FX Pre-Positioning For 'Wild Wednesday': Yellen, BoC, UK Labor

Yesterday offered a quiet start to a busy week in the foreign exchange market with volatility focused on what we’ll dub as wild Wednesday. The day kicks off with the UK’s labor report followed by Janet Yellen’s semiannual testimony to Congress and the Bank of Canada’s monetary policy announcement. Later that day the Fed releases its Beige Book report and in the evening (NY Time), China shares its June trade numbers. With that in mind, trading today will be dominated by pre-positioning for these big events. The U.S. dollar appreciated slightly yesterday against the Japanese yen and British pound but is off its highs as U.S. rates retreat. We think the dollar will resume its rise today as investors bank on Yellen's continued optimism and hawkishness. Yellen has very little reason to deviate from her hawkish guidance after Friday’s “good enough” nonfarm payrolls report. All 3 members of the Fed leadership (Yellen, Fischer and Dudley) point to the improvements in the U.S. economy as reasons for policy normalization and the 222K increase in nonfarm payrolls along with the upward revision to jobs in May should be enough for Yellen to maintain her credibility and justify her positive labor market assessment. We expect Yellen to focus on the improvements in the U.S. economy and stress the need for policy normalization on Wednesday, paving the way for further gains in the greenback.

While European currencies were unchanged, there was subtle strength in the euro and subtle weakness in the pound. UK and German 10-year yields were down the same amount, but Germany’s stronger trade and current account balances reinforced the positive trend in the Eurozone economy. For the U.K. on the other hand, softer data cast doubt on the hawkish comments from the Bank of England. It is difficult to imagine how the UK central bank could seriously consider tightening soon with data consistently falling short of expectations. Service, manufacturing and construction sector activity slowed in the June while industrial and manufacturing production turned negative. This, along with a stronger pound in May, caused the trade deficit to increase. With that in mind, Bank of England members Haldane and Broadbent are scheduled to speak today. We know that Haldane is hawkish but if Broadbent joins the chorus of central bankers supporting policy normalization we could see GBP/USD rising back above 1.2950 quickly. Broadbent is the longest serving MPC member and has never dissented in the 6 years he’s been on the committee. The last we heard from him, he expressed caution about the weakening pound and Brexit, although these latest comments are more than a month old. We like EUR/GBP to the upside but prefer to wait and see which way Broadbent leans. EUR/USD on the other hand could drift lower down to 1.1350 on pre-Yellen positioning despite firmer Eurozone fundamentals.

USD/CAD gave up earlier gains to end the day yesterday below 1.29. According to many economists, the Bank of Canada is widely expected to raise interest rates by 25bp on Wednesday. We are a bit surprised by these aggressive forecasts but there’s no doubt that the loonie is strong and traders will carry these positive views into the rate decision. If the BoC raises interest rates, Governor Poloz could downplay the move as a removal of the insurance cuts made in 2015. With inflation moving downward and the Canadian dollar up more than 6% over the past 2 months, policymakers will be careful about ushering in a new period of CAD strength. There was very little movement in the Australian and New Zealand dollars. Even though New Zealand credit card spending and Australian business confidence were released earlier, the market’s appetite for U.S. dollars should determine how these 2 currencies move in the next 48 hours.