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USD Gains As Markets Eye Elections

Published 23/09/2017, 06:42 am
Updated 09/07/2023, 08:31 pm

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

The Federal Reserve breathed new life into the U.S. dollar this week by confirming that it sees one more rate hike this year. The announcement, which was accompanied by plans to reduce the balance sheet, caught investors by surprise, sending the dollar sharply higher. However since Wednesday’s announcement, the greenback has been unable to extend its gains and instead ended the week slightly higher against the Japanese yen, British pound, Canadian and Australian dollars, flat versus the euro and lower against the New Zealand dollar. In the week ahead, the main driver of currency flows should be politics. General elections will be held this weekend in Germany and New Zealand and sometime in the coming week, more details on U.S. tax reform is expected. In addition, investors should be watching U.S.—North Korea tensions as the recent name calling could spiral into something worse that could rattle the FX market.

The most important takeaway from the news flow this past week is the Federal Reserve’s hawkishness.
Although U.S. data has been mixed, Federal Reserve officials looked beyond the strain caused by the hurricanes and the unevenness of U.S. data to call for another rate hike this year along with 75bp of tightening in 2018. This hawkishness caught the market by surprise because most people expected the Fed to announce plans to shrink its balance sheet — which it did — and provide little in the way of guidance. However with stocks hitting record highs on a daily basis, Federal Reserve officials saw no reason to back away from its plan to tighten as it saw spending expanding at a moderate rate, investment activity increasing and labor activity strengthening. The Federal Reserve believes that the hurricanes would not alter the economy’s general course because according to Janet Yellen, the recovery is on a strong track. This unambiguously positive monetary policy outlook and the prospect of tax reform should limit the slide in the dollar barring any geopolitical risks. On Friday, Yellen’s hawkishness was reinforced by hawkish comments from Fed Presidents Kaplan, George and Williams. Next week we’ll hear from Dudley, Evans, Kashkari, Mester, Bullard, Rosengren, Fischer, Harker and Yellen again. If most of these policymakers confirm that they see another rate hike before the year is out, we could see renewed gains in the greenback. Fed-speak should overshadow the New Home Sales, consumer confidence, GDP revision, personal income and spending reports.

German Chancellor Angela Merkel is widely expected to coast to victory at this weekend’s election.
She is running for her fourth term (12+ years) and her position is so secure that many have looked beyond the election to her next government. Germany won’t be hit by populism as the latest polls show her party, the Christian Democratic Union and its sister party the Christian Social Union, have 36-37% support with many exit polls showing last-minute voters favoring the incumbent. A victory for Merkel will mean a victory for the euro. Although EUR/USD backed off 1.20 on Friday, investors are anticipating a win. In the very unlikely scenario that she loses, EUR/USD will crash quickly and aggressively and could fall below 1.18. If she wins, it will be under the backdrop of an improving Eurozone economy and a hawkish central bank. Manufacturing and service-sector activity accelerated in September according to the PMIs. This has and should continue to limit the slide in EUR/USD and could extend the gains for EUR/JPY and EUR/CHF. Next week’s Eurozone economic reports should continue to support the euro as we are look for improvements in the German IFO, unemployment and inflation reports.

Once again, U.K. Prime Minister Theresa May disappointed the market.
In her widely publicized Brexit speech on Friday she provided nothing of substance and made no mention of the terms of exit including the divorce payment she expects to pay the European Union. While this could be interpreted to mean that she is open to discussion it could also be viewed as lack of progress. Either way, investors sold sterling after her speech, leaving GBP/USD vulnerable to further losses. Like the euro, sterling’s slide will be limited by the Bank of England’s hawkishness. U.K. retail sales rose significantly more than anticipated in August, hardening the case for a rate hike. There are a handful of second-tier UK economic reports scheduled for release in the new week. They are not expected to have a significant impact on sterling. Instead investors will be watching Bank of England Governor Carney’s speech on Thursday and BoE member Broadbent’s speech on Friday.

Between the 3 commodity currencies, the New Zealand dollar should be the most active with a general election and a monetary policy announcement on the calendar.
Based on NZD's end-of-week rally, the incumbent Bill English is expected to win. However the race has been close and we do not rule out an unexpected victory by Jacinda Ardern. If Arden wins, NZD is likely to sell off but if English secures a victory we could see a slight bounce in the currency. As for the RBNZ, the last we heard from the central bank, it expressed concern about the strong currency, saying it is very much neutral on rates. Since the last monetary policy meeting in August, we’ve seen improvements and deterioration in the economy. Inflation and housing activity seem to have ticked up slightly but credit-card spending and service-sector activity slowed. The currency is trading marginally weaker. The bottom line is there hasn’t been enough improvement or deterioration for the RBNZ to change its guidance and if it maintains a cautious outlook, NZD will end up selling off against currencies where rate hikes are anticipated.

USD/CAD rose above 1.2300 on Friday on the back of softer Canadian data.
Consumer prices rose 0.1% in August, which was slightly less than anticipated. Retail sales beat expectations rising by 0.4%, but excluding autos, the increase was far more modest and less than anticipated. It is difficult to say if these reports eliminate the chance of another rate hike from the Bank of Canada because inflation and spending still increased from the previous month. Still, the mere fact that BoC cast doubt on additional tightening could be enough of an excuse for more profit taking on short USD/CAD positions. Canadian GDP is due for release at the end of next week but the main focus for CAD will be Governor Poloz’s speech on Wednesday.

Meanwhile, the Australian dollar ended the week lower after S&P downgraded China and RBA Governor Lowe expressed little desire to follow in the footsteps of other central banks.
Unlike the Federal Reserve, European Central Bank, Bank of England and the Bank of Canada, the RBA is in no rush to raise interest rates. According to Governor Lowe, who spoke on Thursday, the Australian economy looks to be improving and is on course for further progress in jobs and inflation. Yet global rate rises have no automatic implications for Australia as the flexible A$ allows independence on timing of rate rises. While he admits that rates are more likely to go up than down — Lowe believes investors should be prepared for higher rates — the market clearly interpreted Lowe’s comments to mean that the RBA will lag behind the Fed, ECB, BoE and BoC. There are no major Australian economic report scheduled for release in the week ahead so the main driver for AUD should be the market’s appetite for U.S. dollars and speeches delivered by RBA's Debelle and Bullock.

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