By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Thursday was an uneven day for the U.S. dollar, which traded slightly higher against the Japanese yen and euro but lower against sterling and the Canadian and Australian dollars. As expected, the House voted and passed its version of the tax-reform bill. This triggered a nominal rally in the greenback because while it's good news, everyone knows the real hurdle is in the Senate. The Senate Finance Committee had originally planned to vote on its version this week, but last-minute changes caused significant rifts between Republicans and Democrats. Senator Ron Johnson and Susan Collins became the first Republicans to come out against the Senate bill, which could become a serious problem because the GOP cannot afford to lose more than 2 votes as they have just a 52-48 majority in the Senate and no Democrats are willing to support the bill. Also, the Senate and House still have to reconcile their bills before they are combined into a final plan that is voted on by both houses of Congress. So it will still be a long road ahead before President Trump signs tax reform into law, especially if the Republicans keep trying to tie in the Affordable Care Act. The challenges ahead explain the hesitant rally in the U.S. dollar despite the rise in U.S. rates. Thursday morning’s U.S. economic reports were all weaker than expected with jobless claims ticking up, manufacturing activity in the Philadelphia region slowing and import- and export-price growth easing. In other words, manufacturing, inflation and labor-market activity all deteriorated over the past period, weakening the case for unambiguously hawkish guidance at next month’s Fed meeting. We heard from a few Fed Presidents on Thursday and the comments from Kaplan and Mester suggest that they will support a year-end hike.
Euro ended the day only slightly lower against the U.S. dollar. We expected the pair to extend its losses after Wednesday’s sharp intraday reversal – and it did – but the sell-off found support above 1.1750. A slowdown in consumer-price growth in October contributed to early weakness but USD's decline prevented further losses for the euro. With that in mind, the pair still looks weak on a technical basis and with the ECB keeping policy steady for the next 6-8 months and the Fed continuing to talk about tightening, we still believe that EUR/USD is headed lower. On Thursday morning, ECB member Mersch said the euro area still needs monetary stimulus and it would not hesitate to act if needed as its tool box is not limited to asset purchases. ECB member Praet agreed that the central bank needs to remain patient and persistent on policy as inflation is subdued despite signs of growth. Friday’s Eurozone current-account numbers are not expected to have a significant impact on the euro.
Sterling, on the other hand, carried a bid throughout the North American trading session. Retail sales grew 0.3% in October, which is not great, especially considering that spending increased only 0.1% excluding auto fuel purchases. However investors were relieved that spending did not contract for a second month in a row. Nonetheless, wallets in the U.K. are being pinched by faster inflation and slower wage growth, creating concerns that this year’s shopping season could be exceptionally weak. A number of Bank of England members spoke Thursday and the main takeaway is that they didn’t say anything particularly damaging to sterling. Governor Carney talked mostly about Brexit and how the economy would have done better without the divorce. Broadbent said the central bank was right in raising interest rates this month because inflation is above target and dwindling spare capacity means there’s upside risk. Cunliffe, on the other hand, believes that price pressure remains low and there’s greater risk that it will undershoot expectations than exceed it. Like many BoE officials, he wants to see clear signs of wage growth before tightening again. Despite a busy economic calendar filled with market-moving events, GBP/USD did not break out of its narrow 1.3062-to-1.3230 trading range and that's a sign of the pair’s resilience.
Meanwhile, there was very little consistency in the performance of the commodity currencies. The Canadian dollar traded sharply higher, the Australian dollar was little changed while the New Zealand dollar extended its slide for the sixth day in a row. There’s been no new NAFTA developments so CAD took its cue from Canadian yields, which rose strongly on Thursday. USD/CAD’s yield spread moved in favor of the loonie, explaining Thursday’s move in the currency. The Canadian dollar is in play Friday with consumer prices due for release. While economists are looking for slower CPI growth, the sharp rise in the price component of the IVEY PMI index suggests that the risk is to the downside. Thursday’s reports were better than expected with manufacturing sales rising strongly and international securities transactions shooting higher in September. The Australian dollar found support from stronger labor market data. Although total job growth fell short of expectations, full-time jobs rose strongly driving the unemployment rate down to 5.4%, the lowest level in 4 years. However wage growth stagnated and consumer-inflation expectations declined so the good jobs report won’t take the Reserve Bank of Australia out of its seat. The New Zealand dollar was hit Thursday by AUD/NZD demand as the focus shifted back to the currency Thursday night with the business PMI index and Q3 PPI reports scheduled for release. A strong number is desperately needed to stem the slide in NZD/USD.