Payrolls Satisfy the Fed, But is it Enough to Take Dollar Higher?
Daily FX Market Roundup 12.08.17
By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
The November non-farm payrolls report posed no threat to the Federal Reserve’s plans to raise interest rates next week. At 228K job growth and 0.2% wage growth, the labor market is healthy enough for the central bank to move forward with 2017’s last round of tightening. Although NFPs was one of this week’s most anticipated economic releases, it had less of an impact on currencies than the Bank of Canada’s rate decision and the Brexit deal. The greenback ended the week higher against all of the major currencies and the question now is whether it can extend its gains into year end. On a fundamental basis, there are a few reasons why the dollar could end 2018 on a strong note. First and foremost is tax reform. As the tax conference between the House and Senate heats up, the GOP’s motivation to get a deal done before the end of the year should translate into positive progress and gains for the dollar. The second is repatriation – many U.S. corporations are expected to repatriate their earnings before the year closes to lower current tax obligations. This process creates demand for the dollar but the exact amount is difficult to tell as some foreign earnings could already be denominated in dollars. Secondly, the Federal Reserve is widely expected to raise interest rates in the week ahead and even if Yellen limits her forward guidance, the Fed’s outlook for gradual rate rises may remain change because they have long been supported by Mr. Jerome Powell, who is poised to take over as Fed Chair in February.
Although Fed fund futures are currently pricing in a 98% chance of a hike on December 13th, 62% chance of another quarter point move by March 2018 and an 80% chance by June 2018, investors are skeptical about Yellen’s optimism. They certainly have good reasons because even though job growth was strong in November and average hourly earnings increased, wage gains remain subdued, putting pressure on consumer spending. Inflation is also low and there’s been a slowdown in service and manufacturing activity. The only bright spot is housing but changes in the tax bill and the prospect of a rate hike will weaken prices and future demand. So while we think the dollar will rally into FOMC and year end, it could still fall on the rate announcement, giving investors the opportunity to buy at lower levels. Aside from the rate hike, there will be press conference by Janet Yellen and updated economic projections.
The breakthrough in Brexit talks was the biggest story this past last week. After weeks of negotiations and countless setbacks, a “historic deal” was reached on Friday that allows the EU and the UK to move to phase 2 of the talks. But instead of rising, sterling dropped on the news as investors see key issues (Irish border) still unaddressed and the EU’s chief negotiator Michel Barnier said the next phase of Brexit talks could be tougher than the first as “Not everyone has yet well understood that there are points that are non-negotiable for the EU.” As investors see a long rocky road ahead they are reluctant to buy into sterling’s rise. Up until the very last minute Prime Minister May struggled with separation issues ranging from the Irish border, the Brexit bill payment and the rights of EU and UK citizens. Both sides conceded a bit on citizen rights with UK allowing its courts to take the European Court of Justices’ case law into account during their rules. On the Brexit bill, the UK has offered to pay between 40 to 45 billion euros which is less than the EU’s initial estimate of the costs which is closer to 55-60 billion. The EC hasn’t said much on this and we suspect that it will be an area they will compromise on with Britain making the bigger concessions. The real issue though continues to be the border with Ireland which there was very little detail other than a pledge to provide specific solutions to address the unique situation of Ireland and a promise that in the absence of a Irish border deal, the UK will maintain full alignment with the single market and customs union.
The EUR/USD fell every day this past week despite generally healthy data. Although part of this could be attributed to the rise in the U.S. dollar, the single currency is also pressured by Germany’s political troubles and a dovish central bank. There is a monetary policy meeting on the calendar and the last time the ECB met, they cut their asset purchase program but said rates would remain at current levels well past end of QE, which means October 2018. Despite improvements in the labor market, manufacturing and service sector activity, we don’t expect the central bank to change their views and a reminder of their dovish stance could extend the slide in EUR/USD below 1.17, or have little impact on the currency. Either way, we don’t expect the euro to rally on the back of the rate decision. In addition to the monetary policy announcement, the German ZEW survey and Eurozone PMIs are also scheduled for release.
All 3 of the commodity currencies traded lower this week with the Australian dollar falling to a 6 month low against the U.S. dollar. Although retail sales and service sector activity accelerated, an initial run to 0.7650 faded quickly on the back of weaker Q3 GDP and trade balance. AUD selling pressure is intense and with AUD/USD ending the week below the 100-week SMA, 74 cents could be the next level challenged if the upcoming labor market report falls short of expectations. While the New Zealand dollar also lost ground against the greenback, an uptick in dairy prices helped to moderate the currency’s slide and pushed the AUD/NZD cross below 1.10. Last but certainly not least, the worst performing currency this past week was the Canadian dollar, which was crushed by the Bank of Canada’s monetary policy outlook. To everyone’s surprise, the BoC chose to overlook all of the recent data improvements, focusing instead on moderating growth, considerable trade and geopolitical uncertainty and the ongoing slack in the labor market. They attributed any rise in inflation to temporary factors and said continued cautiousness is needed on rate moves. Having raised interest rates twice this year, the Bank of Canada wanted to make it clear that heading into the New Year, they have no immediate plans for tightening. Looking ahead, here are no major Canadian economic reports on the calendar but BoC Governor Poloz speaks on Thursday. If USD/CAD extends its gains, it should find formidable resistance near 1.2950.