By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Get ready for some big moves in currencies this month. Between Friday’s U.S. nonfarm payrolls report, next week’s European Central Bank meeting, FOMC on March 16, the Bank of Japan announcement on March 15, the fiscal year-end in Japan and a potential meeting between OPEC and non-OPEC oil ministers, its March madness in the forex market. We’ve already seen big moves in currencies over the past 2 months with the British pound falling 5.5% and the Japanese yen rising by approximately the same amount but more swings are likely in the coming months.
The action kicks off with Friday’s NFP report and based on the latest rally in the U.S. dollar, investors are hoping for a positive release. Although economists are forecasting a sharp rise in payroll growth (the current forecast is 195K vs. 151K in January), private payroll provider ADP is expected to report lower employee additions. The Federal Reserve’s Beige Book report is also scheduled for release and it will be interesting to see whether they have any fresh observations about the economy’s recovery and the labor market. An unambiguously positive ADP report followed by a strong ISM non-manufacturing index will be needed to convince investors that it is prudent to be long dollars going into such a high risk event because even if payrolls growth increase, average hourly earnings and the unemployment rate could disappoint. With that in mind, investors have been encouraged by recent reports including this morning’s ISM manufacturing index and construction spending. The rally in the dollar reflects the growing belief that even if the Fed holds rates steady next month, it will maintain a hawkish bias.
Eurofell to a 1-month low against the U.S. dollar despite better-than-expected Eurozone economic data. German unemployment rolls dropped by the exact amount that economists anticipated but the Eurozone unemployment rate slid to a 4-year low of 10.3% from 10.4%. The Eurozone PMI manufacturing index was also revised higher led by the improvements in Germany. However the prospect of ECB easing next week kept EUR/USD under pressure. Wednesday’s Eurozone PPI report and the U.S.’ Beige Book release is not expected to help the euro. We continue to look for further losses in the currency pair and a potential break of 1.08.
The British pound ended the day in positive territory despite a major deterioration in manufacturing activity. The UK PMI index dropped to 50.8 from 52.9, the lowest level in nearly 3 years. The initial headline sent sterling lower but the currency snapped back quickly, taking out the 1.40 handle before the NY open. The only reason why sterling did not hold onto its losses was because the data has yet to reflect the stimulative impact that the recent fall in the pound will have on manufacturing. Nonetheless, this was an extremely soft report that entails widespread weakness and lower price pressures. We continue to look for sterling to trade lower and expect Thursday’s PMI services and composite reports to reinforce the softness in the economy.
Meanwhile, the strong rally in U.S. equities lifted all three of the commodity currencies. The Canadian dollar was the best performer with rising oil prices and stronger GDP numbers sending CAD to its strongest level since early December. The economy expanded by 0.2% in December, which lifted the year-over-year rate to 0.5%. What was most remarkable about the release was the fact that economists were looking for zero annualized and quarterly growth but in Q4, Canada’s economy expanded by 0.8%. Considering that oil prices fell nearly 20% in the last 3 months of the year, the acceleration in GDP shows the underlying strength and contribution of the non-resource industry. OPEC and non-OPEC nations are looking to meet this month ahead of the official June OPEC meeting. At $35 a barrel, the need to cut production is far less urgent, but if prices fall below $30 a barrel, oil-producing nations will want to consider bolder action.
The Australian dollar increased in value despite the drop in Chinese PMIs. Australian manufacturing activity actually accelerated in February, which was a bit of a surprise and helps explain the neutral posture of the central bank. The Reserve Bank of Australia left interest rates unchanged overnight and while they appear slightly more worried about inflation, they offered little concern over the recent slowdown in demand in Asia and the sharp falloff in employment data in Australia last month according to our colleague Boris Schlossberg. Nonetheless, fourth quarter GDP numbers were scheduled for release Tuesday evening and slower growth was expected.
The New Zealand dollar also performed well Tuesday thanks to the first increase in dairy prices this year. After falling at every auction in 2016, dairy prices finally rose 1.4%. While this increase barely offsets the declines in 2016 thus far and certainly does not signal a shift in trend, the uptick on a day when risk appetite was that strong added fuel to the fire. Earlier this week we saw other evidence of improvements in New Zealand’s economy, which should collectively ease the Reserve Bank’s concerns, reducing the need for another round of easing.
Finally, the Japanese yen traded lower across the board Tuesday. We are well out of intervention territory in USD/JPY but with economic reports continuing to show weakness in Japan, the Japanese government needs to take further action to stimulate the economy. We’ve already seen the PBoC step up to the plate and while the BoJ’s efforts have yielded limited results, we are looking for fiscal or monetary stimulus in the near term. March is an important month for Japan because it’s the fiscal year-end, which means that repatriation flows could slow the yen's slide. This is, historically, a positive month for USD/JPY.