rush to raise interest rates. According to Governor Lowe, who spoke Thursday evening, the Australian economy looks to be improving and is on course for further progress in jobs and inflation but global rate rises have no automatic implications for Australia as the flexible A$ allows independence on timing of rate rises. While he admits that rates are more likely to go up than down so investors should be prepared for higher rates, the market clearly interpreted Lowe’s comments to mean that the RBA will lag behind the Fed, ECB, BoE and BoC. For this reason AUD/USD dropped more than 1.3%, the largest one-day decline in 4 months. We expect AUD to continue to underperform and see a potential move down to 78 cents. However we like selling AUD versus EUR and CAD in particular.
The New Zealand dollar also traded lower against the greenback but its losses paled in comparison with AUD. The weakness was a bit surprising considering that growth accelerated in the second quarter with GDP rising by 0.8%. Q1 growth was also revised up to 0.6% from 0.5% helping the year-over-year growth rate hold steady at 2.5%. In light of this report, the only logical explanation for the currency’s underperformance is the fear that the RBA’s reluctance to tighten means the RBNZ is certainly not considering a rate hike at this time. The last we heard from New Zealand’s central bank, which has a meeting next week, it was worried about the strong currency, saying it was very much neutral on rates. The Canadian dollar recovered earlier losses to end the day up against the greenback. This intraday recovery mirrored the intraday rebound in oil prices. Investors are also optimistic ahead of Friday’s consumer price and retail sales reports, especially after the sharp rise in wholesale sales. The market expected wholesale sales to fall by -0.7% but instead they jumped by 1.5%. The Bank of Canada is widely expected to raise interest rates again this year and Friday’s reports will go a long way in confirming/denying that sentiment.
Although the U.S. dollar ended the day higher against some currencies and lower versus others, the lack of meaningful follow through to Wednesday’s rally is a sign that the dollar rally is losing momentum. Despite significantly-lower-than-expected jobless claims, a much stronger Philadelphia Fed Index and increase in leading indicators, the greenback did not extend its gains. While the jobless claims report was distorted by employees returning to work after the hurricanes, the improvement in manufacturing activity in the Philadelphia region is unambiguously positive. With all of Thursday’s economic reports supporting the Federal Reserve’s hawkish views, we believe that the pullback in the dollar will be short lived, particularly for USD/JPY and USD/CHF. Meanwhile, as expected the Bank of Japan left interest rates unchanged but what was surprising about its announcement was the fact that 1 of the 2 new members of the policy committee voted for more accommodation, feeling that the current level of stimulus is insufficient to drive inflation back to 2%.
Both euro and sterling performed strongly. ECB President Draghi spoke in the morning and is expected to speak again on Friday. Although he didn’t touch on policy, investors are waiting with bated breath for the head of the European Central Bank to confirm that a taper decision will be made next month. Eurozone data continues to improve with economic confidence falling less in September compared to August. Friday is a big day for the euro with September PMIs due for release. Slightly softer numbers are expected but the rise in the ZEW and improvement in investor confidence suggests that the risk could be to the upside for these reports. If that’s the case, EUR/USD could make another run for 1.20. Sterling rose back above 1.35 thanks in part to better-than-expected public finances. Investors are also optimistic that Prime Minister May will seek a soft exit from the E.U. when she provides an update on how Brexit is going from Florence on Friday. Most reports say that May will offer to pay 20 billion euros (EU is looking for EU60B) if they are given access to the single market. The European Union is not expected to respond Friday so the market’s reaction will be exclusively to May’s proposals.
Friday's 4 Main Events
- Eurozone PMIs and ECB President Draghi for EUR
- Prime Minister May’s Brexit speech for GBP
- Canadian Retail Sales & CPI for CAD