The trade war is back and investors don’t like it. The U.S. dollar traded higher against all of the major currencies today on the back of a stronger jobs report and President Trump’s threat of fresh tariffs on China and Japan. Stocks extended their slide and unless the President retracts his threats, further losses are likely which means more risk aversion and losses for the major currencies. Today’s non-farm payrolls report guarantees a Fed hike on September 26th. Not only were there more than 200K jobs created in the month of August but wages are growing! Average hourly earnings rose 0.4% last month, the strongest pace of growth in nearly a year. Between the record highs in U.S. stocks last month and the pickup in earnings, next week’s retail sales could surprise to the upside as well. Comments from U.S. policymakers have also been hawkish with Fed Presidents Mester, Rosengren and Kaplan looking for the policy rate to move towards neutral.
The greenback should extend its gains versus EUR, AUD and other major currencies, but the outlook for USD/JPY is tricky. USD/JPY dropped as safe haven carry flows returned home after President Trump hinted that Japan could be the target for their next trade fight. He’s focused on reducing deficits and in a phone interview with the Wall Street Journal he said they may not be happy “as soon as I tell them how much they have to pay.” Late Friday, he also tightened the noose on China by threatening to impose another $267B in tariffs. These threats make it very difficult for stocks and USD/JPY rise. Although the Yen crosses could be hit the hardest, if Trump throws out more threats next week or China/Japan return with hard words of their own, USD/JPY will fall. At the beginning of the month we talked about how September is historically a weak month for stocks and President Trump’s trade war could make things even worse.
The Australian and New Zealand dollars hit a 2-year low and further losses are likely. AUD/USD was hit the hardest by President Trump’s threat of new tariffs on China.Between the mortgage rate hikes, global trade tensions and yuan weakness, the outlook for Australia is grim and therefore AUD/USD could extend its slide below 70 cents. The New Zealand dollar also tumbled – there’s been an irrefutable downtrend in New Zealand data and the deterioration should be evident in next week’s manufacturing PMI report. We believe there could be another 2 to 3% drop in NZD/USD before the pair finds a bottom.
On Friday we learned that Canada lost 51K jobs last month with the nation’s largest province, Ontario, seeing part time work decline by the biggest amount in close to a decade. The increase in full time work is encouraging but with such a significant pullback, the economy is not at risk of overheating. However the market is looking for a rate hike from the Bank of Canada this year and according to Deputy Governor Wilkins, the central bank debated dropping the line “gradual approach” to rate hikes from their policy statement, adding that normally there would be a rise at this point to preempt inflation. This tells us that the central bank is clearly hawkish and open to the idea of raising interest rate before the end of the year. Yet they also don’t want to pre-commit without seeing how the trade talks progress. If a deal with the U.S. is reached before the October meeting, there’s nothing standing in the way of a hike. Not only would we see USD/CAD fall aggressively when the headline hits but it will be the start of a new downtrend that could take the pair down to 1.29. If there’s no deal, USD/CAD could hold strong into the rate decision.
Euro and sterling were also victims of risk aversion and U.S. dollar strength. Sterling had traded above 1.30 on the back of positive Brexit comments from the EU but it gave up all of its gains to end the day in negative territory. There’s a Bank of England monetary policy announcement in the week ahead but Brexit negotiations and data should have a greater impact on the currency because having just raised rates in August, they are in no position to tighten again. The market is also not pricing in another rate hike from the BoE until the middle of next year. The euro ended the week near its 2 week lows on the back of softer German data. Italian yields fell every day this past week so Italy is less of a problem but there’s very little reason for the ECB, who also has a policy meeting next week to change their neutral bias. The central bank made it clear at recent meetings that they have no plans to raise interest rates until late next year and data since the July meeting has been mixed. ECB President Draghi is worried about low inflation and given the lack of a significant increase in price pressures, his view that it is too early to call victory on inflation will remain unchanged. He will make this along with his concerns about global trade clear during his press conference this week. With US data improving and the Fed poised to raise interest rates later this month, neutral comments from the ECB could drive EUR/USD to 1.14.