By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Stronger-than-expected U.S. industrial production and consumer confidence numbers sent the dollar soaring against all of the major currencies. The biggest losers were the commodity currencies and the euro, which extended Thursday’s slide. The market has completely forgotten about this week’s softer retail sales and consumer price reports but these numbers will be important ahead of Wednesday’s Federal Reserve meeting. The greatest risk for the U.S. dollar ahead of the Federal Reserve meeting is not that the central bank will forgo a rate hike. but that they could lean toward 3 instead of 4 rounds of tightening this year. The market is pricing in a 100% chance of quarter-point hike and despite the slowdown in retail sales and consumer-price growth last month, U.S. policymakers gave us no reason to believe that rates will remain unchanged. In his semi-annual testimony on the economy last month, Fed Chair Jerome Powell was unambiguously positive. He made it very clear that he felt the economy is growing at a solid pace, inflation is on the rise and there’s no recession risk. Although retail sales slowed, the U.S. economy added 313K jobs last month. Service and manufacturing activity expanded and CPI growth accelerated year over year.
Almost every one of the FOMC voters who spoke over the past month has been hawkish, encouraging investors to price in a 90% chance of 100bp of tightening this year. This is an aggressive forecast that traders hope will be reinforced by the Fed’s higher dot-plot forecasts on Wednesday March 21. Aside from a decision on interest rates, this month’s FOMC meeting also entails a press conference and updated economic forecasts. If the adjustments are hawkish, it will be overwhelmingly positive for the dollar and could drive USD/JPY toward 108. However if the Fed is anything short of unambiguously hawkish, we could see USD/JPY reverse course and aim for 105.
It should also be a busy week for sterling with a Bank of England monetary policy announcement, retail sales, consumer prices and labor-market reports scheduled for release. After numerous tests, GBP/USD rejected 1.40 and appears on its way back down to 1.3800. Whether this key level is broken or not will be determined by the BoE and FOMC rate decisions. American policymakers meet before the Brits but U.K. inflation and employment numbers will be released before both monetary-policy announcements. At the last BoE meeting, sterling shot higher after the central bank raised their 2018 and 2019 GDP forecasts adding that rates may need to rise faster and earlier than previously expected. This hawkishness caught the market by complete surprise. Although there’s been more weakness than strength in the U.K. economy since the last meeting – manufacturing activity slowed, retail sales growth barely turned positive and consumer-price pressures eased – it's unlikely that the central bank will walk back their positive outlook so quickly. This is not a monetary-policy announcement that is accompanied by a press conference by Mark Carney (like the last one) so the statement is likely to be unchanged, which could be enough to send sterling higher against the euro and U.S. dollar. If we are right and there are no major adjustments to the BoE’s outlook, EUR/GBP could hit .8750. Brexit Secretary David Davis is also headed to Brussels this weekend to meet with EU negotiator Barnier and investors are hoping that this means negotiators are close to a deal as he has avoided the trip in recent months.
The European Central Bank may not have a monetary-policy meeting on the calendar but that does mean the euro will take a back seat. The FOMC rate decision alone has enough power to trigger big moves in EUR/USD but upcoming Eurozone PMIs and the German IFO report will also contribute to volatility. Although EUR/USD ended last week about where it started, it sold off 3 out of 5 trading days because everyone from ECB President Draghi to members Praet, Coeure and Villeroy made it very clear that they are in no rush to change their forward guidance. They felt that policy needs to be patient and persistent because inflation is subdued and euro strength could drive prices even lower. The uniformity of these comments are an important reason why euro has been under so much pressure. Investors will be looking to the upcoming economic reports for confirmation – if the data is weak, reinforcing the central bank’s views, EUR/USD will fall as the single currency underperforms. However if the data is good, it could help sustain the uptrend in the currency. The PMIs and IFO will be released the day after FOMC so the Fed's tone could have a larger impact on EUR/USD trade.
The Canadian dollar was hit the hardest this past week. The loonie came under such heavy selling that USD/CAD broke through 1.30 to trade at its strongest level since July 2017. Although Canada received a “temporary exemption” from tariffs, President Trump’s tweet about Canadian trade on Thursday revived NAFTA concerns. Softer-than-expected housing data also added to the pain, reinforcing Bank of Canada Governor Poloz’s dovish comments at the start of the week. While Poloz expressed confidence in the economy, saying there’s untapped potential with room to expand, the possibility of this expansion happening without driving inflation means they are in no rush to raise interest rates. Poloz “doesn’t know when they will be raising interest rates again,” and that line alone was enough to drive USD/CAD sharply higher. On a technical basis, if these gains are sustained, USD/CAD could climb as high as 1.32. Canadian inflation and retail sales are on the calendar but these numbers along with BoC Deputy Governor Wilkins’ speech are not due until the second half of the week. This means USD/CAD could extend its gains if investors respond positively to FOMC.
The Australian dollar sold off at the end of the week despite positive comments from Reserve Bank Assistant Governor Kent and stronger consumer confidence. Lower commodity prices, risk aversion and a general demand for U.S. dollars caused AUD/USD to break the bottom of a 3-day range and close in on a 3-month low. There is quite a bit of support near .7700 but looking back to January 2018, lower peaks point to further weakness for AUD/USD. Australian labor-market numbers and the RBA minutes are scheduled for release in the coming week.
The New Zealand dollar was also hit hard as data weakened ahead of the Reserve Bank’s monetary-policy announcement. At the last policy meeting, the RBNZ lowered their GDP forecasts, emphasized a neutral policy and warned that a drop in inflation expectations could trigger a rate cut. NZD sold off following the rate decision but recovered on the back of stronger dairy prices and healthier labor data. Since the last policy meeting, the New Zealand dollar has been one of the most resilient commodity currencies. Data has been mixed with retail sales firm at the end of the year but weakening in January and February. Service-sector and manufacturing activity slowed but housing and inflation data have been stronger. None of these changes warrant an adjustment in guidance and the Deputy Governor is still leading the meeting before Adrian Orr takes over as the new RBNZ governor the following week – so earth-shattering announcements are not anticipated.