By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
***No Report, Wed-Friday. Back on Monday.
The general public, investors included, have been unnerved by the devastating terror attacks in Brussels Tuesday morning. Events like these always drive investors to sell first and ask questions later, which is why the euro and U.S. stocks were down. Unfortunately it was never a question of if but a matter of when another brutality would occur after the Paris attacks. As the months past, investors became complacent but Tuesday’s events serve as a harsh reminder of one of the greatest risks Europe faces this year. This is the type of event that could shift market sentiment and drive a top in equities and currencies. But ONLY if these attacks are quickly followed by more terrorism.
As we saw in November and January of 2015, investors don’t allow terrorists to terrorize them for long. The euro fell only 3 cents after the shootings in November and primarily on expectation for ECB action. In January after the Charlie Hebdo attack, EUR/USD fell only 1 cent in the week that followed. It later collapsed but only because investors were positioning for ECB Quantitative Easing. Central-bank expectations is what makes the current outlook for the euro different from 2015. No one expects the ECB to react to the latest attacks after having taken aggressive steps earlier this month, which means losses in the euro should be limited. European data is just beginning to turn positive and any pullback in EUR/USD should be limited to 1.1050. The Eurozone PMI reports were released early and they showed improvement in service and manufacturing activity. Although investor confidence weakened, German business confidence ticked higher, a sign that the ECB’s efforts are finally paying off.
For the second day in a row, sterling was the worst-performing currency. Part of the weakness was due to risk aversion but weaker economic data played a major role in the decline. Consumer prices grew a less than expected 0.2% in February. This modest increase left the year-over-year rate unchanged at 0.3%. Producer price growth also slowed on the input level but CPI is key. Inflation is drastically undershooting the central bank’s 2% forecast and even the year-over-year rate is running at a modest 1.2%. While the recent rise in oil prices should have eased some of the decline, this level of inflation growth will prevent the Bank of England from raising interest rates anytime soon. Meanwhile Brexit risks are rising. Chancellor Osborne and London Mayor Johnson will be speaking to Parliament on Wednesday and Thursday about the costs of Brexit and chances are the headlines won’t help the currency.
The U.S. dollar traded higher against all of the major currencies Tuesday with the exception of the Canadian and Australian dollars. Tuesday’s second-tier U.S. economic reports were mixed with manufacturing activity in the Richmond region and house prices increasing. According to Markit Economics, manufacturing activity grew at a faster pace across the nation but the increase was less than economists anticipated. While there are a handful of U.S. economic reports scheduled for release this week, U.S. data won’t be a leading driver of dollar flows. Instead, risk appetite and Fed speak will have a larger impact on the currency.
Even with Tuesday’s decline in USD/CAD, the currency pair remains above 1.3000. After breaching $40 a barrel on Monday, oil has largely held onto its gains. We have been looking for a top in the commodity but resistance is now closer to $43 a barrel. USD/CAD is near a bottom but there could be another test of the lows if the EIA report shows a significant decrease in inventories. Higher inventories on the other hand could send oil prices tumbling lower and USD/CAD above 1.31.
Meanwhile there’s been a major divergence between the Australian and New Zealand dollars, 2 currencies that tend to move in lockstep. AUD was one of the few currencies to appreciate against the greenback Tuesday while the New Zealand dollar saw losses. The increase in gold prices should have helped both currencies but AUD received an added boost from Monday night’s RBA comments. Investors feared that RBA Governor Stevens would make a concerted effort to talk down the currency by saying that he preferred to see it closer to 65 cents than 75 cents but he sounded far more relaxed. All Stevens said was there’s some risk the currency may be getting ahead of itself -- a relatively tame comment given the 8 cent rise over the last 2 months. Stevens also noted that there’s room to ease if there is a serious downtrend but there’s no indication that they are in a rush to do so. These relatively neutral comments pale in contrast with the easing bias of the Reserve Bank of New Zealand and explain why there’s been such a big divergence between AUD and NZD.