By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The Trump Administration plans to cut taxes and the Federal Reserve’s intention to raise interest rates one more time this year should have driven Thursday's dollar sharply higher. But instead of rising, the greenback fell because investors are not convinced that the Fed and President Trump will sufficiently deliver. Although Thursday’s U.S. trade balance, GDP and jobless claims were better than expected and Fed President George — not a voting member of the FOMC — said it is appropriate to have further gradual hikes, the comments from other U.S. policymakers who have spoken this week were far less encouraging. On tax cuts, Treasury Secretary Steven Mnuchin said that President Trump will not accept anything less than a 20% corporate tax rate and would be willing to consider a 4th tax bracket. These comments suggest that the plan is far from complete and it will take months before receiving Congressional approval. With next week’s nonfarm payrolls report expected to reflect the loss of job growth due to the hurricanes, the dollar could see a deeper correction. Bond traders seem to share our view as ten-year Treasury yields go from up 3bp to flat by the end of the day. Personal income, spending and the Chicago PMI report will be released on Friday. Given the softness of wage growth and the unexpected decline in retail sales last month, the risk is to downside for Friday’s reports.
After falling for 3 consecutive trading days, the euro finally rebounded against the U.S. dollar and we think more gains are in store. Germany’s unemployment report is due Friday and based on the PMIs, widespread improvements have been seen in the labor market. Stronger German data against weaker U.S. data would highlight the disparities between the 2 economies and encourage further gains in the currency. With the FOMC meeting and Trump’s tax announcement behind us, investors will now shift their focus to next week’s U.S. nonfarm payrolls report and the October ECB meeting, both of which are expected to be positive for EUR/USD. Although German Chancellor Angela Merkel still hasn’t formed a coalition government, she will eventually and when the announcement is made, the EUR/USD will rise on the evaporation of election uncertainty. For all of these reasons, we expect EUR/USD to find its way back up to 1.1850 and possibly even 1.19.
Thursday's best-performing currency was the British pound, which shot up to 1.3450 on the back of U.S. dollar weakness. We haven’t heard from Bank of England Governor Carney as there's no set time for his speech, but since he is only at the BoE conference until Friday, we are likely to hear from him tomorrow. Based on the performance of the currency, there’s no doubt that investors are looking for the BoE head to repeat that a rate hike may be needed in the near future. Friday is a busy day for pound sterling with current account balance, Nationwide House Prices, mortgage approvals and revisions to second-quarter GDP scheduled for release. These reports are not major market movers but after a week with very little U.K. catalysts, we could finally see a move fueled by sterling fundamentals. However if Carney speaks, his comments will have a more significant and lasting impact on the currency. Taking a look at how the currency is trading, GBP/USD appears prime for a move back up to 1.35 after a four-day decline.
All 3 of the commodity currencies traded higher against the greenback led by gains in the Canadian and New Zealand dollars. After shooting higher on Wednesday, USD/CAD has done a good job of shrugging off Bank of Canada Governor Poloz’s less-hawkish comments. It is clear that speculators are committed to buying the loonie despite Thursday’s more than 1% drop in oil prices and pullback in Canadian bond yields. Fundamentals have shifted against the Canadian dollar but with the greenback falling USD/CAD traders are finding fresh reason to sell the currency. The New Zealand dollar extended its post RBNZ gains as investors looked past the central bank’s concerns about inflation and firmly neutral monetary policy stance. The Australian dollar, on the other hand, ended the day unchanged as AUD/NZD selling weighed on the currency. No Australian economic reports were released on Thursday and nothing is expected on Friday. Investors will have to look to next week’s RBA meeting for more pronounced guidance.