By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The year is drawing to a close with extended moves in many major currencies. USD/JPY is trading at the top of its 9-month range and the EUR/USD is about 200 pips from its year to date high, which is a dramatic appreciation from where it started the year, at 1.05. This past week has been marked by quiet strength in the euro, U.S. dollar and commodity currencies. It is not common to see simultaneous gains in the majors as the dollar usually drives FX flows, but this week was all about risk appetite stemming from Congressional approval of the tax-reform bill, which sparked gains for currencies, Treasuries and equities. President Trump signed the tax bill into law on Friday and the Senate passed a temporary spending bill to keep the government running through January. Outside of last-minute year-end flows, there’s not much to drive FX moves next week. The U.S. calendar includes the Conference Board’s consumer confidence index, pending home sales, the trade balance and Chicago PMI. Not much is expected from these second-tier releases though they should be stronger, which would keep the dollar bid along side repatriation flows. Fed Presidents Bullard, Harker and Mester are scheduled to speak and they are not expected to deviate from the central bank’s positive outlook and view that gradual tightening is needed. The latest U.S. economic reports were mixed with personal spending and new home sales rising more than expected but personal income, durable goods orders and the University of Michigan Consumer Sentiment index fell short of expectations.
No Eurozone economic reports were released on Friday and after 4 out of 5 days of gains, EUR/USD could pull back in the coming week even though the long-term outlook is positive. The latest economic reports were mixed with German producer price growth slowing and the expectations component of the IFO report slipping. Trade and current account activity in the Eurozone also slowed in October. The German economy is performing well but the prospect of softer German CPI next week could prevent further gains in the currency. There’s also plenty of resistance above current levels at 1.19, the November high of 1.1960 and of course 1.20. Angela Merkel is still working on forming a coalition government and it is not clear how much longer it will take but the drawn-out process has created an environment of complacency for EUR/USD traders.
The U.K.’s political troubles on the other hand are very real. The Brits have gotten approval to move to the second stage of Brexit talks but there are still many unanswered questions and comments from the European Union’s Chief negotiator suggests they are still playing hardball. No new developments are expected next week but come January, there will be fresh parliamentary debates (on Jan 16 and 17). In the meantime, Prime Minister May’s political crisis is deepening with the resignation of Damian Green, one of her closest political allies over a porn scandal. This is a difficult loss for May as she heads into most challenging parts of Brexit negotiations and could give fodder to those in the government who seek to push May out. Sterling for the most part has been resilient but as negotiations continue, the currency is at risk of more volatility and losses.
Meanwhile it was a great week for the commodity currencies. The Canadian dollar finally broke out of a tight consolidation, paving for fresh gains in the coming year. Friday’s GDP report fell short of expectations with growth stagnating instead of accelerating but the disappointment put only a small dent into the Canadian dollar’s rally. Overall, consumer spending and inflation are up year over year with these reports reinforcing the tremendous progress that the central bank has seen in the economy, which increases the odds of a first-quarter rate hike next year. Although we do not expect big moves in USD/CAD next week, if the healthy pace of growth in spending and inflation can be sustained for another month, the market will start pricing with a March hike, sending USD/CAD to 1.26 and lower. There were no major economic reports from Australia but that did not stop AUD/USD from rising to its strongest level in more than a month. The gains in the currency were fueled by improvements in risk appetite and higher commodity prices as we’ve seen recoveries in gold, copper and iron ore rates. The New Zealand dollar was also resilient in the face of mostly weaker data. Dairy prices dropped by the largest amount in a year, the trade deficit widened while Q3 GDP growth slowed. Nonetheless, investors were relieved that GDP did not contract as much as it could have given the recent weakness in trade and retail sales. We continue to believe that challenging times lie ahead of New Zealand but for the time being it seems that risk appetite is the primary driver of the currency. No economic reports are scheduled for release from any of the 3 commodity producing countries so it should be a quiet week.