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FX Update: The Fed gets ready to pull the trigger

Written by Howard Wilcox on March 7th, 2017.      0 comments

US markets continued to be buoyant last week with both the USD and equities trading higher as continuing solid economic data reinforced views that the US economy was starting to hit its straps. Helping the USD rally were a raft of comments over the week from various US Fed officials that an interest rate hike was now deemed necessary at the next FOMC meeting on March 14-15th. These views were reiterated by a speech on Friday by Fed Chair Yellen, where she left little doubt that a rate rise is forthcoming and even raised potential that the pace of increases may need to be accelerated, given the perceived danger of the Fed being too slow in boosting rates, “We realize that waiting too long to scale back some of our support could potentially require us to raise rates rapidly sometime down the road, which in turn could risk disrupting financial markets and pushing the economy into recession,” she said. Yellen all but declared that the Federal Open Market Committee would increase rates for the first time this year at its March 14-15 meeting, saying that such a move “would likely be appropriate” if the economy stays on its current track. She also suggested that would not be the last increase this year. US Equity markets after making new record highs earlier in the week came off towards week’s end as the realisation emerged that any Trump stimulus measures were likely to be many months away and more immediate rate rises would have a greater effect. The Eurozone area better economic results continue to be outweighed by the political situation, especially in France where the polls continue to show continued support for the anti-EU National Front party of Maine LePen. This week has opened with stocks in Tokyo and Seoul falling and the JPY strengthened after a North Korean intercontinental missile launch which saw three missiles fall into the sea inside Japan’s exclusive economic zone. Markets have also being cautious in weighing up news out of China, from the National People's Congress meeting that has seen GDP growth reset at a lower “6.5% level or higher if possible” and reiterated the pursuit of a neutral monetary this year. Later this week there are the ADP payroll data on Wednesday which should give a “heads-up” to Friday's crucial Non-farm payroll figure.

Still retains a negative tone, after dropping to a low of 0.7542 on Friday the Australian dollar has managed to claw its way back to the 0.7581 level however in the face of the stronger USD it continues to have trouble regaining the 0.7600 handle. Economic data continues to show sluggish growth, with retail sales rebounding in January by 0.4%, up from a 0.1% fall in December 2016, but household consumption remains relatively flat as record low wages growth and higher household debt levels eat into spending power. However the positive figure will give some comfort to the RBA given that it was a pickup in household consumption that helped the economy dodge a recession in the Q4 last year. The RBA will release its rate decision later today after its monetary policy meeting, rates are expected to remain unchanged at 1.5%, but it is expected that the rhetoric from the RBA will indicate a more moderately hawkish stance and acknowledge the improvement in the global economic climate. The ongoing strength of commodity prices, especially iron ore, remains positive for the Australian economy although comments of a more moderate Chinese growth rate of 6.5% over the weekend from the Chinese Premier inject a hint of caution. We look for the Australian dollar to trade around current levels ahead of the RBA statement, upside resistance is at 0.7620, with support at 0.7570 if broken would open the way to 0.7530. Given the firm USD tone, AUD rallies look to be a selling opportunity.

New Zealand
The New Zealand dollar is again on the back foot this morning, opening around 0.6995 against the USD after slipping through the 0.7000 level overnight, the first time since January. Although New Zealand economic fundamentals remain solid , this move is all about USD strength especially given the clear message given by the US Fed over the last week that US interest rates are on the rise and that the pace of such moves may increase. This is in stark contrast to the RBNZ’s intentions that NZ rates are unlikely to move higher within the next 2 years. There is another Global Dairy auction late tonight with milk powder futures pricing in a drop of around 8% in prices, given the increased production and volume offered such a move would not be surprising. Given we are seeing a lot of US data this week culminating in the Non-farm payroll figure on Friday, we expect the New Zealand dollar to remain under pressure. Next support level against the US is at 0.6950/60 level which if broken, is likely to see a descent to the 0.6860/80 range. New Zealand’s underlying stable political environment and aforementioned solid fundamentals should eventually provide NZD support but given the current USD trend, the NZD tone remains negative and any buying interest will be at lower levels.

