The meltdown in the forex market on Friday is a reminder of why you shouldn’t be sleeping at the wheel in the month of August – either stay away or be prepared for big moves in the financial markets.
Summer vacations in Europe and the US mean lower liquidity, which can compound movements in currencies. In the first 10 trading days of August, the US dollar Index hit 1-year highs, driving EUR/USD to its lowest level since July 2017. GBP/USD hit its weakest level since June 2017 and the Australian dollar fell to its lowest since January 2017. NZD/USD reached levels not seen since March 2016. These moves were fast and aggressive, driven first by concerns about local factors (Brexit, RBNZ) and later by Turkish contagion. Economic data had very little impact on the markets and we should expect more of the same in the week ahead.
Turkey has its own troubles but it is not a localized risk. They are in a political spat with the US, the market isn’t happy with their economic policies, Washington has imposed sanctions and the rising US dollar is driving up the cost of debt. Other countries like China and Russia also have diplomatic tensions with the US, the Trump Administration has imposed sanctions on many nations, Argentina has political troubles and the stronger dollar poses serious risks for countries around the world. So in the low liquidity month of August, emerging-market troubles could spill over to the rest of the world. The European Central Bank previously expressed concerns about non-hedged exposure of European banks to Turkish companies. If Turkish banks fail, there’s no question that it will affect markets around the world.
US Dollar
Data Review
- PPI Final Demand 0.5% vs 0.2% Expected
- PPI Ex Food and Energy 0.1% vs 0.2% Expected
- PPI Ex. Food Energy and Trade 0.3% vs 0.2% Expected
- CPI 0.2% vs 0.2% Expected
- CPI Ex. Food and Energy 0.2% vs 0.2% Expected
Data Preview
- Empire Manufacturing, Retail Sales, Industrial and Manufacturing Production – Potential for upside surprise as Redbook retail sales rose 0.9% over the previous month. Wage growth accelerated
- Philadelphia Fed, Housing Starts and Building Permits – Will have to see how Empire State survey fares but a stronger dollar, higher interest rates could take a toll on these reports
- The University of Michigan Report – Potential for upside surprise after IBD/TiPP Economic Optimism index Hits 14-month high
Key Levels
- Support 110.00
- Resistance 112.00
The US dollar is rising because investors are flocking into the safety of the greenback. While the stronger dollar is a growing problem for countries around the world, so far it hasn’t taken a significant toll on the US economy. A strong currency is supposed to hurt exports, drive inflation lower, cause businesses to curtail hiring but so far we haven’t seen any evidence of that. Inflation growth is still strong with year over year core CPI growth rising to its highest level since 2008 last month. Job growth is healthy, wages are on the rise and consumer confidence is steady. The only place we’ve seen an impact is corporate earnings. Retail sales, which is the only piece of market moving data on the US calendar this week should be slightly weaker but strong enough to allow the Fed to raise interest rates.
At some point, the strong dollar will take a bite out of the US economy, especially if it continues to stress other countries but we haven’t seen evidence of that yet. The relentless uptrend in the dollar won’t end until US officials try to talk it down or policymakers take steps (verbally or physically) to stem the slide in their own currencies. Otherwise, divergences in growth and monetary policy are being reinforced on a weekly basis, pushing currencies further into the extended territory. In the weeks ahead, we look for trading ranges to expand and new milestones to be reached. It will be important for traders to stay on the lookout for comments or policy changes because current trends in the FX market will remain in place until a major catalyst shifts investor sentiment.
