With no major economic reports released in the last 48 hours, FX traders have been yanked around by risk on / risk off flows. Investors are having a hard time deciding whether the drop in yields is positive or negative for stocks. On the one hand, lower rates are good for borrowing but on the other, the yield curve inverted as a result of falling interest rates. An inverted yield curve correctly predicted nearly every recession in the past 50 years – being wrong only once. The reason why it is so accurate is because when short term rates exceed long time rates, it is telling us that investors are worried about the near term outlook for the economy and want to be compensated more for tying up their money during this time. But don’t expect a recession to happen next month – on average, we’ve seen the yield curve invert 18 months before a recession so it may be well over a year before growth starts to contract. With that in mind, there’s no doubt that global growth is slowing as central bankers around the world warn about the implications on their domestic economies. So while declines in stocks are finding buyers, a deeper decline could be right around the corner which is why the Federal Reserve thinks interest rates need to stay where they are currently to support the economy. This means that for the US dollar, which is still holding above 110 against the Japanese Yen, the downtrend should remain intact.
While we haven’t see much movement in USD/JPY, AUD/USD and NZD/USD traders are being more aggressive about discounting the possibility of a US or global recession. Both currencies are down sharply today with NZD experiencing its biggest one day decline in 7 weeks. The last time NZD/USD fell this much, economists had been looking for the unemployment rate to rise from 3.9% to 4.1% but instead it rose to 4.3% in the fourth quarter. Today’s move was triggered by dovish comments from the Reserve Bank of New Zealand. The RBNZ surprised investors last night by saying a rate cut is more likely now than a hike as the balance of risks shifted to downside due to lower business sentiment and a more pronounced global downturn. This is a major departure for Governor Orr who just last month said the chance of easing did not increase despite recent downgrades to growth. Having broken below a number of important technical levels, the next stop for NZD/USD should be the March low near .6750. The slide in NZD also affected AUD but softer Chinese industrial profits were to blame as well. Profits dropped 14% yoy between January and February and this deterioration could prompt additional policy action from the central bank. The Canadian dollar also ended the day lower following a smaller than expected improvement in their trade balance.
The best performing currency today was sterling, which rallied on the back of Prime Minister May’s pledge to resign if Parliament supports her Brexit deal. While this changes nothing in the Withdrawal Agreement, it seemed to be enough for some MPs to switch their votes. A third meaningful vote could happen at the end of the week and if it is approved, we could see a wild rally in GBP.
After selling off sharply on Tuesday, EUR/USD remained under pressure as German 10 year bond yields drop to a 2.5 year low. There are no shortages of factors keeping the euro down including the ECB’s dovishness, negative German rates and risk aversion. However tomorrow’s economic reports could help rather than hurt the currency. Eurozone confidence and Germany’s consumer prices reports are scheduled for release. While the contraction in manufacturing activity should dampen sentiment, business confidence and investor confidence improved last month so the risk is to the upside for tomorrow’s reports.