By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
All of the major currencies traded sharply higher Thursday on the back of strong gains in U.S. equities. Risk appetite has been healthy throughout the week but investor optimism carried the S&P 500 and Dow Jones Industrial Average to record highs. These moves also drove EUR/USD, GBP/USD and USD/JPY to 2-month highs. While a stronger-than-expected Philadelphia manufacturing index and lower jobless claims reports contributed to the rally, trade relief is the main reason why investor sentiment is so strong. The trade war hasn’t disappeared but aside from limited retaliation by China, tensions did not escalate further this week. The economy is strong and earnings have been great and there’s a good chance that the Federal Reserve will give the market a break after raising interest rates next week. Investors also feel confident that its just a matter of time before NAFTA and Brexit deals are reached. USD/JPY hit 112.50 and we think the rally could extend to 113 before next week’s FOMC rate decision.
Another reason why all of the major currencies performed well on Thursday is because the U.S. is not the only country with good data. Economists expected UK retail sales growth to contract but rising wages helped boost spending by 0.3% in August. As this uptick in consumer demand follows reports of higher price pressures, GBP/USD broke above 1.32 to trade within a pip of the next big figure. This is the first time that GBP/USD has closed above the 100-day SMA in 4 months and despite the pullback from the day’s highs, the pair is poised for further gains. At minimum, GBP/USD could trade up to its July high of 1.3363 but there’s a good chance that if Brexit negotiations move in the right direction, the pair could hit 1.35. It's important to remember that speculators are aggressively short sterling so there’s a significant need for short covering. This means that a reversal in GBP/USD could extend faster and further than we would normally anticipate. Right now, there’s still a lot of friction as Prime Minister May refuses to accept the European Union’s Irish border proposal and the EU continues to reject her plan for a free flow of goods. But both parties seem more motivated to get a deal done now than in the past, which is why sterling is rallying despite these negative headlines.
The EUR/USD also broke out Thursday on the back of U.S. dollar weakness and the improvement in risk appetite. No major Eurozone economic reports were released but the euro tends to have a decent correlation with stocks. We’ve noticed that EUR/USD moves in line with Brexit sentiment so the hope for a deal has also helped the currency. However with Eurozone PMIs scheduled for release on Friday, domestic growth will play a more significant role in EUR/USD flows. If the weakness that we’ve seen in German industrial production and factory orders carries over to the manufacturing and service sectors, the EUR/USD will recede back to 1.17. If the numbers are good, we should see 1.1850 easily. Meanwhile the Swiss franc ended the day higher against the U.S. dollar and lower against the euro. The SNB left interest rates unchanged and expressed renewed concerns about the franc. Although they continue to describe the CHF as highly valued, they said the currency has appreciated noticeably and are therefore prepared to intervene if necessary. They also cut their inflation forecast and said second-half growth could be softer.
Hands down, Thursday's best-performing currency was the New Zealand dollar, which rose more than 1% versus the greenback and Japanese yen. As we suggested in yesterday’s note, New Zealand GDP growth beat expectations in the second quarter as a result of strong retail sales and trade. The economy expanded 1%, the fastest pace in 2 years. Despite recent reports of weakness in consumer confidence and dairy prices, this solid GDP report reduces the chance of easing by the central bank and encourages short covering ahead of next week’s Reserve Bank meeting. NZD/USD could easily test its August 28 high of .6727 in the next 24 hours. The Australian and Canadian dollars also appreciated against the greenback but their gains were modest. Friday is a big day for the Canadian dollar with retail sales and the consumer price index scheduled for release. CPI is expected to fall but the uptick in the price component of the IVEY PMI index signals a potential upside surprise. Consumer spending is expected to recover but employment and wage growth have recently weakened. Canadian foreign minister Freeland is back in the U.S. for trade talks but there’s very little chance of a deal this week.