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FX Update: 2017 should provide plenty of FX market volatility

Written by Ian Dobbs on January 10th, 2017.      0 comments

Currency markets have traded mostly within established ranges over the holiday period, with little economic data available over this time to cause major moves. However several events are approaching which have the ability to cause a significant uptick in market volatility. The first is the inauguration of Donald Trump as US President on January 20th and the subsequent direction of US policies that he will implement over the next 4 years; then the Brexit exit announcement by the UK government expected to come in March which will indicate whether this will be a "hard" or "soft" process which will influence both the EUR and GBP. Also likely to be an ongoing theme over the year is the pace of global interest rate increases as central banks move to normalise interest rates after several years of record low rates. We expect the US Fed to lead the charge in this regard. Politics is also expected to  remain at the forefront for most of the year as the Trump administration settles in and elections are held in Germany, France,  the Netherlands and of course here in New Zealand.

The Australian dollar has traded higher on the softer US dollar, underpinned by continued gains in base metal prices. Data released on Monday showed that Australian Building Permits rebounded in November after sinking in October, up by 7.0% monthly basis, against an upwardly revised slump of 11.8% in the previous month. This has resulted in a year-on-year result of -4.8%, against previous -24.9%. November Retail Sales figures were released this afternoon and they disappointed coming in at only +0.2% month on month. The market was expecting a result of around 0.4%. This has put a little pressure on the AUD in the past hours.

New Zealand
As 2017 now gets underway, there are a  number of important themes that  will shape the outlook for interest rates, the New Zealand dollar and the economy more generally. One domestic theme that is worth watching is household behaviour. Up until recently restraint was the key word, with the housing boom not being followed by the corresponding uptick in consumer spending, which has helped contain domestic inflation pressures. However, there are emerging signs that this is changing, with some pre-2008 behaviours becoming apparent. This may prove transitory, but if not and we see a return to the household consumption habits of old, the RBNZ will take note and is likely to enact earlier OCR rate hikes, with the potential for wider swings in the economic cycle. There are a number of different themes which are likely to affect the New Zealand economy this year, global developments, inflation stirrings, reflation trends and politics – there looks set to be no shortage of market drivers to focus on as 2017 gets underway.

United States
Focus for the US looking ahead will be the policies, both domestic and foreign, of the new Trump administration. The implementation of such policies have a big potential to accentuate market volatility. Also firmly in the frame is the Federal Reserve and its likely path of rate hikes. The Fed has already signalled late last year hikes may be more frequent than first expected, as it moves to normalise rates after an extended period of record low interest rates. Furthermore, as bond yields have correspondingly risen, the US Federal Reserve has become increasingly hawkish in anticipation of greater fiscal spending and inflation under the incoming Trump Administration. This Fed hawkishness has been reinforced by consistently strong employment data that has essentially placed the US close to full employment. As a result, the Fed's newly-accelerated outlook for monetary tightening stands in stark contrast to the much more dovish stances of other major central banks. This divergence between the Fed and others has helped prompt the rally for the dollar against its major currency rivals, while USD-denominated gold has plummeted. US equity markets continue to remain firm but the 20,000 mark for the Dow remains elusive with some market commentators predicting a gradual retracement in equities as the "Trump bump" influence lessens as the inauguration date approaches.

United Kingdom
The GBP has generally been weaker over the last few days on the back of hard Brexit fears.  Prime Minister Theresa May has suggested that she is willing to go for a full Brexit instead of trying to maintain the UK's access to the common market by giving up part of the UK's sovereignty and this came after last week's resignation of EU ambassador, Ivan Rogers. The pound is vulnerable in this environment, but on the other hand, focus will very quickly turn to France and the idea of a "Frexit" and muddled ongoing talks with the EU, however we expect pressure will continue to mount on the pound and further declines are a real possibility.

German exports jumped more than expected in November, posting their steepest monthly rise in four-and-half years and pushing up overall industrial production which drove growth in Europe's biggest economy in the final quarter. The data, released by the Federal Statistics Office and the Economy Ministry on Monday, reaffirmed expectations for a strong rebound in the fourth quarter of 2016 after the economy halved its quarterly growth pace in the third due to weaker exports. With elections in both the major Euro members,  Germany and France, later this year and given the emergence in popularity of right-wing parties in both nations, we may well see politics outweighing economics as a force effecting swings on financial markets over the next 6-months. 

The USD/JPY looks to find the 120.00 level a "bridge to far " as it continues to retreat from the high of 118.60 made on the January 3rd, moving back to the 115.70 area, tracking the poor performance of American stocks and yields. Concerns about a "hard Brexit" and Chinese woes continue to fuel demand for safe-haven assets and this is likely to be an ongoing theme benefiting the JPY over the next 3 months. China's Central Bank has struggled with a plummeting Yuan last week, and on Saturday the government said that its foreign exchange reserves fell to a near a six-year low. From a technical point of view, the USD/JPY looks increasingly bearish after the failed attempt to sustain gains beyond the 117.00 figure.

Although Canadian firms reported the highest hiring and investment plans since 2014, the currency could not escape the slide in oil.  Over the last few days, crude prices tumbled nearly 4% on concerns about rising U.S. output and Iraqi exports.  U.S. oil rigs increased for the 10th straight week to a count of 529 rigs while Iraq, OPEC's second biggest producer reported record production levels in December.  Canadian yields also fell sharply, adding pressure on the Canadian dollar.

Economic Events.
  • NZ GDT Price Index -3.9%
  • UK services PMI 56.2 vs 54.8 expected
  • US Non-Manufacturing PMI 57.2 vs 56.6 expected
  • Canadian Employment change 53.7k vs -5.1k expected
  • US Employment Change 156k vs 175k expected
  • Australian retail sales 0.2% vs 0.4% expected