By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Monday's best-performing currency was sterling, which raced above 1.43 versus the U.S. dollar, extending a rally that has seen zero retracement in the past 7 trading days. There are a number of reasons why investors are buying up the pound but in order for GBP/USD to hit 1.45, economic data needs to validate the rise. While Monday’s strength can be tied to U.S. dollar weakness, seasonality, risk appetite and higher U.K. bond yields, the primary reason for sterling’s outperformance is the prospect of a rate hike next month. The market is pricing in a 96% chance of tightening but those odds could change drastically if all of this week’s economic reports fall short of expectations. We know that service and construction activity slowed in March while manufacturing activity held steady. Although we’ll see the April numbers before the next Bank of England meeting, this week’s retail sales, inflation and employment reports are the last of these releases before the May 10 meeting. While consumer spending is expected to fall, inflation and earnings are expected to grow at a healthy pace. We’ll get the first look at whether that’s true with Tuesday’s employment report. If average weekly earnings accelerate like economists expect, GBP/USD will hit fresh 1-year highs near 1.44. However if wage growth slows, profit taking could send GBP/USD back below 1.4250. For GBP/USD to hit 1.45, we would need to see wage growth, inflation and retail sales surprise to the upside this week.
The U.S. dollar came under selling pressure Monday after President Trump taunted Russia and China by accusing them of “playing the currency devaluation game as the U.S. keeps raising interest rates.” This contradicts the Treasury Department’s decision to pass on labeling China as currency manipulator on Friday and suggests that underneath it all, President Trump wants to escalate rather than diffuse tensions with China. Concerns about U.S. policy and mixed retail sales discouraged investors from buying dollars despite the rally in the Dow. Consumer spending grew 0.6% last month but excluding autos and gas, spending growth held steady at 0.3%. While these numbers weren’t terrible they were not strong enough for investors to get excited about the outlook for the U.S. economy, particularly as manufacturing activity in the NY region slowed more than expected in April. Comments from Fed officials were also mixed with Fed President Kaplan talking about volatility tightening financial conditions, Bostic seeing little movement in wages and mixed reactions from firms on pricing power. Kashkari also felt that inflation and wages are growing slowly while Fed President Dudley said he doesn’t know how many more hikes are needed in 2018. USD/JPY looks set for a move back to the bottom of its recent range near 106.60. Prime Minister Abe leaves Tuesday to meet with President Trump – so watch for those headlines.
EUR/USD has its eye on 1.24 and Tuesday’s German ZEW survey will be the next piece of data that could determine whether the currency pair breaks this level. Unfortunately, we fear that investor confidence declined in April as softer economic reports and equity market volatility weigh on market sentiment. According to a survey from Bloomberg News, the outlook for euro area and German growth this year is lower and “this represents the first downward revision in well over a year.” However as important as it may be, EUR/USD won’t live or die by the ZEW survey and as the week progresses, the pair could still rally if the dollar continues to fall.
All 3 of the commodity currencies traded higher on Monday but their gains have been modest. A decline in oil prices had little effect on the Canadian dollar, which has been trading in a tight 85-pip range versus the U.S. dollar for the past 4 trading days. Manufacturing sales are scheduled for release on Tuesday and if the data rebounds as anticipated, paving the way for optimism from the central bank, we could see USD/CAD break the bottom of its range. Stronger than expected service-sector PMI lent support to the New Zealand dollar but with the currency’s rally starting to lose momentum, a sharp rise in dairy prices may be needed to reinvigorate the bulls. The Australian dollar was in play Monday evening ahead of the RBA minutes and Chinese data scheduled for release. We know that the RBA feels that the global markets are underpricing risks with governor Lowe expressing specific concerns at the last meeting about President Trump’s international trade policies. There’s also been talk about China looking at devaluing the yuan and if they choose to do so, it would be negative for the Australian dollar.