By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Wednesday's sell-off in U.S. equities prevented the dollar from rallying on the back of hawkish Fed minutes. This wasn’t a big surprise because politics is the main focus and President Trump has his eye on Russia and Syria. Earlier this week he canceled his trip to Latin America to prepare a response to the chemical attack in Syria and today he went on twitter to warn Russia that, “missiles are coming” to Syria. Although Trump created more confusion by saying Russia “needs us to help with their economy….and we need all nations to work together,” the Pentagon added that it is ready to provide the president with military options if he thinks it is appropriate. Russia’s UN envoy responded by urging the U.S. to “refrain from the plans,” adding it will “bear responsibility” for any “illegal military adventure.” While it's not clear how far President Trump will go – we’ve seen him walk back from economic or military threats often – investors are nervous and selling U.S. dollars as a result.
U.S. House Speaker Paul Ryan also announced that he would not be seeking re-election in November. His decision reflects a lack of confidence in the current administration and the party’s ability to secure a majority at this year’s elections. Representative Dennis Ross of Florida announced his resignation an hour later and more could follow. Ryan is the most prominent member of the party to resign and his exit poses a serious risk to the Republican party’s ability to maintain control of Congress. For better or for worse (we’ll let you decide), if the Democrats win in November, it will make it very difficult for President Trump to get anything done in the second part of his term. These political developments overshadowed consumer prices, which fell -0.1% in March. Investors and economists had hoped for an increase after yesterday’s PPI report but the underlying trend is still positive with CPI ex food and energy rising 0.2% and the year-over-year accelerating. Real average weekly earnings also increased. The tone of the FOMC minutes was hawkish with the Fed seeing “significant fiscal policy growth boost over the next few years.” As a result, “almost all Fed officials saw gradual rate hikes as appropriate” with “a number of Fed officials” seeing the need for a “steeper rate path.”
EUR/USD extended its gains, trading higher for the fourth day in a row on the back of positive comments from the ECB and the weaker U.S. dollar. According to European Central Bank President Draghi, who spoke Wednesday morning, he is confident that inflation and wages will rise as the economy improves. He doesn’t feel that there will be a big impact from U.S.-Chinese trade tensions but the effect on confidence could be important. Unfortunately the rally stopped a few pips short of 1.2400 and unless we see an additional leg lower in the dollar, euro may struggle to break that level in a meaningful way over the next 24 hours. That's because Eurozone industrial production numbers area scheduled for release on Thursday and the risk is to downside after the sharp decline in German IP.
Sterling also ended the day higher against the greenback, shrugging off weaker industrial production data. IP rose only 0.1% in February as manufacturing production fell -0.2%. Although the trade deficit narrowed, the decline in exports and imports reflects weakness rather than strength. The National Institute of Economic & Social Research also sees GDP growth accelerating to only 0.2% in March, which is less than anticipated. GBP/USD has significant resistance near 1.42 and its ability to extend beyond that level hinges on the market’s appetite for U.S. dollars and Thursday’s speeches from the Bank of England’s Broadbent and Carney.
While all 3 of the commodity currencies held onto their gains versus the greenback, the loonie was the only one to extend its rally. USD/CAD broke below 1.26 to trade at its strongest level in 7 weeks. There was no Canadian data but the sell-off was supported by the price of crude oil, which hit its highest level since December 2014. Canadian 10-year bond yields are also up sharply and with the prospect of a NAFTA deal, USD/CAD should extend down to 1.25. Meanwhile, weaker Australian consumer confidence and softer price pressures in China prevented the Australian dollar from extending its gains.