By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Friday’s unambiguously strong nonfarm payrolls report sent the U.S. dollar soaring against all of the major currencies. Fed Fund futures went from pricing in a 57% chance of a 2016 rate hike Thursday to a 71.6% chance on Friday. With 255K jobs added in July and average hourly earnings growing by 0.3%, the U.S. economy shines compared to its peers. The outlook for the economy is also bright with the rise in the participation rate and number of hours worked per week. Americans are working more, making more and this healthy environment encouraged others to rejoin the workforce. This stands in sharp comparison to the grim outlooks for the U.K., Japan, parts of the Eurozone and Canada. While we are still skeptical of the Fed’s commitment to raising interest rates this year, each piece of positive data will only harden the calls of the hawks who have already been saying that September is a live meeting and rates could rise this year. We highly doubt that a rate hike will come next month but the FOMC statement could be more optimistic, helping the dollar sustain its gains against all of the major currencies. In the week ahead, there’s not much in the way of market-moving U.S. data until Friday when we have retail sales, producer prices and the University of Michigan Consumer Sentiment index scheduled for release.
The big question for the British pound next week is whether we’ve seen a bottom. Sterling crashed on the heels of the Bank of England’s monetary policy announcement but there was very little follow through after the rate decision. U.K. policymakers sent a very strong message to the market by combining a 25bp rate cut with a 60 billion government bond-buying program and a new initiative to buy 10 billion pounds of corporate bonds. According to Mark Carney, this “early and comprehensive” multistep approach was aimed at reducing uncertainty, bolstering confidence, blunting the slowdown, and supporting the necessary adjustments in the U.K. economy.” Sterling crashed after the BoE over-delivered but losses were limited because Governor Carney’s comments were not overwhelmingly dovish. Yes, the central bank is ready to lower the bank rate further if needed and increase all elements of Thursday’s package but Carney also made it very clear that the “lower bound in interest rates is above zero” and he is “not a fan of negative interest rates.” He believes that helicopter money is a “flight of fancy” and he doesn’t see a scenario where negative rates is discussed, so if BoE were to ease again, it would be in other ways like additional bond purchases. The bank reduced its GDP outlook for 2017 but kept its 2016 forecasts unchanged. It also believes that inflation will rise given the weakness of the pound. Having taken such an aggressive stance, the Bank of England is now in wait-and-see mode, which could actually lift sterling because of the extreme level of short positioning. Last week’s PMIs were weak but much of the selling has already happened and in the coming week there is very little market-moving U.K. data. We only have U.K. industrial production and trade balance scheduled for release. Sterling should still remain under pressure but we do not rule out a further short squeeze before a move toward 1.30.
While it may be a quiet week for the British pound, it should be a very busy week for commodity currencies. The most important event risk on the calendar is the Reserve Bank of New Zealand’s monetary policy announcement. Like the BoE and RBA, the RBNZ is expected to cut interest rates by 25bp and if New Zealand also adopts a neutral stance, NZD will rise because 2% is still one of the most generous yields out there. However if they buck the trend and continue to maintain a strongly worded dovish stance, the currency could sink below 71 cents versus the U.S. dollar. Meanwhile the market completely ignored the moves by the RBA this past week. The central bank lowered rates by 25bp to 1.5%, noting that global growth has slowed below average pace and that further appreciation of the exchange rate would complicate the economic transition in Australia. They also acknowledged that growth in Australia expanded at a moderate pace, but noted that inflation would remain low for the foreseeable future. It appears clear that the RBA move was prompted more by exchange-rate considerations rather any immediate threats to economic growth and the central bank offered no further guidance regarding its intentions ahead. That, combined with the fact that AUD is still one of the highest yielders among the majors, took the currency close to 77 cents in the days after the monetary-policy announcement. There are no major Australian economic reports scheduled for release, but the week starts with Chinese trade numbers followed by industrial production and retail sales – data that will undoubtedly have a material impact on AUD and NZD.
The Canadian dollar sold off hard on Friday after significantly weaker-than-expected employment data. More than 32k jobs were lost in July, which stands in stark contrast with the strong job growth in the U.S. What was particularly worrisome was the fact that all of the job losses were full time, and without the rise in part-time work, job losses would have exceeded 70k. The unemployment rate also increased while the participation rate declined, which was completely opposite to the U.S. It's why USD/CAD traded so strongly at the end of the week. Even the sharp increase in the IVEY PMI report failed to offset the sting of job losses. The trade deficit was also larger than expected, putting pressure on the Bank of Canada to ease again. We expect CAD to underperform in the coming week though with no major economic reports scheduled for release, the commodity currency will most likely take its cue from oil.
Lastly, it has been a relatively quiet week for the euro because August tends to be a dull month for the Eurozone. Last week’s PMI numbers were mostly better than expected but since they were revisions, the impact on the currency was limited. Next week the main events are German industrial production, trade balance and second-quarter GDP. The euro largely traded on U.S. dollar flows, which along with risk appetite, we expect to remain the primary drivers of the currency. Technically, the pair should hold between the 100-day and 200-day SMs at 1.1085 and 1.1235 respectively but the bottom looks heavy.