After a week like the one we’ve had, everyone is wondering if 2019 will be a year where 500+ point daily moves in the Dow and 100 pip rollercoaster rides in currencies become the norm. Although the moves in FX don’t seem significant, on an intraday basis the swings have been wild. The year started with a warning that slower Chinese demand took a big bite out of sales in the fourth of 2018 and will dampen earnings in the first quarter of 2019. This bombshell triggered a flash crash in currencies that took USD/JPY down 400 pips in a matter of minutes. Pairs like EUR/USD and AUD/USD also saw multi-cent losses. However the flash crash proved to be just that as all of the major currencies rebounded on Friday on the back of a strong U.S. non-farm payrolls report that drove the Dow up more than 700 points.
Although the December jobs report was exceptionally strong with the US economy adding the most jobs since February, the acceleration in average hourly earnings and 312K increase won’t be enough to draw investors back into the dollar. The problem is that going into 2019, the Federal Reserve signaled fewer rate hikes and on Friday, Fed Chair Powell reinforced that outlook by saying that while jobs and wage data were strong, they do not raise their concerns about inflation. Instead, he expressed concerns about China weakness spilling over to other parts of the world and said he felt that the drop in the manufacturing ISM report was worth keeping an eye on. More importantly, he stressed the need to be patient as we watch how the economy evolves and the need to be prepared with flexible policy. The markets are sending downside risk signals and the Fed will take into account the market’s concerns. Stocks soared in response as investors sensed Powell’s hesitancy in raising interest rates. In fact Fed fund futures are now pricing in a rate cut this year which is a stark contrast to the central bank’s forecast for 2 hikes.Regardless, the cautiousness of the central bank and the strength of US labor data provides the perfect catalyst for recoveries in the Japanese Yen and Swiss Franc crosses, euro, Australian, New Zealand and Canadian dollar. USD/JPY rebounded on Friday but like USD/CHF, the downtrend is well established so recoveries will be shallow.
In our 2019 preview, we expected some additional losses for the Canadian dollar at the start of the year before a late spring, early summer recovery. However CAD bulls jumped the gun and have taken USD/CAD down 200 pips in the last 48 hours. From every angle, it seems that USD/CAD has peaked and is poised for a deeper move below 1.33. Today’s softer than expected Canadian labor market report and stronger US jobs number failed to discourage the sellers. The data wasn’t terrible because after the single biggest one month job gain since 2010, a slowdown in hiring was widely expected. The good news was that unemployment rate did not increase but wages held steady. 2019 should be a good year for Canada and the central bank will take that outlook into consideration when they meet next week. The Bank of Canada is widely expected to leave interest rates unchanged at 1.75% but their outlook could brighten.
The Australian and New Zealand dollars became the best performing currencies on Friday thanks to stronger Chinese data. Service and economic activity accelerated at the end of the year according to Caixin’s latest PMI reports. The People’s Bank of China also cut its reserve requirement ratio for the first time in more than 2 years, which helps to free up capital and liquidity. In Australia, the CBA upgraded their December reading of service sector activity in Australia. Trade talks between the US and China begin early next week and while the latest travel warning on China hurts more than helps US-China relations, the Chinese continue to make modest concessions in hopes for a deal. While there are no New Zealand economic reports in the week ahead, the PMI, trade balance and retail sales reports will go a long way in telling us how much the slowdown in China hurt Australia’s economy at the end of the year if at all. In our 2019 forecast we talked about a bottom in AUD/USD, which seems to be happening already.
Sterling also performed well thanks to stronger PMIs. Service and manufacturing activity accelerated at the end of the year but it is hard to imagine that any breakout will be sustainable until we know the resolution of the Parliament Brexit vote. The debate will be held this coming week followed by a vote the week of January 14th. The vote was postponed from December in the hopes that time would allow Prime Minister May to convince more lawmakers to support her plan. So far, it doesn’t seem like she will win the support that she needs which means Britain will leave the EU on March 29th with no deal – the worst case scenario for GBP.
Last but not least, the euro was constrained by downward revisions to December PMIs. Data from the Eurozone this week hasn’t been great and we don’t expect much support from next week’s German industrial production and trade reports. While we believe that 2019 will be a good year for EUR/USD, it may take some time before resistance at 1.15 is broken.