By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar remains under pressure despite its modest gains versus the euro and Japanese yen. USD/JPY rebounded to 112.50 during the North American trading session as yields perked up in the early part of the session, however toward the end of the day, the currency pair sank below 112 before settling slightly above this level. The only piece of U.S. data released Tuesday was the December trade balance and according to the report, the deficit shrank slightly in December. That report, along with Fed President Kashkari’s comments, failed to have much impact on the dollar. Kashkari said a strong dollar should help hold down inflation and fiscal policy should support growth, but the outlook is still unclear. Meanwhile, President Trump’s administration continued to push forward with its plan for a border wall. According to DHS Chief Kelly, the “wall will be well underway within 2 years.” The fact of the matter is that the president hasn’t let up on his protectionist policies, which makes investors very nervous. As we mentioned in Monday’s note, between protectionism in the U.S., populism in the Eurozone and Brexit in the U.K., market participants have many reasons to be worried about the outlook for the global economy. With no major U.S. economic reports scheduled for release on Wednesday, the path of least resistance for USD/JPY should still be lower.
There are 2 monetary policy meetings on this week’s calendar -- the first was Monday night’s Reserve Bank of Australia meeting and the second is Wednesday's Reserve Bank of New Zealand announcement. Like the RBA, the RBNZ is widely expected to leave policy unchanged but a lot has changed in the world since the central bank’s last monetary-policy meeting in November when it cut interest rates by 25bp. The performance of New Zealand’s economy has been mixed. While consumer spending and the labor-market activity slowed, GDP, the trade balance, dairy prices and inflation have been on the rise. The question for the RBNZ will be whether further easing is still needed. When it met in November, the central bank sent the currency tumbling after it surprised with a rate cut. At the time, it was unhappy with NZD's high level and the impact it was having on inflation in the tradables sector. Wheeler did not believe that rates would need to be cut again but his colleague McDermott described the currency as too high, saying it hadn't reached the floor on rates and would ease again if necessary. Unfortunately, the New Zealand dollar has remained strong over the last 4 months, providing the economy and the central bank with very little relief.
The Reserve Bank of Australia, on the other hand, maintained a relatively upbeat tone, noting that conditions in the global economy improved in recent months.It said, “the Bank’s central scenario remains for economic growth to be around 3 per cent over the next couple of years. Growth will be boosted by further increases in resource exports and by the period of declining mining investment coming to an end. Consumption growth is expected to pick up from recent outcomes, but to remain moderate. Some further pick-up in non-mining business investment is also expected.” According to our colleague Boris Schlossberg, “analysts were mixed in their responses with some pointing to a more bullish tone of the statement while other still projected that the next move from RBA will be a rate cut. Still the market appears to be in an almost universal consensus that rate will remain stationary for quite some time.” The Canadian dollar traded sharply lower but it struggled to extend its gains beyond 1.32 amidst mixed economic reports. While Canada reported a stronger-than-expected trade balance (economists had anticipated a pullback), building permits dropped 6.6% and the IVEY PMI index plunged to 57.2 from 60 in January.
Sterling enjoyed a late-day rally against the U.S. dollar and euro on the back of hawkish comments from the Bank of England. According to monetary policy committee Kristin Forbes, based on the current trend of the UK's inflation, she might consider voting for a rate increase. Citing resilient employment and output statistics for the region, even in light of Brexit concerns, Forbes expressed concern for the central bank’s tolerance of overshooting inflation targets. Although she is widely viewed as one of the most hawkish members of the central bank and her views diverge with Governor Carney’s cautious outlook, her comments were enough to turn the pound around, driving sterling sharply higher against all of the major currencies. At the start of the North American trading session, sterling had experienced the sharpest overnight losses on the back of lower house prices. But by the end of the day, it was one of the strongest performers. There are no major economic reports on Wednesday's U.K. calendar, which means Brexit headlines and risk appetite will drive the currency’s flows.
Having traded as low as 1.0650, the euro rebounded to end the day just under 1.07. The initial decline in euro was sparked by a severe miss in industrial activity. German industrial production fell –3% in December, significantly worse than the 0.3% increase investors had anticipated. However the slide in the dollar after the London close helped take EUR/USD off its lows. Turmoil in Greece continues to hamper the currency as Greek 10-year bond yields jumped to 8%. The IMF seemed split over terms of the Greek bailout, which might hamper the IMF’s participation in country's bailout. The divide comes over the size of surplus Greece must retain. The majority of the group contends that the current surplus levels -- which equal about 1.5% of GDP -- is adequate, while another group remains steadfast on a surplus of 3.5% of GDP. As political and economic turmoil continue to dominate headlines in the Eurozone and with no market-moving data on tap for Wednesday, the euro seems poised to remain at the whim of the market’s appetite for U.S. dollars.