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FX Update - Article 50 looms for the UK Pound

Written by Howard Wilcox on March 28th, 2017.      0 comments

4:15pm (NZT)
Risk assets have taken a back seat with equities falling and the USD softening, as investors view with increasing scepticism the Trump administration’s ability to implement his economic agenda based on tax cuts and infrastructure spending after last week’s shambolic failure to get agreement an amended health care deal. Reflation trades are continuing to weaken, with volatility climbing as the S&P 500 heads for the worst month since October after hitting record highs earlier in March. Not helping, is a sudden contraction of US bank lending, with data showing that US corporate borrowing is falling at a rate similar to that around the time of the Lehman Brothers crisis. US money supply growth is also markedly slowing. These monetary and credit signs are often leading indicators for the general economy. Historically, credit downturns 4 to 5 quarters earlier, have preceded recessions.  The drop could reignite concerns that a highly leveraged US corporate sector may react strongly to even limited interest rates increases. Data from the US Federal Reserve shows that the $2 trillion market for commercial and industrial loans peaked in December. The sector has weakened abruptly as lenders tighten credit, especially for non-residential property. Over the last three months it has dropped at a rate of 5.4pc on annual basis, a pace of decline not seen since December 2008. Across in Europe, Britain is preparing to pull the Brexit “trigger” tomorrow, the 29th March, initially this is not expected to move the market, the date having been well advertised, but sterling has strengthened over the last couple of days. During the weekend cracks were beginning to show in the 27 country Eurozone bloc as they prepared to sign the Rome declaration, setting out the future of the bloc. There have been deep divisions among EU members, with Poland and Greece both threatening to refuse to sign a formal declaration unless given concessions on issues, including immigration and austerity…….so nothing new there then..?

The Australian dollar has continued its drift lower, remaining under pressure as weaker data for Australia’s terms of trade and increasing bearishness around base commodity prices start to take effect. Iron ore prices were again lower as stockpiles at Chinese ports increase and concerns grow that steel demand will slow as the general economy’s momentum fades and traders exit some of their long iron ore and copper metal positions. The Australian dollar is still below the 0.7700 level at 0.7630 and if support at 0.7600 is broken look for an extension to the 0.7550 level. On the topside a move back over 0.7700 must be sustained for moves higher but resistance at 0.7740/50 is solid and has provided a barrier previously.

New Zealand
The New Zealand dollar opened the week positively continuing its buoyant mood from mid-last week. It wasn’t to last with equities and commodities declining to a two week low early morning Tuesday putting pressure on the US Dollar and bringing sellers to the market, the New Zealand dollar drifting off its high of 0.7067. Later in the week Wheeler speaks about reserve bank risk which will certainly add some much needed local excitement. Overall this week expect to see the kiwi remain between 0.7000 support and 0.7100 the topside band.

United States
The USD fell to a 4 month low and US equity markets came under heavy selling pressure on the follow-through from Friday’s healthcare reform defeat.  Investors are losing confidence in Trump’s ability to deliver on his ambitious economic agenda of “phenomenal” tax cuts and big increases in infrastructure spending. However the decline was tempered late in the session with stocks and the USD coming off session lows on the realisation that although there were cracks in the Trump-trade , Republicans have vowed to succeed with other policy priorities that are market friendly and there are little signs of any faltering in US economic growth data that has underpinned the rally.
Little major data this week but plenty of speeches from various Fed officials which should keep singing the gradual rate rise song.
United Kingdom
Ahead of the Article 50 enactment, BoE policymakers have noted that the UK’s exit from the EU is a key risk to financial stability, warning UK banks that any knee-jerk reactions to Brexit would have repercussions for the UK economy. It has warned that any sudden changes could “disrupt the provision of market liquidity and investment banking service , particularly to the EU real economy , which could spill back to the UK economy through trade and financial linkages”.
The impending triggering of Article 50 tomorrow is widely expected to produce a knee jerk hit on the Pound. Given the slow grind higher over last week, it can be assumed that much of this is priced in, with GBP arguably at (near term) fair value levels. The healthier mood in the GBP has been partially ‘aided’ by the BoE tone, where the majority of the Monetary Policy Committee appear to be warming to a rate hike closer in on the horizon. This view was aided by the higher than expected inflation figures last week allied with by stronger than expected retail sales. The Pound remains well inside 1.2000-1.2800 range for now, so look for focus to switch to EUR/GBP again. The GBP traded at 1.2613 yesterday, its highest level since 2nd February, but has slid overnight to 1.2557. A break below 1.2535 would see further falls back into the 1.24 region , conversely a move over 1.2600 would target 1.2700, (unlikely any time this week).

The EUR has been bolstered by the backdrop of improving data out of the EU as a whole, and this was underpinned by the PMI’s in Germany and France last Friday, leading to the composite index for both manufacturing and services beating expectations. The shift in ECB policy to a more neutral stance has also given the single currency a boost with some members advocating a rate move ahead of tapering. Overnight a better than expected German IFO confidence survey showed that Business sentiment unexpectedly improved in March. The unwinding of the "Trump trade" gathered momentum overnight, resulting in the EUR/USD cross rallying to a fresh yearly high of 1.0905, however it has drifted back to 1.0860, and even these levels will be hard to sustain ahead of the French elections, along with the clear rate differentials, which cannot be ignored as the market looks to ‘price in’ what is effectively ‘normalisation’ much further ahead. We look for 1.0900-1.0950 as the next major area of resistance in EUR/USD.

Japanese industrial output continues to improve as exports rise according to data earlier this week. There has been no change in BoJ outlook with rates expected to stay low as other central banks look to gradually increase interest rates. Nonetheless the JPY has strengthened considerably on inflows from the risk-off trade as USD longs have liquidated positions as the “Trump-trade” unwinds. A week ago the USD/JPY was trading at 112.85 and we saw a 110.10 low overnight, current level is around 110.63 but a break of 110.00 could extend to the 109.20. Intermediate support is at 109.70/75.

The Canadian Dollar closed the week pushing higher to 1.3385 after Core Durable Sales printed at the expected 0.4%. Political uncertainty remains on the table as CAD consolidated above 1.3350 after the Trump administration pulled the healthcare bill questioning how valid trumps fiscal stimulus plans really are. Technically the Canadian Dollar edges towards the yearly high of 1.3530 with GDP figures releasing at the end of the week volatility will remain. In other news Canadian marijuana was boosted this week with the government introducing a bill soon which will legalize marijuana by 1 July 2018.

Major Announcements
•    Canadian Retail Sales 1.7% vs 1.3% expected
•    Global Dairy Trade Price Index 1.7%
•    RBNZ leaves interest rates unchanged at 1.75%
•    UK Retail Sales 1.4% vs 0.4$ expected
•    Canadian Inflation 0.2% as expected
•    US Core Durable Goods Orders 0.4% vs 0.5% expected
•    German IFO Business Climate Index 112.3 vs 111.2 expected