By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It was another topsy-turvy day in the foreign-exchange market with the U.S. dollar spending most of Tuesday trading lower. However at the close, comments from Fed Presidents Dudley, Williams and Harker sent the greenback soaring. Harker and Dudley are voting members of the FOMC and the former said 3 rate hikes this year is appropriate while the latter said the case for a rate rise is more compelling. As we mentioned on countless occasions this past week, Fed speak has been very consistent and it’s only a matter of time before the dollar responds appropriately. But the greenback wasn't out of the woods ahead President Trump Congressional address, which could certainly derail the currency. Investors are worried that Trump will disappoint by failing to unveil an infrastructure-spending program large enough to satisfy the market. On Monday, President Trump took some of the excitement out of the speech by saying that a tax plan will not be introduced until the healthcare revamp is worked out -- so instead, he’ll be sharing details on his infrastructure-spending plans and the question is will that be enough? Traders should be prepared for a volatile Asia trading session that should probably be avoided as there will be plenty of trading opportunities on Wednesday. Meanwhile, the U.S. economy continues to perform well with most of Tuesday’s U.S. economic reports surprising to the upside. House prices increased in December, manufacturing activity in the Chicago region expanded at its fastest pace since January, activity in the Richmond region expanded at its fastest pace since April 2010 and consumer confidence reached its highest level since 2001. Although the trade balance widened and fourth-quarter GDP was not revised higher as economists anticipated, personal consumption at the end of the year was stronger than initially reported. So all in, Tuesday’s reports confirm that the U.S. economy is improving and validate the Federal Reserve’s call for tightening. The odds of a rate hike increased to 54% from 40% on Friday. This means the U.S. dollar should be trading higher but clearly political concerns are overshadowing economic fundamentals and monetary-policy direction.
There are many major economic reports scheduled for release on Wednesday, one of which will be the Bank of Canada’s monetary policy announcement. USD/CAD traded sharply lower ahead of the rate decision, indicating that investors do not expect optimism from the BoC. The last time the central bank met, it raised its GDP forecasts for 2016 and 2017 and said inflation will return to target in the months ahead. However, instead of rising, the Canadian dollar crashed because Bank of Canada Poloz said a rate cut remains on the table. Since then, the performance of Canada’s economy has been mixed. Retail sales weakened but consumer prices, oil, housing, employment and trade increased. If these improvements cause the central bank to refrain from talking about easing, USD/CAD will fall, but if rate cuts are mentioned again, the currency pair will extend its gains. The New Zealand dollar, on other hand, traded sharply higher despite Monday's terrible trade numbers. The Australian dollar saw very little action versus the U.S. dollar changes Tuesday evening with manufacturing PMI, fourth-quarter GDP and Chinese PMI numbers scheduled for release. The recent consolidation in AUD/USD signals a potential top, but the economy has been performing well and Tuesday night’s reports could confirm that.
Although euro has yet to break 1.06 in a meaningful way, it held onto its recent gains versus the U.S. dollar. The only European economic reports released were from France -- we learned that inflationary pressures rose less than expected but consumer spending rebounded. Investors are also finding some relief from ongoing reports that Macron is gaining a greater lead over Le Pen. Wednesday is a busy day for Europe with German labor and inflation data scheduled for release. Job creation was the strongest since June 2011 according to the PMIs and producer prices rose sharply, pointing to higher inflationary pressures. Revisions to Eurozone PMIs are also scheduled for release and our bias for positive numbers all around suggests that euro should outperform non-dollar currencies.
Sterling traded lower against all of the major currencies. The losses comes on the back of Charlotte Hogg’s appointment hearing where she highlighted uncertainties and painted a less-than-optimistic picture of the UK economy. Hogg said there is still a lot of uncertainty regarding Brexit and that she sees both downside and upside risk. She also said that she would only be willing to give UK banks 12-18 months post-Brexit to make transitional agreements. Taking a hard line, Hogg said that banking regulations should be firm -- even after Brexit. The timeline seems to be a lot quicker than what many banks were hoping for. Scottish First Minister Sturgeon also added to the political muddy waters, saying in an op-ed on Tuesday that PM May will be to blame if a second independence referendum comes to pass. Sturgeon went on to say that there is still time for May to reconsider her position on a Hard Brexit for the whole UK but that time was running out and an independence vote looks more like a necessity. On Monday, GfK Consumer Confidence painted a grim picture, posting another drop on a print of -6 in February. Although it was in line with expectations, the number is slightly lower than the -5 the previous month. UK manufacturing PMI numbers are scheduled for release Wednesday and after last month’s disappointing figures, investors are looking for a recovery.