By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Forex traders are not the only ones hanging their hopes on Donald Trump, who plans to make a big announcement on tax reform on Wednesday. Ten-year treasury yields rose 6bp while U.S. stocks soared and the Nasdaq climbed to a record high. Tax reform would free up capital and pave the way to greater spending by individuals and businesses. Trump is a master salesman and Wednesday will be about how well he sells his plan. The president is widely expected to reiterate his campaign promises to lower the corporate tax rate to 15% from 35% and bring the highest tax rate down to 25% from 39.6%. Of course, the problem has always been in the lack of details on how tax cuts will be funded because they won’t pay for themselves. If Trump is light on details, the dollar could unwind its gains quickly but if he over delivers, USD/JPY will make a run for 112. As indicated by Mick Mulvaney, the director of the White House Office of Management and Budget, “I think what you’re going to see on Wednesday is some specific governing principles, some guidance. Also some indication of what the rates are going to be. I don’t think…anybody expects us to rollout bill language on Wednesday." While risk of disappointment is greater, investors are optimistic and may end up giving the new president the benefit of the doubt. Meanwhile, June rate-hike expectations continued to inch upward despite weaker U.S. data. Consumer confidence fell off its highs, house prices grew at a slower pace and manufacturing activity in the Richmond region slowed. New-home sales rose strongly but the increase failed to offset the downward revision to the past month’s report. No major U.S. data is scheduled for release on Wednesday, allowing investors to focus solely on Trump’s tax-reform speech.
The improvement in risk appetite also took the EUR/USD above its post election-spike high of 1.0930. This is a sign of strength for the currency and signals the possibility of a stronger rally toward 1.10. No Eurozone economic reports were released Tuesday and based on the price action of the currency, investors are clearly hoping that the European Central Bank, which meets on Thursday, will emphasize the economy’s improvements and look beyond the decline in price pressures. Unfortunately we don’t think that is likely after ECB President Draghi’s comments last week about policy remaining accommodative. The biggest problem for the ECB is the rising euro. Inflation is low and the recent strength of the currency only drives price pressures lower.
The commodity currencies are in play over the next 24 hours with Australian consumer prices and Canadian retail sales scheduled for release. Although all 3 commodity currencies traded lower, AUD held up comparatively well ahead of the CPI report. Inflation is expected to tick higher with the year-over-year rate jumping to 2.2% from 1.5%. CPI growth is extremely important to monetary policy and after this month’s more cautious RBA statement, the pace of price growth will be key in determining whether AUD/USD holds or breaks 75 cents. We know that the Reserve Bank sees inflation picking up in 2017 but they are not overly concerned because wage growth is subdued and there’s significant competition in the retail sector. Speaking of retail, Canadian retail sales are scheduled for release on Wednesday and consumer spending is expected to stagnate after last month’s strong rise. While we agree that spending growth will slow, the bar is low, which means there’s scope for an upside surprise, especially in light of the overall strength in the labor market. USD/CAD broke above 1.36 on Tuesday, hitting a high of 1.3625. Although the currency pair has fallen from its highs, between Trump’s tariffs on Canadian lumber and U.S. dollar strength, the path of least resistance for USD/CAD is still higher. Tuesday's worst-performing commodity currency was the New Zealand dollar. With no New Zealand data released overnight, the only explanation for the move is AUD/NZD demand. Although credit card spending numbers were due Tuesday evening, cross flows could still drive NZD/USD
Sterling resumed its rise on the back of stronger public finances and rising bond yields. Public finances rose to 34.3B in March, up from 12.9B. Net borrowing rose to 4.4B from -0.7B but borrowing in general fell by 20B thanks to a surge in corporate and income tax receipts. This leaves the government’s deficit reduction plans on track as Brexit negotiations begin. Unlike some of the other major currencies, GBP/USD has been consolidating quietly with the downside limited by 1.2750 and the upside capped by 1.2850.