By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Sterling fell against the U.S. dollar for the second day in a row as disappointing economic data sends the currency, gilt yields and rate hike expectations lower. If Thursday’s retail sales report shows consumer spending contracting more than expected, you can officially kiss the rally in GBP/USD goodbye. With consumer price growth slowing to 0.1% in March from 0.4% and average weekly earnings growth holding steady at 2.8% instead of rising, a contraction in retail sales in excess of 0.6% could encourage the Bank of England to postpone a rate hike. Inflation is now at its lowest level in a year. The market is currently pricing in an 83% chance of tightening on May 10, down from 87.5% on Friday. Although most recent economic reports ranging from the PMIs to CPI have fallen, investors are latching onto the 2 votes in favor of an immediate hike in March. Now, even if retail sales decline, that does mean that the BoE will forgo tightening because in May, there will also be a Quarterly Inflation Report and press conference making it the perfect time for the central bank to tighten. With that in mind, the BoE has also used the report and presser to telegraph changes the following month – so they could hold off till June. Either way, after Thursday’s retail sales report, there’s still 3 weeks until the next BoE meeting. Therefore a softer reading could send GBP/USD down to 1.41.
Meanwhile, USD/CAD rose above 1.26 following the Bank of Canada’s monetary policy announcement. The pair probably would have extended its rally to 1.27 if not for the price of oil, which climbed to a fresh 3.5-year high after crude stocks took an unexpected tumble. Despite all of the improvements in Canada’s economy, Bank of Canada Governor Poloz and Deputy Governor Wilkins did not feel that underlying issues are evolving well enough to send an unambiguously positive signal to the market. The tone of their press conference was cautious with Poloz saying the economy is not yet able to stay at full capacity on its own and therefore interest rates may need to remain below the neutral range. They also see companies hesitant to invest because of NAFTA risks. As a result, the BoC feels they need to be data-dependent and the pace of rate hikes is a considerable question mark as headwinds prevent a full recovery. Trade protectionism remains the biggest risk for Canada and they expressed no excitement about the recent progress in NAFTA talks. Given how much USD/CAD had fallen ahead of the rate decision, we believe their lack of optimism will lead to additional short covering that should take USD/CAD to at least 1.2680 if not all the way to 1.2750. Technically, the next key resistance for USD/CAD is between 1.2685-1.2700, where the February 9 swing-high meets the 50% Fibonacci retracement of the January-to-March rally and the next big figure.
As for the U.S. dollar, it traded higher against most of the major currencies with the exception of the Australian dollar and euro. The Beige Book was positive with the Fed districts citing more price pressures, real estate activity, loan growth, consumer spending increases, tight labor markets and a generally modest-to-moderate expansion in activity. However businesses voiced concerns about tariffs and the districts reported only modest wage gains despite widespread job growth. There was nothing particularly insightful in the comments made by Fed Presidents Kaplan, Dudley and Bullard. Thursday’s jobless claims and Philadelphia Fed manufacturing reports are not expected to have a significant impact on the currency. The euro ended the day unchanged against the greenback. Its resilience in the face of softening data has been impressive and on Wednesday at least, it benefitted from Iran’s decision to stop using U.S. dollars for transactions.
For the next 24 hours, the focus will be on sterling, the Australian and New Zealand dollars ahead of Wednesday night's New Zealand first quarter inflation report and Australia’s labor-market numbers. Both reports were expected to be strong with higher food and commodity prices lifting inflation in New Zealand and stronger employment conditions in the services and manufacturing sectors supporting job growth in Australia. Both currencies have been under pressure and are hovering below key resistance levels so good data could reinvigorate their rallies. For Australia, in particular, employment change is expected to increase and the jobless rate could fall but the number to watch is full-time job growth.