By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The biggest story in the FX market Wednesday was the bottom in GBP/USD. Over the past 48 hours, sterling rose strongly against the greenback and the latest move has taken the currency pair above its 9-day-long consolidation range. After selling off 550 pips from high to low in mid September, the British pound is in the midst of what could be a very significant turn for the currency. In fact, this year every single major reversal in GBP/USD has been a minimum of 500 pips and the sample size of 11 big moves is not small. This suggests that from the bottom of 1.5110, GBP/USD could rise as high as 1.5610. The latest rally in sterling was driven by better-than-expected data and Anheuser-Busch Inbev's (NYSE:BUD) bid for U.K.'s SABMiller (LONDON:SAB). Industrial production rose 3 times more than expected in August, which was a breath of fresh air after back-to-back data disappointments. At $104 billion, the brew maker deal is large but the impact of M&A transactions on the forex market fade quickly and in this case, it is still not clear if a deal will be made as SAB quickly rejected the higher bid proposal.
The sustainability of the GBP/USD rally hinges not on M&A news but on Thursday's Bank of England meeting. The central bank is widely expected to leave policy unchanged but with the minutes now released alongside the monetary policy decision, the number of dissenters and the overall tone will have a significant impact on the currency. Since the last meeting, we have seen a lot more weakness than strength in the U.K. economy. The only bright spot is the labor market and wage growth. Thankfully employment is critical to the outlook for the U.K. economy and wage growth is one of the most important considerations for monetary policy. Wages rose strongly in July and with the unemployment rate falling, earnings could accelerate through the rest of the year. The Bank of England is in no position to raise interest rates and there is no scenario where they would act before the Federal Reserve. But if they sound comfortable with the outlook for the economy, GBP/USD could extend its gains, which would be just the blessing it needs to hit 1.55.
The New Zealand dollar was the best performing currency of the day. In the short span of 7 trading days, NZD/USD has risen from 63 cents to 66 cents. No economic reports were released overnight but NZD is still riding on Tuesday's Global Dairy Trade auction high. Milk prices increased for the fourth auction in a row, solidifying expectations that dairy prices have bottomed. As New Zealand's most important export, this recovery cuts the need for further easing from the Reserve Bank of New Zealand because the drop in prices was the primary motivation for their decision to lower rates 3 months in a row between June and September. If prices continue to stabilize, the RBNZ will be done for the year. Resistance in NZD/USD is at 67 cents and we believe that the rally could extend to that level but further gains may be difficult.
Short covering in the Australian dollar also drove AUD/USD sharply higher. 7 days have now past without a down day for the currency. Unlike the New Zealand dollar, the gains in AUD was not supported by fundamentals. According to Tuesday night's report, construction-sector activity slowed in September and early gains in commodity prices faded by the end of the North American trading session.
After dropping below 1.30 in the early U.S. session, USD/CAD recovered sharply to end the day in positive territory. Softer economic reports continue to pour in with building permits falling 3.7% in August. The reversal in USD/CAD however was triggered by oil inventory data. EIA reported a massive increase in inventories last week, which caught traders off guard and led to a significant reversal in oil prices. Having bottomed at 1.30, USD/CAD now appears to be headed for another test of 1.32.
While Euro ended the day only slightly lower against the U.S. dollar, it experienced significant losses versus GBP, AUD and NZD. EUR/GBP dropped 0.8%, which was the strongest one-day decline in 2.5 weeks. Economic data out of Germany continues to be worrisome. Industrial production dropped 1.2% in August erasing the past month's rise. As our colleague Boris Schlossberg noted, that "may be only the start of bad news for the engine of Europe as the VW (XETRA:VOWG_p) troubles are sure to weigh on data in the months to come." Between the downside surprise in the PMI manufacturing index, industrial production and factory orders, chances are that Thursday's German trade balance report will also be weak.
The Bank of Japan left monetary policy unchanged Tuesday night and their decision provided a boost to the Japanese yen. No changes were expected but some investors believed the recent weakness in Japanese data would push the central bank to say that a further increase in Quantitative Easing is likely. We heard none of that Tuesday night and in response, the yen rallied.
There was very little consistency in the performance of the dollar. FOMC minutes are scheduled for release on Thursday but given that the meeting was held before the abysmal nonfarm payrolls report, investors will most likely look beyond the report.