By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Donald Trump is now officially the President of the United States, the most powerful country in the world and from here on forward for the next 100 days, every day matters. Investors will be watching Trump's initial executive actions closely. His inauguration speech was focused on protectionism, which sent jitters across the financial markets. The dollar, which had initially traded higher before the inauguration turned negative by end of the North American session. In the first hours of the Trump Presidency, the White House announced that the U.S. will be withdrawing from the Trans Pacific Partnership and will seek to renegotiate NAFTA. Trump's first executive actions included taking down the Affordable Care Act website, signing the Mattis waiver bill into law and formal nominations to Senate and a proclamation for a National Day of Patriotism. There wasn't much more and for that reason the market was disappointed. Looking ahead, there's talk that as much as 200 executive orders targeting Obama policies could be announced on Monday with more ambitious plans to come in the days/weeks to follow. U.S. politics will overshadow economics in the coming week, especially with a light economic calendar. No major U.S. reports are scheduled for release at the start of the week. The trade balance, Markit's PMI reports, new home sales and leading indicators are due on Thursday followed by fourth-quarter GDP numbers, durable goods and revisions to the University of Michigan consumer sentiment index on Friday. There are also no speeches scheduled for Federal Reserve officials. We know that the Fed expects to raise rates 3 times this year but that hinges on Trump delivering a major fiscal stimulus plans. So expect choppy trading in the dollar in the coming week as the market reacts to every speech/policy announcement that Trump makes.
Taking a step back, the hope and danger of Trump policies have investors and foreign governments on edge. Since the election, we've heard from a number of global policymakers who have little confidence in how Trump's policies will affect their economies as they are uncertain as to how much he'll follow through with his pledge for protectionism and a threat of trade wars. In the days since the election, Trump and members of his administration have taken China head-on. He's criticized the country for its excessively weak currency and threatened to slap them with steep tariffs. Since then he's also suggested that he wants to push China on its one-China policy while Rex Tillerson, his choice for Secretary of State, said that the U.S. could block China's access to islands in the South China Sea. This prompted a state-run Chinese newspaper to warn that the U.S. should "prepare for a military clash." So not only could the U.S. be in a trade and currency war with the world's second-largest economy, but there could be military conflict as well. Of course that's unlikely, but relations between the two nations could sour significantly with the potential for a new cold war between the U.S. and China. None of this is positive for the U.S. dollar or the U.S. economy.
Meanwhile, the commodity currencies took center stage at week's end with China releasing mostly stronger economic reports. Apparently GDP growth accelerated to 6.8% in the fourth quarter, up from 6.7% in Q3, retail-sales growth also increased although industrial production ticked lower. However the initial benefit that AUD and NZD received from these numbers faded at the European open on Friday as traders bid up the U.S. dollar. With that in mind, AUD and NZD still ended the week slightly higher against the greenback and euro. Looking ahead, inflation reports are scheduled for release from both Australia and New Zealand. We actually expect divergent price pressures with higher commodity prices and consumer inflation expectations driving Australian CPI upwards, but lower dairy and food prices in New Zealand should keep NZ CPI under pressure. This means AUD/NZD, which had been trapped in a tight 1.0450-1.0560 trading range for the past 9 trading days could finally breakout to the upside.
USD/CAD reversed sharply over the past week as the Canadian dollar experienced steep across-the-board losses. The sell-off was sparked by the Bank of Canada's talk of a rate cut. Even though the central bank raised its growth forecasts for 2016 and 2017 and said that inflation is expected to return to target in the months ahead, the only line that the market cared about was on easing. BoC Governor Poloz said a rate cut remains on the table, which is a departure from last month's firmly neutral monetary-policy stance. The central-bank head feared the consequences from any U.S. protectionism and worried that excess capacity raises the risks of missing their inflation goal. His concerns were validated by the surprise drop in consumer prices -- the second month in a row that CPI declined. However it's worth noting that core prices increased, which means that the overall outlook is not entirely negative. Unfortunately, retail sales also missed expectations, rising only 0.2% in November against a forecast for 0.5% growth. Looking ahead, we expect the Canadian dollar to continue to underperform and more specifically, we like buying dips toward 1.33.
The euro ended the week virtually unchanged against the greenback despite dovish comments from the European Central Bank. As expected, the ECB left monetary policy unchanged and Mario Draghi made no mention that they were considering tapering. While he admitted that inflation increased lately and favorable conditions were preserved, he also said the council needs to look through the rise in inflation because there is no convincing upward trend in underlying inflation. Although the central bank expects the economic expansion to firm further, they also felt that QE could be expanded if the outlook worsens -- and they could as the "risks to the economic outlook remain on the downside." If not for the volatility in the greenback, the euro should be trading much lower. However after multiple intraday tests of 1.0600, it is clear that the bulls do not want give up control. Of all of the major currencies, the one with the most significant economic reports is the euro. January PMIs are due for release on Tuesday followed by the IFO report on Wednesday.
Sterling, on the other hand, had a particularly good week following Prime Minister May's highly anticipated Brexit speech. although she signaled plans for a hard exit, investors were relieved that there is a clear step forward. Unfortunately, her policies won't be kind to the U.K. economy, especially in the near term as Britain will not be seeking partial membership for the EU and it won't be participating in the single market. The good news is that the government will put the deal to a vote in Parliament and May has stressed that she will do her best to avoid a disruptive Brexit cliff-edge by aiming for a phased transition. The U.K. Supreme Court delivers its verdict on Article 50 Tuesday Jan. 24 and it's almost certain that it will rule in favor of Parliament's approval to trigger article 50, which could spark another near-term spike in GBP. After the initial euphoria fades, we expect sterling to resume its slide. There are no major U.K. economic reports scheduled for release next week outside of fourth-quarter GDP numbers and Bank of England Governor Carney's speech on Wednesday.