FX Wednesday: Here’s What Happened

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

We haven’t seen this type of volatility in the foreign-exchange market in weeks. In the last 24 hours, trading ranges expanded sharply leading to big moves in currencies. The NY session started with strength for the U.S. dollar and weakness in euro and sterling. Although the greenback ended the day higher versus the Japanese yen, it experienced significant losses against other major currencies. The only explanation for Wednesday’s moves is risk appetite – yet it took a while for USD/JPY to catch up to the broader market. With the Dow rising over 300 points Wednesday, 30K is in sight and currencies are benefitting from the prospect of a continued rally in equities. Having hit a low of 110.20 during the Asian trading session, USD/JPY quietly traded higher throughout the day but didn’t break 111 until Fed Presidents Evans and Kaplan made a hawkish shift. Evans, who voted against a rate hike at the last meeting, said he expects strong growth this year and next as the tax cut should add to business investment and jobs. Kaplan said the base case in 2018 is for 3 rate hikes as the tax cuts could drive unemployment down to the 3% range by the end of the year. Neither Evans nor Kaplan are FOMC voters this year but the market cared more about their positive outlook than their direct influence on policy. If the doves can be convinced the economy is strengthening and the case for rate hikes hardening, then the hawks could squawk even louder. As expected, the Beige Book confirmed that all Fed districts saw modest-to-moderate economic growth with labor-market tightening and wages on the rise. Foreign central banks are also growing uncomfortable with the recent strength of their currencies, so we may finally see the dollar recover some of this month’s losses. Wednesday’s USD/JPY rally should see continuation regardless of Thursday’s housing reports and Philadelphia Fed Index index. We are looking for a move to 112 but beyond that, there will be resistance between 112.30 and 112.50. Wednesday’s big event was supposed to be the Bank of Canada’s monetary policy decision. It raised interest rates by 25bp in a move that Governor Poloz described as a “no brainer.” At first, the Canadian dollar dropped because the policy statement expressed concerns about NAFTA and stressed the need for accommodation to keep inflation on target. The BoC also maintained its view that cautiousness is needed on future rate rises. However, the Canadian dollar recovered its losses when Governor Poloz and Deputy Governor Wilkins took to the podium an hour later. They expressed some concerns about wages and the risk of stalling the expansion by raising rates too quickly, but they also felt that tightening too slowly would risk an inflation buildup. Poloz said a rate hike would have validated what they’ve seen in the market and while he can’t say how much accommodation is needed, the economy is likely to warrant higher rates over time (according to the policy statement). The main takeaway from the day’s announcement is that the central bank felt the economy is strong enough to make a hike an easy decision and while it needs to be cautious moving forward, it’s optimistic – and that keeps another round of tightening in play. The downtrend in USD/CAD remains intact for the time being and we expect a move below 1.2400 that could extend down to 1.2350. Thanks to risk appetite, the Australian and New Zealand dollars hit fresh 3-month highs on Wednesday, ahead of a busy evening in Asia with Australian employment and Chinese GDP data scheduled for release. The brightest spot of the Australian economy has been the labor market and we’ll soon learn if the momentum was sustained at the end of the year. It would be difficult for job growth to come anywhere close to the 61.6K increase reported in November but if employment change meets or beats the market’s 15K expectation just slightly and the unemployment rate declines, it would be enough to send AUD/USD well above 80 cents. However if job growth slows more than expected and full-time jobs suffer the most and the unemployment rate holds steady, we could see a sharp correction in AUD/USD, especially ahead of what is widely believed to be slower Chinese growth in Q4. 2018 will be a challenging year for China and softer GDP, retail sales and industrial production numbers will remind investors of the trouble to come. These economic reports should have a meaningful impact on AUD and NZD. Meanwhile, for the past week we have been warning about ECB jawboning and we’re seeing the first signs of discomfort from the central bank. On Wednesday morning, ECB Vice President Constancio joined ECB member Nowotny in suggesting that the strong and sudden moves in the currency is a concern. If it were to rise further, there’s no doubt that Mario Draghi will share his two cents, which would result in a much larger decline for the currency. What’s interesting about EUR/USD is that 1.22 has held as rock-solid support for the past 72 hours. We think it’s only a matter of time before this level is broken, paving the way for a steeper slide down to 1.2100 and possibly even 1.20. With the greenback ending the day strong, we would not be surprised if 1.22 breaks in the Asia session just as EUR/USD shot above 1.23 Tuesday night. There was no explanation for the move outside of low-liquidity stop hunting but the nearly 1-cent reversal in the last 2 hours of the NY day puts the pair at serious risk for a deeper reversal.

GBP/USD is 100 pips off its 1.3943 high but is holding up much better on a technical base than the euro. The V-shaped move in the currency was driven by risk appetite followed by dollar strength. We continue to believe that 2018 will be a good year for sterling but in the near term, buying GBP vs. JPY, CHF or the commodity currencies may be a better bet. With that in mind, European Union officials are certainly not making it easy as European Commission President Juncker urges Prime Minister May to reverse Brexit and offer to allow the country to re-apply for membership after departing.

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