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GBP falls sharply then surges on Brexit rumours. All-time highs for US stock market help lift USD.

By Nick Parsons

Through the Northern Hemisphere day on Tuesday, AUD/USD traded in a fairly tight range either side of 0.7600 and a closer look at the charts shows it just spent more time above this level than below it. The AUD/NZD cross hit a low of 1.0964 before recovering 20 pips in the London afternoon and into the NY session. Overall, the AUD rose against the USD and CAD, was little changed against the EUR and fell against the GBP after a late surge in the British Pound (see below).

In a new opinion poll published this week by Roy Morgan, only 31 per cent of people think 2018 will be “better” than 2017 – the lowest figure recorded since the survey began in 1980. Younger Australians are more positive than older generations, with almost half (46%) of 18-24-year-olds expecting next year to be better, while just 20 per cent of over 65s feel that way. Perhaps the younger respondents feel that housing might at last become less unaffordable; not a problem if existing homeowners have little debt, but potentially a major issue for the economy if they do. Aside from exports of iron ore, the Australian economy is hugely driven by the residential property market which according to a BIS report earlier this month has had a 55-year bull market; the longest of any country in the world. So important is housing that the total value of all properties is around four times the size of GDP.

By way of comparison, in the UK it’s around 3.5, in Canada around 2.4 and in the US around 1.6 times GDP. A huge amount of debt has had to be taken on by homeowners to accumulate this property wealth. After Switzerland, Australia has the greatest proportion of household debt to GDP in the world; a little over 120%. What is more, there is more debt held by older homeowners than anywhere else on the planet. This, of course, is all fine and well as long as there’s a steady stream of new entrants to the market, interest rates don’t go up and prices don’t fall. The simple problem for Australia is that it has been actively discouraging overseas property buyers, whilst prices are still too high for locals and the monetary policy debate has shifted to when and by how much interest rates will go up. Bigger picture, keep an eye on property prices for clues to the Aussie Dollar outlook…

The Kiwi Dollar has done very well to hold on to Monday’s sharp and totally unexpected gains. In fact, it even managed to extend them during the London morning on Tuesday before finding the air a little thin after its rapid ascent. Its’ best levels against the currencies we follow closely here were NZD/USD0.6944, NZD/EUR0.5841, AUD/NZD1.0964, NZD/CAD0.8881 and GBP/NZD1.9118.

Having moved so much in a news vacuum, we’ll now get to see whether the incoming data, speeches and publications validate or contradict the price action. Things really kick into gear locally this morning with the publication of the RBNZ Financial Stability Report and then Acting Governor Graeme Wheeler up in front of a Parliamentary Select Committee. The main interest will likely be on the assessment of the success – or otherwise – of the so-called ‘macro prudential’ controls in the housing market and whether or not these are to be lifted any time soon.

On Thursday the ANZ business survey will be closely watched as it’s the first look at a whole fresh month of data since the new Labour-led government was formed. It will be pored over for any sign that the recent sharp fall in the NZD is impacting confidence, activity or inflation expectations. First of all, let’s see what the Governor has to say…

The pound had a quite remarkable Tuesday, falling quite sharply against every major currency for 18 hours then regaining all its losses and more in the space of just 20-30 minutes. Let us explain… At its’ worst, around the end of the London trading session, GBP losses extended from just over 40 pips against the CAD to 50 versus the EUR, 90 against the USD, 130 against the AUD and a huge 170 pips against the NZD. The day had begun with the release at 7am London time of the Bank of England’s annual Financial Stability Report.

It’s fair to say there were some very grumpy journalists: they had been in a locked room in Threadneedle Street from 5am to write up their stories ahead of an 0700 GMT embargo. The seven biggest UK banks passed a stress test that was as tough as if the UK crashed out of the European Union, the BoE said, with sterling slumping, interest rates rising to 4 per cent and a record housing market crash. It is undoubtedly good news that the UK financial system is seen as resilient but the almost exclusive focus on downside risks – the whole purpose of the FSR – nonetheless sowed the seeds of doubt amongst currency investors and pressured the pound throughout the London day.

