By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
No bulls were in sight Monday as the U.S. dollar traded lower against all of the major currencies. Softer U.S. data may finally be catching up to the greenback but the primary reason for the dollar’s slide was the improvement in risk appetite. Reports that the U.S. will “only” impose a 10% instead of 25% tariff on $200 billion of Chinese goods had some investors hoping that a smaller penalty will discourage Chinese retaliation. We don’t see how a fresh round of tariffs, regardless of the amount, can be positive for U.S.-China relations, especially after China threatened to hit back when these tariffs were first announced. Now, with their patience wearing thin they may not back down. Trade tensions are also hurting the U.S. economy with American businesses strongly criticizing the tariffs. The cracks are beginning to show as the manufacturing sector in the NY region experienced a significant slowdown in September. With consumer spending and inflation also weakening, the Federal Reserve may choose to forgo a hike in December after tightening later this week. If the U.S. proceeds with 10% tariffs and China stays silent, the dollar will extend its slide against all of the major currencies except for the yen, which also benefits from risk appetite. However if they opt for 25% tariffs or China retaliates, risk aversion could return quickly. President Trump planned to make an announcement after Monday's market close.
Monday's best-performing currency was sterling, which rose to its strongest level against the U.S. dollar in 6 weeks. The market is operating on the assumption that a Brexit deal in one form or another will be made. The Irish border is the biggest hang up but there are reports that the EU is more willing to accept the idea that border inspectors come from the UK. While encouraging, Prime Minister May said Monday that it is time for the EU to respond to their proposal and not just fall back on previous positions, which suggests that negotiations may not be moving as well as the market believes. This is a big week for the UK with inflation and retail sales scheduled for release. We believe that price pressures will accelerate given the uptick in shop prices reported by the British Retail Consortium and the increase in input/output costs reported by manufacturing- and service-sector PMIs. If we’re right and CPI accelerates, GBP/USD could extend its gains above 1.32.
The euro and Swiss franc also rallied on the back of U.S. dollar weakness. EUR/USD in particular benefitted from positive comments by the Bundesbank. Despite the recent downturn in German data, the Bundesbank expects German growth to improve significantly with the upswing intact. ECB member Vasiliauskas added that there’s no reason to talk about extending stimulus. The Swiss franc has been very strong – the currency hit a 5-month high against the U.S. dollar and is trading near a 1-year high versus the euro. The Swiss National Bank meets this week and they won’t be happy with the recent rise in the currency. If they express more concerns about the currency’s strength, we could finally see a top in the Swissie.
Commodity currencies benefitted the most from the improvement in risk appetite with the New Zealand dollar leading the gains. NZD/USD rallied despite weaker service-sector activity. The New Zealand dollar is in play this week with a dairy auction on Tuesday and second-quarter GDP on the calendar. The deeply oversold currency is craving a recovery but that can only happen if there’s good data. So far, dairy prices have struggled to rise and growth as a whole has been subdued. The Australian dollar was exceptionally vulnerable to the tensions between U.S. and China. Last week, the Trump Administration said it wanted to restart trade talks with China but over the weekend, there were reports that the Chinese could skip the meeting altogether. According to Wall Street Journal, “Another issue complicating any further talks with Washington: Chinese officials regularly complain that they don’t know whether any U.S. officials are empowered to cut a deal. In addition, they worry that any offer Beijing makes to Mr. Mnuchin could be opposed by trade hawks led by U.S. Trade Representative Robert Lighthizer and trade adviser Peter Navarro and then get turned down by Mr. Trump.” While Trump’s announcement on China will have the greatest impact on AUD and NZD overnight, the Australian dollar could get a lift from the RBA minutes as the tone of the last monetary policy statement was positive. Although USD/CAD bounced off 1.30 on the back of softer Canadian housing data, the pair failed to extend lower as investors wait for updates on US-Canada trade talks. There was no high-level meeting on Monday but Canadian foreign minister Freeland plans to return to the U.S. this week. No date has been announced but the clock is ticking and something needs to happen by Thursday for the September 30 deadline to be reached.