United States
US equity markets continued the softer tone, with the Dow dropping below the 21,000 level as Friday’s comments from Fed Chair Yellen that a rate increase next week was pretty much a “done deal” was digested by the market, introducing a dose of reality. Also adding a hint of caution was the rescaling of the Chinese GDP growth target to “6.5% or higher” over the weekend at the People's National Congress meeting, down from the previous 6.7%. The Trump administration gave no further indications on the “phenomenal tax” deal but this is now generally acknowledged to be several months away, with any effect l not be seen in the economy until well into the second half of the year giving more weight to ongoing economic data and potential Fed rate moves. US economic data continues to be positive with January factory orders up 1.2% (expected 1%) and durable goods orders for January revised higher from 1.8% to 2.0% , we expect the ADP jobs data on Wednesday to be good which should give an indication that Friday’s pivotal Non-farm payroll figure will again be a solid one.( estimates are for 185,000+) Look for continued USD strength against both the JPY and EUR as the later continues to be hit by political problems in France and the Netherlands as those elections draw close. The USD is currently trading around 1.0580 against the EUR after the EUR failed to hold the 1.0600 level, the USD tone remains positive with a likely test of the 1.0545 level which if broken would see a test of the March 2nd low of 1.0494.
United Kingdom
The big news this week for the UK, will be the delivery of the Budget on Wednesday 8th March by Chancellor Hammond. It is expected to show the UK economy growing faster than expected since the Brexit vote, which has led the Government's own fiscal watchdog to state borrowing will probably be £12billion less than it forecast in the Autumn Statement last November. The latest borrowing figures showed stronger tax receipts from workers and businesses this fiscal year will provide Mr Hammond with a boost after massive upward revisions to borrowing over the next five years following the decision to leave the EU. UK equity markets continued to surge following on the “Trump- trade” but the GBP has slid lower as Brexit fears resurfaced, and UK Services PKI data fell below forecasts, falling to a 5 month low, trading back below the 1.2300 level. Although fundamentals continue to look solid , we look for continued weakness in the GBP against the USD, as PM May looks to pull the Article 50 exit trigger in late March  and the USD continues to strengthen on further rate hikes. Look for a move to the 1.1800 level over the next month, but this e move is unlikely to be linear and rebounds will present trading opportunities.

No change in the political scene driving most of the EUR negative tone. Another poll on Monday showed National front leader Maine Le Pen continuing to gain on her conservative opposition Macron, up another 1%. Later this week we will see industrial output for Germany, France and the UK along with German factory orders. These are expected to continue the more positive tone seen of late. There is an ECB meeting on Thursday but no change in rates is expected even after Eurozone inflation hit the 2% target level in February. Expect quantitative easing to continue until the end of the year as underlying price pressure remains muted as the stronger inflation figure appears to be driven by volatile energy and unprocessed food price inflation, factors the ECB has previously said it would disregard in looking to adjust monetary policy. Core inflation is what matters to the ECB , this would have to exceed 1% for several months before the ECB would start to taper its QE purchase programme and with core inflation set to track around 0.9% for most of this year it is unlikely any move will be forthcoming from the ECB until late Dec/early Jan 2018.
Look for continue pressure on the EUR, support is at 1.0520 the 1.0470, immediate resistance at 1.0635 unlikely to be tested over the next few days.

The Japanese economy continues to be lifted by capex, industrial output, exports, and fiscal support.  After the recent capex report, expectations are for Japan's Q4 GDP to be revised from 0.2% to 0.4% (from 1.0% on an annualized basis to 1.6%). Japan will also report its January current account later today.  Seasonal factors are dominant.  The current account and the trade balance tends to (has for 20 years) deteriorate in January compared with December (and improves in February).  Unlike Germany, Japan's trade balance does not drive the current account. Investment income is typically larger than the trade surplus. The JPY and Japanese equity market took a knock yesterday after the new of the North Korean missile launch hit the wires. The USD/JPY is now around 113.95 after hitting a high yesterday of 114.12 , but the trend for the USD remains positive and we look for a test of the 115.00  level and above  later this week. However near term price action is expected to be choppy around current levels ahead of jobs data release.

GDP data last week showing that week showing Canada’s economy is growing at the fastest pace since the collapse in oil prices two years ago maybe masking some other concerning issues , that of Canada’s business’s missing out on the rebound. Non-residential business investment has fallen in eight of the last nine quarters and is down 19% over that period. Investment in plant and machinery is now at 37% of GDP, the lowest level since 1981. On balance a rapid change in investment spending activity looks some way off with spending in the manufacturing sector falling again for the second year. However it appears that consumer spending is picking up the load, representing abnormally high proportion of total GDP. Given this scenario, the stance of the BoC to keep rates on hold looks set to continue for some time, with an accompanying softer CAD. The decision of the BoC to hold rates as opposed to the US Fed increasing signal, has seen the USD continue track higher against the CAD. After trading around 1.3163 a week ago the US unit is now trading at 1.3400 against the CAD, we look for the weaker tone to continue.

Major Announcements
•    US GDP 1.9% vs 2.1% expected
•    US CB Consumer Confidence 114.8 vs 111.3
•    Australian GDP 1.1% vs 0.7% expected
•    Chinese Manufacturing PMI 51.7 vs 50.9 expected
•    UK Manufacturing PMI 54.6 vs 55.7 expected
•    Bank of Canada leaves interest rates unchanged
•    ISM Manufacturing PMI 57.7 vs 56.2 expected
•    UK Construction PMI 52.5 vs 52.2 expected
•    Canadian GDP 0.3% as expected
•    UK Services PMI 53.3 vs 54.2 expected
•    Australian Retails Sales 0.4% a expected