The last week of Q3 was another good one for the U.S. dollar. The greenback climbed to 13-month highs against the Japanese Yen and renewed its rally versus the Swiss Franc, euro, New Zealand and Australian dollars. Interest rate differentials played a major role in the dollar’s rise as the Federal Reserve raised interest for the third time this year. There were a lot of big stories that affected currencies this month including trade wars, Brexit and Italy’s debt crisis. The Japanese Yen was hit hard but the biggest losers were the euro and Swiss Franc. Sterling was the most resilient but trader positioning was the only reason for the currency’s steady performance. As we look ahead, many of the events that affected currency trade in September will continue to rattle the forex market in October. The UK has a Tory Conference this weekend, Italy’s Economy Minister Giovanni Tria could still resign while US-Canada trade negotiations continue. This means that while some of the major currencies found a bottom in late August or early September, they are still at risk of further losses in the third quarter.
The market’s focus on the direction of U.S. monetary policy is the one thing that could change in October. After raising interest rates by 25bp at their last meeting, the Federal Reserve is not expected to change policy for another 2.5 months. One of the main reasons why the dollar is strong is because the Fed’s dot plot moved in favor of another rate hike in December. In June, only half of the Fed Presidents saw 4 rate hikes this year but now 75% of them support an additional move before year-end. As a result, investors have priced in a 72% chance of another quarter point lift in rates. However, a lot can change between now and then so data closer to the December 19th meeting will have greater importance than data in October. In other words this month’s economic reports could have less impact on the dollar. The September ISM numbers and non-farm payrolls report are scheduled for release next week. Job growth and wage growth were strong in August so a slightly softer number is possible. Even if that’s the case however, this report alone won’t discourage the Fed from hiking in December. Technically, the dollar has more room to rise with 114.75 being the key resistance for USD/JPY.
Canada failed to reach a trade deal with the US this past week and all signs point to President Trump moving forward with Mexico alone. However instead of falling, the loonie soared on Friday as investors looked past the trade disappointment to the prospect of a rate hike from the Bank of Canada this month. The belief is that Canada will reach a deal with the US eventually and in the meantime, underlying fundamentals support the need for tightening. Despite the trade tariffs, Canada’s economy is doing well and GDP growth was stronger than expected in July. BoC Governor Poloz even said that uncertainty shouldn’t prevent rate hikes. Next week’s Canadian IVEY PMI and labor market reports should reinforce the case for tightening because a recovery in job growth is expected after last month’s sharp decline.
The biggest problem for the euro is Italy. The single currency was hit hard on Friday after the newly elected populist government decided on a 2.4% deficit target for 2019. Both the EU and the country’s finance minister had hoped to keep the budget between 1.6% and 2% of GDP, but the coalition defied their wishes by agreeing on a much higher budget deficit. In response, Italian stocks collapsed and yields spiked higher. The euro was casualty of these moves because investors are worried that this decision will lead to more trouble for Italy. While the new deficit target is still below the EU’s 3% limit, the decision to go against Finance Minister Tria’s recommendation could prompt his resignation. As an independent economist his appointment was a move to reassure the markets so a resignation could cripple the government. Italy’s President has already asked Tria not to resign to in order to maintain stability and he’s likely to stay on but until he makes an official announcement the uncertainty could keep euro under pressure. If we look beyond Italy’s troubles, German business confidence improved, leading to lower unemployment in the month of September. ECB officials have also been more vocal about price pressures. At the start of the week. ECB President Draghi said he sees a relatively vigorous pick up in underlying inflation and on Friday, ECB member Lane said wage data is increasingly positive. This means that when we hear from the ECB at the end of October, their comments on inflation should be more hawkish. Fundamentally, euro should take its cue from risk appetite, Italy headlines and the U.S. dollar as there’s not much in the way of market moving Eurozone data next week. Technically, as long as EUR/USD remains below 1.1650, the path of least resistance should be lower.
Next week is an important one for the British pound because there’s a Tory Party Conference that ends with a speech by Prime Minister May in the middle of the week. The UK government has rejected the EU’s border proposals and their unwillingness to bend on border terms has made negotiations difficult. With this in mind, Brexit headlines and UK PMIs will have a big impact on sterling this week – our bias is to the downside as May is expected to maintain a hardline approach while UK manufacturing activity is expected to have weakened in the month of September.