By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Throughout this week, nothing mattered more to investors than politics and fiscal policy. On Monday, investors were nervous about the failed health-care bill’s implications. Then the focus turned to Britain’s exit from the European Union and on Thursday, the U.S. dollar went on a rollercoaster ride after CNBC reported that President Trump is studying ways to “penalize currency manipulators” as part of his goal to fight unfair trade. According to CNBC, the administration could be looking at the Trade Enforcement and Trade Facilitation Act that would allow the president to “to block future federal contracts with those countries and to choke off government financing for U.S. businesses seeking to invest there.” A second option would be to brand China a currency manipulator, which could happen even though China has been intervening to prop up the value of its currency. Otherwise, Trump could use threats of currency manipulation to force concessions from other countries. All of these efforts are aimed at boosting the value of other currencies at the expense of the U.S. dollar, which explains why the greenback tumbled when the news hit the wires. However the losses were stemmed by stronger GDP growth, lower jobless claims and a rebound in U.S. yields. At the end of the day, investors believed that Trump's comments would wash over and if his threats were to lead to policy, it would take months. For now, the market cared more about the improvements in U.S. data and the prospect of further rate hikes. For the U.S, dollar, the main focus on Friday will be personal income, spending, the Chicago PMI report and revisions to the University of Michigan consumer sentiment index.
One of Thursday's best-performing currencies was sterling, which bounced off its lows to trade above 1.2500. One of the most complicated divorces in history has begun. We knew this day would come but its inevitability does not minimize its significance. The U.K. is leaving the European Union and investors, businesses and individuals are bracing for the fall-out. So far, the pain has been minimal with GBP/USD recovering a good part of its recent losses. Unfortunately, GBP is not out of the woods because before the day ends on Friday, the European Union will submit its official response to the U.K. and according to leaked drafts of the initial withdrawal guidelines, they won’t be very accommodative in the first round of negotiations. The power has shifted to the EU and there is talk that it might refuse to concede on a free-trade agreement for the next 2 years. The EU also wants Britain to pay 60 billion euros as part of the divorce settlement with some officials ruling out discussions on trade before PM May agrees to settle the country’s financial commitments. We think that at the onset, the EU will adopt a tough stance, submitting a challenging response to the U.K.’s decision and if we are right, playing hardball will not be good for the GBP. The tougher the terms, the greater the pressure we could see on GBP/USD on Friday. Scotland is also preparing to call for a second referendum and an announcement could be made as early as next week.
Softer-than-expected Eurozone data kept EUR/USD under pressure throughout the North American trading session. Inflation rose less than expected in March with German consumer prices rising by only 0.2%. This slowdown drove the year-over-year rate below the central bank’s target to 1.6% from 2.2%. Low inflation has long been one the ECB’s primary concerns and until prices rise in a consistent manner, the central bank will find it difficult to justify tightening. With that in mind, some ECB officials are still talking about a rate hike with ECB member Knot saying that a 2018 rate hike is closer to his expectations. In contrast to the improvements reported by the German IFO, ZEW and Eurozone PMIs, the latest confidence indicators showed a decline in sentiment. All measures from the Economic Confidence to the Business Climate and Industrial Confidence figures declined in March. However we believe Friday’s German unemployment report could stabilize EUR/USD as Germany saw the strongest pace of job growth in 6 years according to its PMIs.
Meanwhile, it was another mixed day for the commodity currencies with the Canadian dollar rising on the back of higher oil prices, the New Zealand dollar falling on quarter-end flows and the Australian dollar holding steady. Crude oil's rise was driven by reports from Kuwait that OPEC is in talks to include all members in extending OPEC cuts. Oil's rise helped drive USD/CAD lower ahead of Friday’s GDP report. Given the strength of retail sales and trade, we believe GDP growth accelerated in January and if we are right, USD/CAD could extend its gains toward 1.3200. Chinese PMI numbers were due Thursday evening and the outcome could affect AUD and NZD. Economists are looking for manufacturing activity to accelerate but the recent strength of the currency may have stifled gains.