Then, at 6pm local time, a headline appeared on the Daily Telegraph website saying, “Exclusive: Britain and EU agree divorce bill”. The story said – and we quote in full - “British and EU negotiators have reached a deal over the so-called ‘Brexit bill’, opening the door to a potential breakthrough in the talks this December. Sources on both sides confirmed that an agreement-in-principle has now been reached over the EU’s demand for a €60bn financial settlement ahead of a crucial lunch meeting next Monday between Theresa May and Jean-Claude Juncker, the European Commission president. Two sources confirmed that the terms were agreed at a meeting in Brussels late last week after intense back-channel discussions led by Oliver Robbins, the UK’s chief Brexit negotiator. The Telegraph understands that the final figure, which is deliberately being left open to interpretation, will be between €45bn and €55bn, depending on how each side calculates the output from an agreed methodology”.

If true – and it’s a big ‘if’ - then it at least means the Brexit talks can continue without the UK crashing out at a very early stage. GBP/USD surged from 1.3230 to 1.3375 with GBP/AUD and GBP/NZD both leaping more than 2 cents in less than half an hour. Whether this story is true, of course, remains to be seen. But it has certainly wreaked havoc in the foreign exchange market.

The US Dollar steadily extended its gains through the European and North American sessions on Tuesday. From a 2-month low of 92.21 at the beginning of the week, its index against a basket of major currencies touched 92.76 in the London morning and on to a best level of 93.00 in New York. The best word to describe the raft of US economic data yesterday was ‘mixed’.

The 20-cities index of home prices rose 6.19% y/y (gotta love those two decimal places!) to show the fastest annual pace of growth since July 2014. All 20 cities in the index showed year-over-year gains, led by a 12.9 percent increase in Seattle and a 9 percent advance in Las Vegas, whilst 8 cities have surpassed their peaks from before the financial crisis. With house prices up and stocks at record levels, consumer confidence comfortably beat consensus expectations, rising to 129.5; its highest level since November 2000.

On the other side of the ledger, after 5 consecutive monthly increases, wholesale inventories tumbled -0.4% m/m in October. This number tends not to get too much coverage but it feeds straight through into GDP – remember that from Economics 101? Also, the advance goods trade balance showed a bigger than expected monthly deficit of $68.3bn after $64.1bn in September.

Overshadowing the data was Jerome Powell ‘s confirmation hearing at the Senate Banking Committee. In prepared remarks, Powell defended the Fed’s use of broad crisis-fighting powers, and said “We must be prepared to respond decisively and with appropriate force to new and unexpected threats to our nation’s financial stability and economic prosperity.” The stock market loved the sound of more air being blown into the bubble and promptly hit a fresh all-time high, dragging the Dollar higher in its wake.

The EUR had a very poor day Tuesday without ever being the centre of FX market attention. By close of business in NY, it had fallen against every major currency. There were no fresh economic data or ECB speakers and though the OECD revised upwards its forecasts for the Eurozone economy, this came as a surprise to precisely no-one. It’s semi-annual World Economic Outlook noted, “Growth has continued steadily, broadening across sectors and countries, supported mostly by domestic demand.

Improving labour markets and very favourable financing conditions continue to boost incomes and promote private consumption, despite lacklustre wage growth. Investment is becoming more supportive of the recovery and has expanded at a dynamic pace in the first half of the year in most countries, sustained by buoyant business sentiment, the need to upgrade the capital stock, rising profits and easy financial conditions. Exports have continued to strengthen on the back of the rebound in world trade. Business and consumer confidence indicators remain very high.” For the FX market Tuesday, the OECD was a big yawn. Yada, yada, yada… EUR/USD finished the day around 60 pips lower at USD1.1840 with similar losses against the Aussie and Kiwi Dollars.

The Canadian Dollar spent most of Tuesday dragged down by falling oil prices. Though a concerted effort to talk crude prices higher ahead of Wednesday’s OPEC meeting in Vienna had been expected, little was actually been heard from the major players about future production cutbacks. NYMEX Crude reached a fresh 2017 high of $58.82 last Friday, fell steadily on Monday to $58.15 and Tuesday morning hit a low of $57.54. USD/CAD rose (weaker CAD) to a one-week high of 1.2816 with AUD/CAD up 40 pips at 0.9740 and NZD/CAD 45pips higher at 0.8870.

In its semi-annual Financial Stability Review, the Bank of Canada said, “Our financial system continues to be resilient, and is being bolstered by stronger growth and job creation, but we need to continue to watch financial vulnerabilities closely”. Ho hum…. This could have been written by almost any central bank in the world today. BoC is optimistic that higher interest rates and regulatory efforts to rein in risky borrowing will make the country’s financial system more resilient, though the process “could take time to unfold and the outcome remains uncertain”. There was no meat here for the animals of the FX market to chew on so they got back to the simpler business of watching oil prices and marking CAD up or down accordingly.