It was another rocky day in the financial markets with the Dow falling more than -1,000 points. It should be no surprise that this volatility kept investors away from currencies especially as U.S. yields continue to rise, adding pressure on the economy. Pairs such as EUR/USD and GBP/USD raced upwards before the equity market open but retreated from their highs by the end of the day. Unfortunately, even if the sell-off in stocks turns out to be nothing more than a healthy correction, we’re going to need a few weeks of stabilization before FX traders can be convinced that its time to return. Until then, expect limited bargain hunting and more profit taking on high beta currencies. This morning’s jobless claims report had zero impact on the dollar with claims falling towards its 45 year low. We also heard from a number of U.S. policymakers in the past 24 hours. Fed President Williams who is the only voting member of the FOMC sees an expansion across the full range of sectors and expects inflation and GDP to rise this year. He sees anywhere between 3 to 4 rate hikes in 2018. Fed President Kaplan who is a non-voter also sees 3 rounds of tightening as the labor market continues to strengthen in 2018 but Harker who is a nonvoter is not convinced that inflation and GDP will rise. With no U.S. economic reports scheduled for release on Friday, equity moves will continue to drive FX flows.
Sterling shot higher on the back of the Bank of England’s monetary policy announcement after the central bank upgraded its 2018 and 2019 GDP forecasts and expressed their belief that rates may need to rise earlier and faster than what they had seen in November. This degree of hawkishness caught the market completely by surprise as manufacturing and service sector activity slowed in the month of January. Yet sterling failed to hold onto its gains as risk aversion overshadowed the unambiguously positive tone of the Quarterly Inflation report and Mark Carney’s speech. Limited spare capacity, excess demand, rising wages, stronger productivity, lower unemployment and faster global growth gave the BoE the confidence to telegraph tightening in an environment of rising volatility, a stronger currency, higher Gilt yields and ongoing Brexit uncertainty. Previously, they felt that inflation peaked but today, Carney said domestic pressures are likely to firm with CPI to rise above 3% again in the shot term and in order to get CPI back to goal, they may need to raise rates faster. They see 3 rate hikes over the course of 3 years and the market is now pricing in a 70% chance of a hike in May, up from 47% yesterday. The BoE’s hawkishness changed the near term course of GBP and we think its only a matter of time before it resumes its rise. Friday’s industrial production and trade balance reports should have a limited impact on the currency.
The euro rebounded off its lows to end the day unchanged against the U.S. dollar. Data was mixed with Germany reporting a smaller trade balance and larger current account surplus. However exports and imports increased, reinforcing the underlying strength of the economy. Comments from ECB officials and the central bank’s economic bulletin provided very little fresh insight. Like his peers Weidmann did not seem overly concerned about the level of the currency – he said euro gains are unlikely to jeopardize the expansion and he called for the ECB to communicate without fear of market backlash. ECB member Praet also indicated that guidance will increase in importance going forward. These comments along with the positive performance of the Eurozone economy suggests that EUR/USD could stabilize above 1.22 especially with no major Eurozone economic reports scheduled for release on Friday.
All 3 of the commodity currencies ended the day unchanged against the greenback with the Australia dollar leading the slide. There were no Australian economic reports released today but AUD failed to participate in a recovery that took NZD/USD back towards its high. Although acting Central Bank Governor Spencer was nonchalant about the recent gains in NZD, Assistant Governor McDermott who is also the head of economics made it clear that their stance on rates is neutral and that a drop in inflation expectations could trigger a rate cut. He expects the New Zealand dollar to weaken as the Federal Reserve raises interest rates. This drove NZD/USD back down after the rate decision but there was aggressive buying of NZD specifically after the London close. China reported a significantly smaller than anticipated trade surplus which hurt AUD and NZD initially even though exports and imports rose more than expected. The 36.9% increase in imports was the fastest pace of growth since last February. While it is a sign of demand picking up, it could also be seasonal as demand is always stronger ahead of the Lunar New Year holiday. The Canadian dollar is in focus tomorrow with labor market numbers scheduled for release. Between the last 2 months of exceptionally strong job growth and the decline in the employment component of IVEY PMI, softer numbers are expected. With that in mind, the forecasts are very low and it may not take much to beat.