The Strength of USD & Meltdown in CAD
Daily FX Market Roundup 12.05.2018
By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
After Tuesday’s nearly 800 point drop in the Dow, investors feared the worst for stocks as this was the largest one day decline in almost 2 months. Yet outside of the sell-off in USD/JPY, the other currencies were unfazed with euro and sterling ending Tuesday unchanged. US markets were closed today in memory of President George H.W. Bush but currencies and equity futures continued to trade. Judging from the more than 100 point recovery in Dow futures, USD/JPY’s move back above 113 and the general strength of the greenback, investors are still hoping for more gains in the dollar. Stronger manufacturing activity and a relatively upbeat Beige Book assessment encourages this sentiment. According to the Fed, the economy is still doing well with most districts expanding at a modest or moderate pace. Prices are rising, labor markets have tightened further and wage growth tended to the higher side of modest. The resilience of the U.S. dollar tells us that investors are waiting for Friday’s non-farm payrolls report and hoping that job growth will be strong enough to revive the dollar’s rally, particularly since the labor market has been the strongest part of the economy and the main source of the central bank’s optimism. We get a first look at how the job market is doing on Thursday with ADP, Challenger layoffs, jobless claims and the non-manufacturing ISM reports scheduled for release.
Unfortunately even if most of tomorrow’s data reports surprise to the upside, the dollar is in the final stretch of its rally. The drop in 10 year Treasury yields was a big deal and reflects concerns about lower price pressures, global growth, less hawkish guidance from the Fed later this month and the possibility of a pause in rate hikes. All of these concerns are real problems that the Fed won’t be able to ignore. When US markets reopen on Thursday, we expect US yields to remain under pressure preventing any meaningful rally in the greenback. The sharp sell-off in stocks and general market volatility should also make businesses hire more conservatively as they worry about the recent decline turning into a deeper more prolonged correction. While the dollar is strong now, rallies should be faded especially if Friday’s jobs report falls short of expectations.
Meanwhile yesterday’s defeat of the UK government in a key Parliament vote and today’s significantly weaker than expected PMI services report should have driven sterling to fresh 19 month lows but GBP held steady as traders pinned hopes on some sort of a Brexit compromise passing the UK Parliament. According to our colleague Boris Schlossberg, as of now there is no evidence that PM May’s plan would pass, but today’s data only underlines the risk ahead. If the politicians allow the matter to spin out of control UK cold tip into a recession as early as the start of the start of the year as the threat of hard Brexit brings all business activity to a standstill. UK PMI Service came in at 50.4 – much lower than 52.5 expected and within a whisker of the 50 boom/bust level. This was the worst reading in 15 months with business optimism weakest since June 2016. According to Chris Williamson, Chief Business Economist at IHS Markit, which compiles the survey: “A sharp deterioration in service sector growth leaves the economy flatlining in November as Brexit concerns intensified. Measured across services, manufacturing, and construction, the survey results suggest that the pace of economic growth has stalled. With the exception of July 2016, when business slumped in the immediate aftermath of the EU referendum, November saw the worst performance since February 2013. “The surveys are so far consistent with 0.1% GDP growth in the fourth quarter, thanks to the expansion seen back in October, but growth momentum has since been lost and risks are clearly tilted to the downside. ”
USD/CAD rose to its strongest level since June 2017 following the Bank of Canada’s monetary policy announcement. No one was surprised by the central bank’s decision to leave interest rates unchanged at 1.75% but what caught everyone off guard was their comment that there may be more room for non-inflationary growth. Back in October when they raised interest rates, the monetary policy statement was adjusted to suggest more aggressive tightening in 2019 but they dialed it back today in recognition of slower growth momentum in Q4. The decline in oil prices is becoming a bigger problem for the central bank because it not only impacts trade but also inflation and overall growth. The BoC admitted today that the energy sector may be materially weaker than they had previously thought. Although USD/CAD failed to close above the June highs near 1.3385, it should be on its way to 1.35.
The worst performing currency today was the Australian dollar, which dropped 0.9% on the back of very weak GDP growth. According to the latest report, Australia’s economy expanded by only 0.3% in the third quarter, pushing year over year growth down to 2.8%, the weakest level in 2.5 years. The fourth quarter could be better with service sector activity improving but we’ll have to see how tonight’s Australian retail sales and trade balance fares. If retail sales also fall short of expectations, which it shouldn’t given the increase in employment and the sharp rise in the sales component of PSI, AUD/USD will test 72 cents. However if it improves like the PSI suggests, we could see a recovery back above 73 cents. For the time being, the uptrend remains intact until 72 is breached. The New Zealand dollar on the other hand is just beginning to turn and with job ads, house prices and commodity prices deteriorating from the previous month, we could see further weakness in the next 24 to 48 hours.
Last but not least the euro ended the day unchanged against the greenback. Having fallen below 1.13 last week, the pair is consolidating above this round number thanks to slightly better data and signs of cooperation between Italy and the EC. Its too early to tell but the pair’s tight trading range points to a pending breakout.