British Pound
Data Review
- Visible Trade Balance 11.38b vs -11.9b Expected
- Visible Trade Balance Non EU -2.94b vs. -3.60b Expected
- Trade Balance -1.86b vs -2.5b Expected
- Industrial Production 0.4% vs 0.3% Expected
- Manufacturing Production 0.4% vs 0.3% Expected
- GDP 0.1% vs 0.2% Expected
Data Preview
- UK Labor Report – Tough to predict as weak job creation in services is offset by strong growth in manufacturing
- UK CPI – Hard to predict as Inflationary pressures moderated in July in the manufacturing sector but accelerated in services. BRC shop prices also fell but at a more moderated pace
- Retail Sales – Potential for downside surprise given weaker growth in BRC retail sales and continued decline in shop prices
Key Levels
- Support 1.2700
- Resistance 1.3000
Sterling weakness has been one of the most consistent trends in the forex market this month. GBP/USD fell every day this past week despite stronger trade, industrial production and Q2 GDP data. Investors are growing more concerned about the risk of a no-deal Brexit, worried about UK bank exposure to Turkish debt and more certain that the turmoil in the financial markets will keep monetary policy unchanged for the rest of the year. The UK government has 7 months to strike a deal with the European Union or risk damaging morale and delaying business investments by extending negotiations. Investors have grown skeptical of Brexit headlines as they ignored reports that the European Union may be willing to offer a major concession to Prime Minister May. Rumors are no longer having a material impact on the currency as investors wait for definitive progress or setbacks on Brexit talk. With a number of important economic reports on the calendar, sterling will remain in focus in the week ahead. The latest employment, inflation and consumer spending numbers are scheduled for release and given the extent of GBPUSD’s decline this month, if any of them surprise to the upside, we could see a furious short squeeze.
Euro
Data Review
- GE Factory Orders -4.0% vs 0.5% Expected
- GE Trade Balance 21.8b vs 20.8b Expected
- GE Current Account Balance 26.2b vs 21.2b Expected
- GE Industrial Production -0.9% vs -0.5% Expected
Data Preview
- GE GDP and CPI – Potential for upside surprise as stronger trade and retail sales points to firmer German GDP.
- EZ Industrial Production, GDP and GE ZEW Survey – Potential for downside surprise given a sharp drop in German IP and factory orders. EZ GDP is hard to predict as it is released the same day as the German report
- CPI - Inflationary pressures moderated in July in the manufacturing sector but accelerated in services. BRC shop prices fell but at a more moderated pace
- EZ Trade Balance – Potential for upside surprise given stronger German and French trade balance
- ECB Current Account and EZ CPI – Inflation rose in Germany but inflation dropped in France
Key Levels
- Support 1.1250
- Resistance 1.1700
For the first time in over a year EUR USD is trading below 1.15. The single currency has been trending lower since the beginning of the second quarter and has come close to testing this support level on numerous occasions. The meltdown in Turkey was the straw that broke the camel’s back, opening the door to the deeper slide towards 1.12. There wasn’t much Eurozone data released over the past week but the few reports we had were far from impressive as factory orders and industrial production in Germany tumbled. The calendar heats up in the week ahead with Q2 GDP, CPI and ZEW scheduled for release. However, all that will take a backseat to Turkey’s troubles. Banco Bilboa Vizcaya Argentaria, UniCredit and BNP Paribas (PA:BNPP) have the greatest exposure to Turkish debt and many of their loans are unhedged. According to data from the Bank of International Settlements, Spanish lenders are the most exposed followed by Italian and French banks. Over the last year, the Lira has lost 33% of its value and its cost of servicing its debt has risen to the highest level in 9 years. If Turkey’s economy crumbles more migrants could be headed to the EU, making Turkey a political and economic crisis for the region. From a fundamental and technical perspective, the euro is vulnerable to additional losses.
