By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Friday’s U.S. jobs report did not have a significant impact on the FX market outside of reinforcing the positive momentum in the economy. A total of 313K jobs were created in February, which was the largest one-month increase in 3.5 years. Although the unemployment rate ticked up and average hourly earnings growth slowed, the most important takeaway is that these numbers are strong enough for the Federal Reserve to raise interest rates later this month. Service-sector activity is still expanding at a healthy rate and according to the Beige Book, the economy expanded at a modest-to-moderate pace between January and February with a tight labor market boosting wages and inflation. February’s inflation and consumer-spending reports will be in focus in the week ahead and spending is expected to rebound after falling at the start of the year. Like the nonfarm payrolls report, unless CPI or retail sales are abysmal, Fed Chair Jerome Powell will deliver his very first rate hike the following week. USD/JPY broke to the upside at the end of the week and could extend its gains to 108 if U.S. stocks continue to rise.
However the most important development over the past week had nothing to do with economic data or central-bank policy. Instead, concerns about trade wars and military action in North Korea eased as the U.S. government softened its tone. As our colleague Boris Schlossberg noted, President Trump’s bark proved worse than his bite as he signed the steel and aluminum tariffs but offered exemptions to Canada and Mexico along with invitations to other nations to apply for exemptions. The actual policy was not as uncompromising as many had feared and for this reason, the dollar surged against the Japanese yen while risk flows returned to other currencies. From a political perspective, President Trump’s plan to meet with North Korean leader Kim Jong Un “by May” is big news because he’s gone in a matter of days from criticizing Mr. Kim to accepting his offer to meet. If the meeting actually takes place (over the phone or in person), it would go a long way in neutralizing one of the greatest threats to market and global stability. This is exactly what Mr. Kim and his predecessors have wanted – recognition from the global community. We think the meeting will go well with both men putting on the charm and promising cooperation because the most important thing historically is that they’ve talked at all. As for the trade war, the big question is whether the threat is over. While we fear the answer is 'no,' for the time being, the more rational leaders of other nations like the vice president of the European Commission have decided to explore the possibility of negotiating exemptions rather than engage in a tit-for-tat and inflame tensions by doubling down with their own sanctions.
While the euro consolidated its post-ECB losses on Friday, there’s no question that investors were not satisfied with the central bank’s outlook for the economy. The only reason why the currency did not extend its slide is because of the improvement in risk appetite. With his less-hawkish speech, Mario Draghi is telling us that while they are more confident in the economy, they don’t plan to taper quickly. As a result, euro will underperform other major currencies in the coming week with the steepest losses against the commodity currencies. There are no major economic reports on the Eurozone calendar so the focus will be on Draghi’s speech on Wednesday.
Sterling, on the other hand, is vulnerable to losses as long as it remains below 1.3950 but if it breaks above it, we could see a much stronger rally. Brexit negotiations are not going well with both sides still stuck on the single market, customs union and Ireland’s border issues. No progress has been made and neither side seems to be budging. The next key Brexit date is March 22, when EU leaders meet in Brussels to sign off on a deal for the transition. They will also talk about the guidelines for negotiating the terms of exit, including trade. Meanwhile U.K. data hasn’t been that terrible – service-sector activity actually accelerated according to the latest PMI report and while the trade deficit expanded slightly, industrial production rebounded at the start of the year. With no UK data on next week’s calendar, the currency’s outlook will hinge entirely on the market’s appetite for euros and U.S. dollars. We expect EUR/GBP to extend its losses.
One of the currencies that we like the most right now is the Canadian dollar because the steel and aluminum tariffs played a major role in its weakness so the surprise exemption should lead to a further recovery. Although the Bank of Canada’s monetary policy statement was more cautious than the market anticipated, a large part of their concerns centered on global policy and NAFTA uncertainty. Renegotiation of NAFTA is still a risk and the BoC is worried about slow wage growth, but there’s still underlying strength in the economy and the latest developments should take USD/CAD to at least 1.2750. Friday’s labor-market numbers were mixed with a lower unemployment rate and rebound in jobs offset by losses in full-time work. However after 5 month's of relatively strong full-time job growth, this decline is modest. There are no major Canadian economic reports scheduled for release in the week ahead so the main focus will be Bank of Canada Governor Poloz’s speech on Tuesday. If he sounds more hawkish than the monetary-policy statement, USD/CAD would hit 1.2700 quickly.
A number of different factors contributed to the Australian dollar’s outperformance. First and foremost, AUD is a risk currency, so it typically rallies when U.S. stocks rise and investors are optimistic. Australia's and China’s trade balances were also stronger than expected and while the Chinese data is partially distorted by the New Year, the 36% increase in exports reflects underlying strength. Although Australian GDP growth slowed in the fourth quarter and retail sales rose less than anticipated, investors were encouraged by Reserve Bank of Australia Governor Lowe’s comment that the next RBA rate move will be up, not down because the economy is moving in the right direction as non-mining spending rises by the largest amount since the financial crisis. Nonetheless, for the time being, the central bank still maintains a neutral bias. Looking ahead, RBA comments are the main focus for AUD with Bullock, Kent and Debelle speaking throughout the week. Technically, higher highs and higher lows point to further gains for AUD/USD, which should at minimum hit 79 cents. After breaking higher on Tuesday, we saw no further gains in the New Zealand dollar for the rest of last week. This consolidation should turn into further movement in the days ahead with fourth-quarter GDP numbers and the manufacturing PMI index scheduled for release. NZD/USD should benefit from an improvement in risk appetite and if GDP growth accelerates like we anticipate, it could trade back to 74 cents.