By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
On Wednesday, the Federal Reserve is expected to raise interest rates for the first time this year but instead of strengthening into the monetary policy announcement, the U.S. dollar weakened against most of the major currencies leading investors to wonder what’s behind the move. First and foremost, no U.S. economic reports were released on Monday and the FOMC is in its quiet period, which means there will be no comments on monetary policy. However U.S. stocks fell sharply Monday, which weighed on USD/JPY but risk currencies such as euro, sterling and the Canadian dollar did not succumb to the selling. With President Trump letting go of Andrew McCabe at the end of last week, the upheaval in Washington is still front and center. A number of other high-profile exits are expected in the coming weeks and unfortunately, political uncertainty is overshadowing Fed policy. At the same time, some positive headlines for other countries attracted demand for those currencies.
EUR/USD, for example, rebounded on reports that policymakers could be shifting their debate from quantitative easing to the steepness of the rate path. This headline led investors to believe that the European Central Bank is serious about normalizing monetary policy. Yet it is at odds with the tone and comments of European policymakers who went out of their way last week to express their concerns about subdued price pressures and the need for patience. This suggested that they are not looking to change their forward guidance until the summer, even if most policymakers believe that bond buys should end in the next year, shifting the conversation to rate hikes. This week in particular, data should reinforce the ECB’s cautiousness with the ZEW survey and PMIs sinking off their highs. Data hasn’t been great as we learned on Monday that the Eurozone trade surplus dropped to 19.9B in January from 23.2B. With this mind, on a technical basis, EUR/USD climbed back above the 20/50 day SMA shifting the pair’s technical outlook to the upside.
Monday's best-performing currency was sterling and the move had everything to do with reports that Brexit negotiations went well this weekend. The U.K and the E.U. agreed to a “large part” of the terms for the Brexit transition. The transitional period will be between March 29, 2019 and December 2020. During this time, EU citizens arriving in the UK will maintain the same rights as prior to Brexit. The UK will also be allowed to negotiate and sign separate trade deals during this period. Unfortunately there was no agreement on the Irish border, which has been a serious issue of contention. Nonetheless, this move forward is the first positive progress we’ve had in Brexit negotiations in a while so it is no surprise to see sterling trade sharply higher. This is an important week for the British pound with UK inflation, employment and retail sales data scheduled for release along with a Bank of England monetary policy announcement. After falling in January, consumer prices are expected to rebound and if it does, it would be consistent with the hawkish tone of the last policy meeting and fuel further gains for sterling, particularly against the euro. Nine days have past without a rally in EUR/GBP, which is the longest stretch of back-to-back weakness since December 2011. Although this begs for a recovery, the “range” in EUR/GBP has been narrow and fundamentals support the possibility of further weakness.
Meanwhile the Canadian dollar benefitted from Prime Minster Trudeau’s comment that Trump seems enthusiastic about getting a NAFTA deal. USD/CAD experienced strong gains over the past month and while the Bank of Canada is in no rush to raise interest rates, we could see USD/CAD pullback to 1.30 as oil prices rise. The New Zealand dollar continues to be one of the best-performing currencies as it rebounds off the 200-day SMA. NZD/USD traders shrugged off weaker service-sector activity to trade strongly ahead of Tuesday’s dairy auction and Wednesday’s Reserve Bank monetary policy announcement. The Australian dollar on the other hand lagged behind. There was no specific catalyst outside of an extension of last week’s weakness. China also has a new central bank governor along with a Harvard educated adviser who will be working together to further open the country’s financial markets and internationalize the yuan. Their goal is to also open certain industries to private and foreign competition and take efforts to control their rising debt. Announcements from China could be coming and the currency that would be affected the most should be the Australian dollar.