AUD, NZD, CAD
Data Review
Australia
- RBA Leaves Interest Rates Unchanged, Slightly Optimistic Tone
- Current Account Balance 5.8b vs -34.1b Expected
- China Trade Balance $28.05b vs $39.05b Expected
New Zealand
- RBNZ Keeps Rates Steady but Pushes Out Forecast for Hike
- GDT Prices Remain Unchanged
- 2-Yr. Inflation Expectations 2.04% vs 2.01% Prior
- Business NZ Manufacturing PMI 51.2 vs 52.7 Prior
Canada
- IVEY PMI 61.8 vs 63.1 Prior
- Building Permits -2.3% vs -0.1% Expected
- Housing Starts 206.3k vs 219.0k Expected
- Housing Price index 0.1% vs 0.1% Expected
- Full-Time Employment Change -28.0k vs 9.1k Prior
- Part Time Employment Change 82.0k vs 22.7k Prior
- Net Change in Employment 54.1k vs 17.0k Expected
- Unemployment Rate 5.8% vs 5.9% Expected
Data Preview
Australia
- Wage Price Index – Potential for upside surprise as the health of labor market should foster stronger wage gains
- Employment Report – Potential for downside surprise given significantly weaker services and manufacturing employment.
New Zealand
- Q2 PPI – Potential for downside surprise give weaker CPI growth
Canada
- Existing Home Sales - CAD housing data is hard to predict but home sales reports are becoming more important
- CPI - Drop in price component of IVEY PMI signals weaker price growth
Key Levels
- Support AUD .7150 NZD .6500 CAD 1.3000
- Resistance AUD .7400 NZD .6700 CAD 1.3200
The commodity currencies have been hit particularly hard by the rise in the US dollar. The Australian, New Zealand and Canadian dollars tumbled, with NZD leading the slide. The Reserve Bank of New Zealand’s interest rate outlook and risk aversion were a double hit for the currency, sending it down to its lowest level in 2.5 years. The RBNZ left interest rates unchanged but they pushed out their forecast for a rate hike out by a year to Q3 of 2020 from Q2 of 2019. This significant change reflects their concern that the moderation in growth could last longer especially with no improvement in dairy prices and manufacturing growth slowing in the month of July. This outlook for rates contrasts sharply with the tightening cycles in the US, UK and possibly Canada. The next major support level for NZD/USD is 65 cents but we see the currency falling as low as 64 cents. This ’s PMI services and PPI reports aren’t expected to help the currency.
Although the Reserve Bank of Australia is far less dovish than the RBNZ, AUD/USD broke its 2-month long range to trade at its lowest level in 19 months. The first leg of the move happened after RBNZ and Turkey triggered the second. Australian fundamentals aren’t terrible but as a high beta currency, AUD has and could continue to sell-off on risk aversion but when the turn happens, it could be one of the first to benefit. While the RBA left interest rates unchanged, they upgraded their 2018 inflation forecast. Governor Lowe believes that the most likely scenario is for the economy to continue on its current track. He is confident that inflation will get back to 2.5% and if the outlook stays favourable the next rate move will be up. With that in mind, he made it clear that there is no strong case for near-term adjustment in policy. AUD/NZD hit its highest level in 9 months and while it sold off on Friday, the pair should resume its rise if upcoming economic reports reinforce the Reserve Bank’s optimism. Labour market numbers for the month of July are due for release this week along with the wage price index, consumer inflation expectations, business and consumer confidence. The RBA Governor will also deliver his semiannual testimony. According to PMIs, job growth was strong in the manufacturing sector and most importantly, wages and inflation expectation could be on the rise due to the prior strength of the labour market and the weaker currency.
USD/CAD on the other hand traded in a comparatively tight 150-pip range until Friday when it broke to the upside. The blowup in Turkey, wild swings in oil, release of key Canadian economic reports and the diplomatic rift between Canada and Saudi Arabia failed to have a significant impact on the currency until the very last few hours of trade. This is because of the divergent effects on the loonie. On the one hand, political tensions, oil prices and Turkey’s problems is negative for CAD (and positive for USD/CAD) but the unexpectedly strong employment report reinforces expectations for a rate hike by the Bank of Canada this year. Not only was job growth in July the strongest this year but the gain in services employment was the largest on record. The unemployment rate also declined to match its 40 year low. Rate hikes in the current environment could become rare making the Canadian dollar more attractive compared to other major currencies. CAD CPI is due at the end of this week and this report will play an essential role in setting expectations for BoC policy.