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AUD awaits NAB Survey and Australian jobs data this week. US NFIB and CPI data will be key for inflation worries and the stock market.

By Nick Parsons

The Australian Dollar remains under pressure. The three main drivers of most of the valuation models of the currency are commodities, interest rate differentials and volatility. When asset markets are quiet, the incremental returns from higher interest rates look quite attractive. As we’ve said before though, when markets are very volatile, this strategy can be likened to picking up pennies in front of a train. Many investors unfortunately got run over last week as volatility surged and all three of the valuation metrics for the AUD turned negative with AUD/USD back on a 77 cents ‘big figure’ for the first time since late December before rallying very slightly into the NY close at 0.7810.

On Friday, the RBA released its latest Quarterly Statement of Monetary Policy; a 68-page document summarising the current state and future outlook for the Australian economy. Essentially, there is hardly any change from the November view though the one-year forecast for unemployment has been revised down 0.25% to 5.25%. The main phrase for interest rate and currency markets was that, “Over the course of 2017, the unemployment rate declined and inflation increased a little. The accommodative setting of monetary policy has played a role here. Further progress on both fronts is expected over the next couple of years. It will be some time, however, before the economy reaches current estimates of full employment and inflation returns to the mid-point of the target”. It is interesting to see the RBA is now stressing the ‘mid-point’ of the inflation target and it is this which has prompted ANZ Bank to change its interest rate forecasts. It was previously looking for 2 hikes this year but now sees the RBA on hold throughout 2018.

Away from the turmoil in global equity markets, the two main domestic highlights in terms of economic data this week are the NAB Survey on Tuesday and the labour market report on Thursday. It seems pretty clear from what the RBA have written and said that wage growth probably holds the key to monetary policy. If employment picks up without any upward pressure on pay, then there’ll be no rush to raise interest rates. RBA Assistant Governor Luci Ellis is scheduled to speak this evening and we’ll see what she has to say – if anything – on recent market turbulence and the outlook for interest rates. The Australian Dollar closed in New York on Friday at USD0.7810, with AUD/NZD at 1.0770 and GBP/AUD1.7690.

After the first 1,000-point drop of the week for the DJIA last Monday, the NZD was boosted by some technically driven selling of the key AUD/NZD pair which fell through a big support level of 1.0850 and tumbled all the way to a 6-month low of 1.0750. Indeed, on Tuesday the NZD was the best performer of all the major currencies we follow closely here. From a high of USD0.7345, however, it was then downhill all the way to a low on Thursday around 0.7180; the weakest in almost 4-weeks, before a recovery on Friday took the pair up to 0.7250.

The RBNZ’s formal comment on the currency in its monetary policy Statement last week was, “The exchange rate has firmed since the November Statement, due in large part to a weak US dollar. We assume the trade weighted exchange rate will ease over the projection period…. Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain and policy may need to adjust accordingly.” Speaking to reporters at the Press Conference, Governor Grant Spencer then said that the bank was not concerned about the New Zealand dollar, "We're comfortable with where it is," adding that the NZD strength was largely on the back of weakness in the US Dollar.

The RBNZ claims to be living in “central bank nirvana” and for all the volatility in global asset markets, it does seem there’s nothing much to trouble policymakers locally this week. Today brings data on credit card spending and on Wednesday it’s food price inflation before the manufacturing PMI survey on Friday. None of these are likely to trouble those in charge of setting interest rates though there’ll be some interest (no pun intended!) in its own quarterly survey of inflation expectations which is released midweek. The New Zealand Dollar finished a very lively week on Friday at USD0.7250 and AUD/NZD1.0770.

The GBP had a very choppy, and ultimately pretty bad week. GBP/USD began at 1.41 exactly, and against a persistently stronger USD, fell to a low on both Wednesday and Thursday of 1.3850. After Thursday lunchtime’s much more hawkish tone from the Bank of England, GBP/USD then surged to a high just over 1.4050 before a complete reversal as the US stock market suffered its second 1,000-point drop of the week. On Friday the pound was sold heavily as a result both of very poor UK merchandise trade figures – which showed the scale of the Brexit challenge – and on a more forceful tone adopted by chief EU negotiator Michel Barnier (see below). GBP/USD tumbled to a 3-week low of 1.3770 before rallying slightly to close on a 1.38 handle.

In his Thursday Press Conference, the BoE Governor was keen to play down the scale and speed of interest rate hikes and despite much probing from journalists, refused to admit directly that interest rates are likely to rise in May. The Statement noted, “Any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent”. Market pricing doesn’t yet have a May hike as a done deal, though the implied probability of a 25bp increase has increased from just under 50% to something nearer 70%. All this, of course, is predicated on Mr. Carney’s two Brexit assumptions – that there is “a smooth transition”, and that it leads to an “average of potential outcomes”. By Friday, rate hike talk had been pushed into the background as EU Chief Negotiator Michel Barnier warned that a transition period immediately after Brexit in 2019 is "not a given". He outlined continuing disagreements between the UK and EU over issues like freedom of movement during the period and said the UK's decision to leave the EU single market and customs union meant border checks at the Irish border were "unavoidable".

