By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Although the U.S. dollar traded higher against all of the major currencies with the exception of euro and sterling, the restrained rally and intraday pullback is a sign that investors haven’t fully bought into the advancement of the tax reform bill. On Tuesday, the tax bill passed the Senate Budget Committee, allowing it to move forward to a full Senate vote. This is a significant turnaround because as early as Monday, there was a lot of pushback from key Republican lawmakers but last-minute deal making and a meeting with President Trump helped to reassure Senators Collins, Corker and Johnson. While Senate Majority Leader Mitch McConnell said they would take a procedural vote today, its fate in the Senate is still unclear. For this reason, investors don’t want to get overly excited as it could be weeks before a final bill is passed.
Meanwhile, North Korea’s missile tests continue to rattle the markets as the latest version could theoretically reach Washington D.C. President Trump responded quickly with a promise of additional major sanctions but the market is worried that the latest provocation could lead to military action. In her appearance before the Joint Economic Committee on Wednesday, Fed Chair Janet Yellen also expressed concerns about low inflation and productivity. Although she said there are encouraging signs from the labor market, she also felt that the economy is not overheating, which suggests that beyond raising interest rates, she may not provide much additional guidance, especially since she will lead only 1 FOMC meeting next year before Powell takes over. Wednesday’s upward revision to Q3 GDP, stronger-than-expected pending home sales and the optimistic Beige Book failed to have a lasting impact on the dollar. The greenback also began decoupling with U.S. yields near the London close. Jobless claims, personal income, personal spending and the Chicago PMI reports are due for release on Thursday but NK and tax reform will be the key drivers of dollar flows.
Sterling hit a one-month high on Wednesday against the U.S. dollar as GBP/USD busted through 1.34. It seems like nothing can hold the currency back as the market is convinced that a Brexit deal is in the works. Sterling bulls have completely ignored the U.K. government’s denial of a Brexit bill deal and did the same on Wednesday when the EU Parliament said not enough progress has been made on Brexit negotiations. Although there are widespread reports from various media outlets that the money issue is being worked out, the UK doesn’t want to sabotage the talks with premature headlines while the EU is keeping the Brits on their toes as they push for agreements on other key issues like the rights of foreign workers and the Irish border. Nonetheless, investors are hopeful that the hearty negotiations will lead to a deal that can be approved at the December 14-15 EU Summit. While the momentum is clearly on the side of sterling bulls, this is dangerous thinking as the EU has resisted the UK every step of the way. So until an official deal is announced, we are weary of the currency’s rally.
The Canadian dollar ended the day sharply lower despite the rise in Canadian yields. The sell-off was driven by the sharp slide in oil prices and a rising U.S. dollar. There was actually quite a bit of volatility in the price of crude on Wednesday, which shot above $58 a barrel before U-turning to hit a 1-week low below $57. OPEC nations are set to extend their supply cuts but there’s talk that they could review the deal in the spring or summer. More details will be revealed at their meeting on Thursday and Wednesday’s volatility in crude is a taste of the big moves to come. The Australian and New Zealand dollars also traded lower on the back of falling commodity prices and a stronger U.S. dollar. We finally get some data from the region tonight in the form of New Zealand’s ANZ business confidence report and Australia’s new home sales and building approvals. Chinese PMIs are also scheduled for release and as both countries are heavily dependent on Chinese demand, the outcome of these reports could have a meaningful impact on the currency.
The euro on the other hand bounced off its lows of 1.1817 to end the day in positive territory. The latest economic reports were mixed with German consumer prices rising in November, Eurozone business confidence ticking upwards but industrial and services confidence fell short of expectations. Even so, all of these represented improvements in the Eurozone economy. The latest comments from ECB officials were also relatively positive with Bundesbank President Weidmann saying the central bank’s growth outlook could be raised, given strong data. He also expressed his skepticism over the need for QE. Vice President Constancio felt that the euro area is much more resilient to possible shocks. German retail sales and labor-market numbers are due for release on Thursday. Given the sharp rise in the employment component of the PMIs, we believe Thursday’s report will show a material improvement in labor-market conditions. If we are right, EUR/USD could squeeze up to 1.19.