FX Traders Should Believe Data and Not the Fed

The price action in the currency and the bond market today tell us that investors believe data and not the Fed. The FOMC minutes were hawkish which is not a surprise considering that the central bank raised interest rates for the first time this year last month. Fed officials talked about lower downside global economic risks, greater upside in fiscal policy risk and described the January consumption slowdown as temporary. These optimistic views and their concern about high stock prices confirm that further tightening is on the way. Yet investors sold rather than bought dollars after the report because nothing in the Fed minutes reflected an urgency to raise interest rates. As a result U.S. yields nosedived, taking USD/JPY down with it as investors turned their focus to the U.S. China Summit and Friday’s non-farm payrolls report. Data wise, this morning’s economic reports raised red flags for Friday’s non-farm payrolls report. While private payroll growth increased strongly according to ADP, job growth in the service sector fell to its lowest level since August. As the employment component of non-manufacturing ISM tends to have a very strong correlation with the broader release, investors sold dollars aggressively after seeing that the Fed minutes contained nothing to alter the market’s expectations for tightening. We expect the dollar to continue to trend lower particularly against the Japanese Yen.

Politically, there’s a lot at stake at tomorrow’s summit between the leaders of the world’s two largest economies. Before the Summit, President Trump set the tone by saying this will be a difficult meeting. There are many political issues at hand like the one China policy and North Korea but Trump has not been shy about his views on China’s unfair currency and trade policies. The BEST case scenario is that both leaders will shake hands, smile and talk about a stronger relationship. Unfortunately, they are walking into the Summit with a strained relationship as Trump rarely misses the opportunity to point fingers at China for its unfair trade practices. FX traders should be nervous because Trump is unpredictable and it is not clear how hard he will press Xi. If the meeting ends with the same awkward press conference as the one held with German Chancellor Merkel, the markets won’t be happy and risk appetite could suffer. This would mean further losses for USD/JPY and other high beta currencies.

The reversal in the U.S. dollar sent all of the major currencies higher and the best performing currency today was the British pound. Stronger than expected service sector activity helped to propel GBP/USD within 2 pips of 1.25. While this may be an important resistance level, it should only be a matter of time before it is broken. According to the PMI report, service sector activity accelerated at its fastest pace in 3 months. Not only did this help to offset the negative sentiment caused by the lower manufacturing and construction PMI reports but it also helps to explain why Kristin Forbes voted for an immediate rate hike last month. However, we are worried about today’s comments from monetary policy committee member Vlieghe who said cautious BoE rate strategy is currently warranted. He worried that the U.K. consumer slowdown will intensify and felt that a premature rate hike is worse than a late one. With that in mind, sterling traders completely shrugged off his warnings and chose instead to see relief in his view that inflation drives policy so price pressures beyond FX could cause a rate hike.

EUR/USD on the other hand continued to consolidate in a narrow trading range. Service sector PMI was revised lower for the month of March, dragging the composite index down to 56.4 from a previously estimated 56.7. There has been very little action in the single currency as concerns about the French election keeps the pair from materially benefitting from the dollar’s decline. German factory orders are scheduled for release tomorrow along with speeches from a number of Eurozone officials including central bank President Draghi so tomorrow could be the day when we finally see a breakout in EUR/USD.

USD/CAD extended its gains on the back of lower oil prices, while the Australian and New Zealand dollars rebounded off their intraday lows to end the day unchanged versus the greenback. Last night’s economic reports were mostly positive with service sector activity in Australia returning to expansionary territory in the month of March. Although house price growth ease in New Zealand, job advertisements increased. While there are no economic reports from Australia and New Zealand scheduled for release this evening, both currencies will be sensitive to the U.S. / Chinese summit and tonight’s Caixin PMI Composite report.