By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Investors took profits on their long U.S. dollar positions on the back of Friday’s nonfarm payrolls report. Job growth was solid and the unemployment rate improved while average hourly earnings grew less than anticipated. With the U.S. dollar rising as much as it did ahead of the labor-market report, earnings was the one minor excuse that traders were waiting for to unwind their positions. Overall, the labor data was solid with 235K jobs added in February and the unemployment rate revised down to 4.7% from 4.8%. Payroll growth in January was also revised higher so while average hourly earnings growth did not accelerate as much as anticipated, the 0.2% increase along with the 0.1% upgrade to January wage growth makes the overall report supportive of March tightening. Unfortunately, it wasn’t good enough to extend the dollar’s gains into the weekend but we expect another leg higher in USD/JPY in the days before the FOMC rate decision. We should see 115 again and possibly even 116 if Janet Yellen suggests that the next rate hike will be sooner rather than later or in June instead of September.
It's important to remember that at the end of the day, Friday’s nonfarm payrolls report does not alter the Federal Reserve’s plans for next week’s monetary policy meeting. When Janet Yellen last spoke, she made it very clear that as long as the economy progressed as expected, a March hike would be appropriate. Investors are on the same page with Fed fund futures, pricing in a 100% chance of a hike next week. Data has been relatively good with activity increasing in the service and manufacturing sectors, inflation on the rise, core spending is growing, sentiment is holding firm and housing-market activity is resilient despite higher mortgage rates. Stocks also climbed to fresh record highs over the past month thanks in part to President Trump’s infrastructure and security spending plans. If the Fed doesn’t raise interest rates in March, it risks falling behind, which remains true after Friday’s nonfarm payrolls. USD's pullback was nothing more than profit taking and we expect renewed strength in the dollar versus the Japanese yen and British pound. Aside from the FOMC rate decision, consumer spending, retail sales, housing and manufacturing reports are also due for release. The Bank of Japan has a rate decision as well but unlike the Federal Reserve, no change is expected from the BoJ.
The euro, on the other hand, could outperform thanks to recent comments from European Central Bank President Mario Draghi. This past week, the ECB left monetary policy unchanged and as President Mario Draghi spoke, the EUR/USD raced above 1.06. Nodding to the improvements in growth and inflation, the central bank raised its 2017 and 2018 GDP forecast by 0.1% and boosted this year’s inflation forecast to 1.7% from 1.3%. Draghi admitted that economic risks are less pronounced and the ongoing economic expansion should be firm and continue to broaden. Draghi's less-dovish comments encouraged traders to take profits on short euro positions and while dollar and euro bulls will need to battle it out, the euro should outperform other currencies. Aside from the German and Eurozone ZEW surveys, there are no major euro economic reports scheduled for release in the coming week, which leaves EUR/USD trading on the market’s appetite for greenbacks. The Swiss National Bank has a monetary policy announcement on the calendar and while policy will be kept steady, the SNB should continue to talk down the currency.
Meanwhile, between the Bank of England’s monetary policy announcement, U.K. employment numbers and the possible trigger of Article 50, it could be an explosive week for the British pound. It is widely believed that Prime Minister May could invoke the article that formalizes the UK's EU divorce after the House of Commons votes on the amendment guaranteeing rights for EU citizens. The House of Lords approved this amendment earlier this month and it was viewed as a big setback for May. If the House of Commons rejects the amendment on March 14, May will most likely press forward with triggering Article 50, which formally kicks off the U.K.’s separation from the common market. However if the House of Commons approves rather than rejects the amendment, May will be faced with the far more difficult decision of overturning Parliament’s rule. Either way, when Article 50 is triggered, we expect a knee-jerk selloff in sterling as the inevitable becomes reality. At the same time, Scotland could announce plans for a second referendum at any time. These events would overshadow the Bank of England’s monetary policy announcement. Since its last meeting in February, the U.K.'s economy has been mixed. While retail sales fell less than anticipated, average hourly earnings growth eased, consumer prices fell as manufacturing- and service-sector activity slowed. So between the recent deterioration in data and the prospect of slower growth post Brexit, we expect the Bank of England to remain cautious.
The Canadian, Australian and New Zealand dollars were hit hard this week by softer data, lower commodity prices and a stronger U.S. dollar. We’ve officially seen the top in AUD/USD and after Friday’s exceptionally strong Canadian labor-market report, USD/CAD could be near a peak as well. USD/CAD has been one of the strongest currencies this month and is due for a correction. Friday’s labor-market report could be the catalyst as more than 105K full-time jobs were added in February, driving the unemployment rate down to 6.6%. This was the largest increase in full-time work since May 2006. Although part-time employment plunged, the change from part- to full-time work is very healthy for Canada’s economy, particularly as wages are on the rise with average hourly earnings increasing 1.1%. The Reserve Bank of Australia left interest rates unchanged this week but its mildly hawkish tone was not enough for AUD to hold onto its gains. The RBA sees global demand as improving but feels that labor-market indicators have been mixed, which is worrisome ahead of next week’s Australian employment report. There are no major economic reports on the calendar for Canada or New Zealand, but softer data including the drop in dairy continues to keep the New Zealand dollar under pressure.