By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The U.S. dollar traded higher against most of the major currencies Tuesday but early gains fizzled on Fed Chair nominee Jerome Powell’s mixed comments and ongoing concerns about North Korea. Starting with data, house prices increased in September, consumer confidence rose to its highest level in 17 years and the Richmond Fed manufacturing index rose to its highest level ever. While the trade deficit deteriorated, the robustness of these later reports highlight the U.S. economy’s positive course. As Powell indicated, the “case for a December rate hike is coming together,” as “strong growth now warrants gradual rate rises.” These comments should have driven the dollar higher, especially after Powell said now it's time to be normalizing rates, but investors chose to focus on his comments about the banking sector. Powell doesn’t seem to be eager to reduce regulation and instead believes that rules should be the most stringent for the biggest firms and higher capital reduces the chance of a bank run. The market was hoping that he would sound more relaxed but it doesn’t appear that he’ll go easy on banks. Also, he doesn’t see any signs of the economy overheating as wages aren’t signaling tightness in the labor market. Labor force growth is really slow these days and the central bank is still monitoring things carefully to see if weak inflation is transitory.
On top of all this, South Korean news reports that North Korea fired a ballistic missile took USD/JPY off its highs. The Senate also hopes to hold a floor vote on tax reform this week but the Senate Budget Committee hearing hit some hurdles with Republican Senators Johnson and Corker threatening to vote 'no' if their individual concerns are not addressed. The market is still waiting with bated breath for tax-reform progress. Wednesday will be another busy one in the FX market with revisions to the third quarter GDP report and the Federal Reserve’s Beige Book schedule for release. The tax bill will remain an ongoing focus that could steal the thunder from any U.S. data and the Beige Book.
Tuesday's most volatile currency was sterling, which spiked higher before the Financial Stability Report, then collapsed in the hours that followed then jumped 70 pips in 5 minutes on the back of reports that the U.K. and E.U. have reached an agreement on the Brexit bill. Then it gave up all of its gains when the U.K. Government denied a Brexit Bill agreement but reversed course once again on the hope for a deal. If made official, this would be a major achievement for Prime Minister May but for the time being, it's nothing more than hope. Although Ireland’s political troubles and their border issue could remain a problem, the Brexit bill agreement should be enough to unlock the talks. Investors cheered the news by erasing all of GBP/USD’s losses and turning the pair positive for the day. With all of this in mind, Tuesday morning’s Financial Stability Report hurt more than helped sterling. Although the Bank of England revealed that all of the major banks including the Royal Bank of Scotland (LON:RBS) passed the latest stress tests, the BoE raised its counter-cyclical buffer to 1% from 0.5% for large banks. The central bank also warned that a disorderly Brexit would mean a lower currency and pain for the economy. It is clear that the head of the U.K. central bank does not share the market or the Prime Minister’s optimism about Brexit. Wednesday’s mortgage and borrowing data from the U.K. isn’t expected to have a dramatic impact on the currency. Instead the market will be trying to figure out how it feels about a Brexit deal.
The Canadian dollar found its way above 1.28 on the back of cautious comments from the Bank of Canada. The Bank’s Financial Stability Review revealed nothing new with the BoC describing the financial system as “resilient.” They see stabilization in the Toronto housing market and strong economic fundamentals. While this assessment may be encouraging, investors latched on to Governor Poloz’s relaxed view on rate hikes – he didn’t think it was time to consider further tightening as it is a little too soon to have a read on how rate hikes have impacted the economy. The BoC’s outlook overshadowed stronger raw material and industrial product prices along with the intraday recovery in oil prices. Although the Australian and New Zealand dollars appreciated against the greenback, AUD and NZD ended the NY session well off their highs. No economic reports were released from either country and nothing is expected this evening. China’s manufacturing PMI numbers could affect these currencies’ moves. After extended downtrends, both currencies have been driven higher by profit taking and short covering.
Last but certainly not least, the euro extended its losses against the greenback, breaking below 1.1850 in the process. The currency pair has been driven entirely by the market’s appetite for U.S. dollars and the swings in U.S. yields. Eurozone confidence numbers are due for release Wednesday along with German consumer prices. These reports are not expected to have a dramatic impact on the currency during this key week where euro is likely to take its cue from the market’s appetite for dollars and pounds.