Dollar Bulls Back In Control, GBP Crashes

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

Dollar bulls were back in control Wednesday with the greenback trading higher against all of the major currencies. USD/JPY traded as high as 114 before retracing to end the day below that key level. However there’s no question that the trend for the dollar has shifted as the market finally latches onto the growing possibility of a March rate hike. Although the hawkish commentary from Federal Reserve officials has been clear and consistent, it took a while for investors to catch onto their intentions. Barring an unexpected slowdown in the U.S. economy, interest rates are rising 3 times this year. The latest economic reports only serve to validate the Fed’s optimistic view of the U.S. economy and the positive outlook in the Beige Book report. Despite the recent slowdown in wage growth, personal incomes rose 0.4% in January. Manufacturing activity also accelerated with the ISM manufacturing index rising to 57.7 from 56. There was some bad news however as personal spending growth slowed to 0.2% from 0.5% and construction spending fell. However these misses don’t detract from the general improvement in the U.S. economy or diminish the odds of a rate hike. President Trump spoke Tuesday night and the market was satisfied with his plan to grow the economy by spending $1 Trillion on infrastructure. No specific details were provided during his speech to Congress but spending means growth and growth reinforces the need for tightening.

As expected, the Bank of Canada left interest rates unchanged and their cautious views kept the loonie under pressure throughout the NY trading session. The central bank felt that there was persistent slack and subdued wage growth with exports facing ongoing competitive challenges. Although inflation is on the rise, the BoC said it would look through the temporary effect of higher oil prices. This implies that it will maintain a dovish bias that leaves the door open to additional easing. There was no speech from BoC Governor Poloz so the impact on the loonie was limited with lower oil inventories sapping some of the gains. USD/CAD remains in focus on Thursday with monthly and quarterly GDP numbers scheduled for release. Given the sharp drop in retail sales, the risk is to the downside for the report. The best-performing commodity currency was the Australian dollar, which soared on the back of stronger manufacturing activity and a hot GDP report. The manufacturing PMI index jumped to 59.3 from 51.2, the highest level since 2001. The economy also expanded 1.1% in the fourth quarter, outpacing the market’s 0.8% forecast. China’s PMI reports were mixed with the official index falling slightly and the independent Caixin report increasing marginally. Australia’s trade balance report was due Wednesday evening and given the sharp rise in the PMI, healthier numbers were anticipated. While the New Zealand dollar ended the day with losses, it is off its lows courtesy of positive comments from RBNZ Governor Wheeler. Rather than express caution, Wheeler said he sees risks around future rate moves equally balanced. Wheeler is still worried about the strong currency and the global economy but the housing market is strong and its too early to say whether the moderation in prices will continue.

One of the worst-performing currencies was the British pound, which fell sharply against all of the major currencies. Having broken below 1.2380 and the 50/100-day SMA, GBP/USD extended its losses below 1.23 and appears poised for a deeper slide to 1.22. Manufacturing activity slowed more than expected in February triggering a deep slide in the currency. The rest of the data was mixed. BRC shop prices dropped less than expected, falling by 1.0% when a drop of 1.4% was expected. Nationwide, house price data showed an increase in February by 0.6% when only an increase of 0.2% was expected. Net consumer credit fell in line with expectations at 1.4b. Mortgage approvals saw a bump in January coming in at 69.9k vs.68.5k expected. Also, Brexit remains a sore spot for the pound — Theresa May’s Brexit bill is expected to be defeated in the House of Lords, causing more back and forth on the terms of exit. The issue is rights for EU citizens residing in the UK. An amendment to the bill guaranteeing rights to EU migrants living in the UK would prolong the process and add uncertainty. It won’t stop Article 50 from being triggered but puts Brexit back in the headlines. Between a possible Scottish referendum and the trigger of Article 50, March could be a tough month for GBP.

While euro also traded lower against the greenback, losses were limited by a sharp rise in German bond yields. Like the U.K., data was mixed. Germany’s manufacturing PMI index was revised lower to 56.8 from 57. German unemployment change showed a drop of -14k, which is better than the drop of -10k expected for February. The country’s unemployment rate held steady at 5.9%. German CPI was in line with expectations, posting an increase of 0.6%. Manufacturing PMI for the Eurozone also missed slightly coming in at 55.4 when 55.5 was expected. Bundesbank’s Weidman said that the original ECB estimate for inflation was inaccurate and most likely inflation numbers would be far higher than projected. Weidman did concede that it was too early to talk about tapering QE efforts and that underlying inflation was still weak. On Thursday, the EZ releases its unemployment rate and PPI data.

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