By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Thursday was an exceptionally active day in the foreign-exchange market with many major currency pairs unwinding Wednesday’s moves. A confluence of factors turned risk-on to risk-off and breakouts into fake-outs. The sell-off began in Asia after the People’s Bank of China Governor Zhou warned about excessive optimism. It exacerbated after the unexpected election decision in New Zealand and then carried over into Europe and North America when Spain took steps to suspend Catalonia’s autonomy. Reports in a Taiwan newspaper that Apple (NASDAQ:AAPL) cut its orders for iPhone 8 also added pressure to asset prices, causing U.S. bond yields to fall and U.S. equities to open sharply lower. All of these factors, combined with the day’s 30-year anniversary of the Black Monday crash of 1987, caused big moves in currencies. We’ll discuss some of these in further detail later but here’s the summary:
5 Reasons Why And One Bonus
- Apple Cuts iPhone 8 Orders
- PboC Warns of Excessive Optimism
- Spain Takes Steps to Suspend Catalonia Autonomy
- Surprise NZ Election Decision
- US Yields and Stocks Fall
- BONUS – Black Monday anniversary
New Zealand’s new coalition government was hands-down the biggest story of the day. The decision by New Zealand First leader Winston Peters to shun the popular vote and form a coalition government with the Labour party’s Jacinda Arden caught the market mis-positioned. While this may be another example of politicians disregarding the majority popular vote, more importantly, the fact that Arden gained enough votes to stay in the race and move on to become New Zealand’s youngest ever female Prime Minister is a testament to the world’s desire for change. Peters chose to form a coalition with Labour because of their ability to advance their economic priorities such as immigration, foreign land buyers and reducing poverty. His decision is summed up best with the comment: “We’ve had to make a choice, whether it was with either National or Labour, for a modified status quo, or for change.” With major policy differences between Labour and National, change is definitely in store. There will be major investments in the housing market with 100k affordable houses built and sold over the next 10 years, the RBNZ will add an employment mandate similar to the Fed, immigration will be cut back and the government will renegotiate elements of the Trans Pacific Partnership to increase restrictions on foreign home purchases. All of these steps are aimed at bolstering an economy that the new government sees as underperforming. For the RBNZ, an employment target could mean a longer period of easier policy. So while NZD/USD just experienced its largest one-day slide since August 24, 2015 – the day of the flash crash in U.S. equities – it’s a sell-on-rallies for an eventual move down to 68 cents.
The U.S. dollar shrugged off stronger-than-expected U.S. data and instead took its cue from yields. Although U.S. rates were down for most of the North American session (led by reports that Apple cut its iPhone 8 orders) they bounced off their lows by the end of the day and the same intraday reversal can be seen in stocks. Ahead of the 30-year anniversary of the Black Monday stock-market crash, investors were nervous as their anxiety heightened by political developments abroad. However at the end of the day, U.S. data is improving. Jobless claims dropped to its lowest level in more than 4 decades, hinting of a strong nonfarm payrolls report next month. The Philadelphia Fed manufacturing index also rebounded to 27.9 from 23.8. Economists had been looking for slower growth but the sharp rise in the Empire State survey suggests otherwise. Fed Chair Yellen speaks on Friday but not until markets close, so most of the day will be spent guessing whether she'll be hawkish or dovish. Chances are, there will be limited new position-taking ahead of her lecture on monetary policy since the financial crisis.
The Australian dollar, on the other hand, was the main beneficiary of NZD outflows. Not only was AUD one of the few currencies to outperform the greenback but it also hit a 17-month high versus the New Zealand dollar. The labor market continues to be one of the country’s primary areas of strength – Australia added another 19.8K jobs in September with steady growth in full- and part-time work. This helped push the unemployment rate back down to 5.5%, the lowest level in more than 3 years. Although the PBoC warned of excesses, China's industrial production and retail sales growth grew slightly mores than expected in September. We wouldn’t be surprised to see AUD/NZD trade up to 1.14 in the coming weeks. The Canadian dollar, on the other hand, had a relatively uneventful day. The pair traded in a narrow range ahead of Friday’s inflation and retail sales reports. Lower oil prices and Canadian bond yields prevented CAD from enjoying the same gains as AUD or EUR. Friday’s economic reports will be crucial going into next week’s Bank of Canada monetary policy announcement. If retail sales and inflation growth miss expectations, it would reinforce the BoC’s less-hawkish views, but with USD/CAD hovering near 1.2450 support, unexpected strength in spending or inflation could take the pair sharply lower.
Sterling traded lower against the greenback but for the third day in a row, it settled above the 50-day SMA near 1.3150. This is notable because Thursday morning’s retail sales numbers were significantly weaker than expected and yet GBP still managed to hold support. Economists expected consumer spending to fall by just -0.1% but instead it dropped -0.8%. Excluding auto and gas purchases, demand was just as bad with spending falling -0.7% – the weakest pace of growth in 4 years. This week’s economic reports don’t help the case for a rate hike and with the ECB expected to make a move next week, we could see further gains in EUR/GBP. Meanwhile, EUR/USD rose to a high of 1.1860, despite the Spanish government’s decision to invoke Article 155 of the constitution, allowing the central government to suspend Catalonia's autonomy. This is a dangerous step that could lead to more violence if the Catalan people decide to block the measures on the streets. Yet investors have cheered the government’s firm stance in doing everything it takes to keep Spain in one piece.