By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Wednesday's price action in the currency and bond market tells us that investors believe data and not the Fed. The FOMC minutes were hawkish, which is not a surprise considering that the central bank raised interest rates for the first time this year last month. Fed officials talked about lower downside global economic risks, greater upside in fiscal-policy risk and described the January consumption slowdown as temporary. These optimistic views and concern about high stock prices confirm that further tightening is on the way. Yet Wednesday's investors sold rather than bought dollars after the report because nothing in the Fed minutes reflected an urgency to raise interest rates. As a result, U.S. yields nosedived, taking USD/JPY down with it as investors turned their focus to the U.S.-China summit and Friday's nonfarm payrolls report. Data wise, Wednesday's economic reports raised red flags for Friday's nonfarm payrolls. While private payroll growth increased strongly according to ADP, job growth in the service sector fell to its lowest level since August. As the employment component of non-manufacturing ISM tends to have a very strong correlation with the broader release, investors sold dollars aggressively after seeing that the Fed minutes contained nothing to alter the market's expectations for tightening. We expect the dollar to continue to trend lower, particularly against the Japanese yen.
Politically, there's a lot at stake at Thursday's summit between the leaders of the world's two largest economies. Ahead of the summit, President Trump set the tone by saying it will be a difficult meeting. There are many political issues at hand like the one-China policy and North Korea, but Trump has not been shy about his views on China's currency and trade policies. The BEST-case scenario is that both leaders will shake hands, smile and talk about a stronger relationship. Unfortunately, they are walking into the summit with a strained relationship as Trump rarely misses the opportunity to point a finger at China for its unfair trade practices. FX traders should be nervous because Trump is unpredictable and it is not clear how hard he will press Xi. If the meeting ends with the same awkward press conference as the one held with German Chancellor Merkel, the markets won't be happy and risk appetite could suffer. That would mean further losses for USD/JPY and other high-beta currencies.
The reversal in the U.S. dollar sent all of the major currencies higher and the best-performing currency was the British pound. Stronger-than-expected service-sector activity helped propel GBP/USD within 2 pips of 1.25. While this may be an important resistance level, it should only be a matter of time before it is broken. According to the PMI report, service-sector activity accelerated at its fastest pace in 3 months. Not only did this help to offset the negative sentiment caused by the lower manufacturing and construction PMI reports but it also helps to explain why Kristin Forbes voted for an immediate rate hike last month. However, we are worried about Wednesday's comments from monetary policy committee member Vlieghe who said cautious BoE rate strategy is currently warranted. He worried that the U.K. consumer slowdown will intensify saying that a premature rate hike is worse than a late one. With that in mind, sterling traders completely shrugged off his warnings and chose instead to see relief, in his view, that inflation drives policy. Price pressures beyond FX could cause a rate hike.
EUR/USD on the other hand continued to consolidate in a narrow trading range. Service-sector PMI was revised lower for March, dragging the composite index down to 56.4 from a previously estimated 56.7. There has been very little action in the single currency as concerns about the French election keeps the pair from materially benefitting from the dollar's decline. German factory orders are due on Thursday along with speeches from a number of Eurozone officials including Central Bank President Draghi, which means that Thursday could be the day when we finally see a breakout in EUR/USD.
USD/CAD extended its gains on the back of lower oil prices, while the Australian and New Zealand dollars rebounded off their intraday lows to end the day unchanged versus the greenback. Tuesday night's economic reports were mostly positive with service-sector activity in Australia returning to expansionary territory in March. Although house-price growth eased in New Zealand, job advertisements increased. While there no imminent economic reports from Australia and New Zealand scheduled for release, both currencies will be sensitive to the U.S.-China summit and Wednesday's Caixin PMI Composite report.