The weekend Press in the UK seems to have taken a break from bashing the government, though this is more likely to be a tactical retreat rather than any great change of strategy. Having said nothing of any substance on Brexit since a speech in Florence back in September last year, UK PM Theresa May is set to give her next major set-piece in Berlin in three weeks’ time. Before then, senior ministers are due to set out this week Britain’s “road to Brexit”, with Foreign Secretary Boris Johnson said to be making the case for a “liberal Brexit” designed to reassure Remain voters. In economic news, the big event will be Tuesday’s CPI figures. Inflation last month slowed from 3.1% to 3.0% and consensus looks for another drop to 2.9% in January. With BoE interest rate policy now aligned very closely with current and expected inflation, it should be a straight read-across for the GBP. The pound finished a very turbulent week in New York on Friday at USD1.3825, GBP/AUD1.7690 and GBP/NZD1.9060.

After the previous Friday’s 666-point foretaste of things to come for the Dow Jones Industrial Average, there were two daily 1,000-point declines last week. Friday looked set for another huge drop before the index then bounced sharply off its 200-day moving average to end the day almost 900 points off its midday low. The US Dollar generally does well in times of equity market turmoil and last week was no exception. From its opening level of 88.90 last Monday morning in Sydney, the USD index against a basket of major currencies rose steadily to a high on Thursday of 90.25; its best level since before Treasury Secretary Mnuchin’s comments in Davos two weeks earlier.

None of the scheduled Fed speakers last week seemed at all concerned by the stock market. Federal Reserve Bank of New York President William Dudley said recent declines weren’t that big and don’t yet change his outlook for the U.S. economy. “This wasn’t that big a bump in the equity market… The stock market had a remarkable rise over a very long time with extremely low volatility…. My outlook hasn’t changed just because the stock market’s a little bit lower than it was a few days ago. It’s still up sharply from where it was a year ago. Having a bump up like this has virtually no consequence on my view of the economic outlook”. This view was largely echoed by Kaplan, Harker, Evans and others. Indeed, there are few signs from the front end of the US money market curve that a 25bp rate hike at the March FOMC meeting is in any more doubt. Two weeks ago, with the stock market at a record high, the market-derived probability of a hike was 76%. Today, it has edged down only very marginally to 72%.

To the extent that the 2.9% increase in average earnings was the ‘trigger’ for the stock market sell-off, investors will now be acutely sensitive to any inflation data. On Tuesday we have the NFIB small business survey which contains a question on earnings. Last month’s Press Release breathlessly enthused that, “2017 was the most remarkable year in the 45-year history of the NFIB Optimism Index… With a massive tax cut this year, accompanied by significant regulatory relief, we expect very strong growth, millions more jobs, and higher pay for Americans.” NFIB Chief Economist Bill Dunkelberg said, “There’s a critical shortage of qualified workers and it’s becoming a real cost driver for small businesses… They are raising compensation for workers in order to attract and keep good employees, but that’s a positive indicator for the overall economy.” It may not be so good for the stock market which will be on edge, also, ahead of Wednesday’s CPI numbers. The USD index ended last week around 90.00.

The euro had a relatively calm week stuck between the opposing forces of stock market turmoil which was good for the USD and more strong economic data in the Eurozone. EUR/USD opened on Monday at 1.2450 though this subsequently proved to be within just a few pips of the week’s high. We wrote on Wednesday evening that, “We have seen what happened in the VIX market in the US when investors in a very crowded trade all tried to pile through the exit at once and there were some tentative signs in EUR/USD that the same might be happening in FX.” Strategists at the major banks had been chasing the spot rate higher, moving forecasts ever-upwards on incoming economic data. By midweek, the announcement of a new German coalition government proved the catalyst for a bout of profit-taking on long EUR positions which took EUR/USD down more than 2 cents to the low 1.22’s.

Whilst there was some relief that Germany had avoided a fresh, destabilising Federal Election, there is concern that Ms Merkel might have conceded too much to the left-wing SPD. Reports suggest that the SPD will be handed the Finance, Labour and Foreign Ministries – a major victory for the Social Democrats – while CSU leader Horst Seehofer, one of the most conservative figures on Merkel's side, would become Interior Minister. Over the weekend, a cartoon in Der Spiegel magazine shows Angela Merkel naked while SPD politicians run away with her clothes, whilst Die Zeit has a cartoon of German eagle crash landing on its head…

There are plenty of ECB speakers again this coming week, chief amongst them Bundesbank President Jens Weidmann who last Thursday said, “The favourable economic outlook lends credence to the expectation that wage growth and therefore domestic price pressures will gradually increase in keeping with a path towards the Governing Council’s definition of price stability… If the expansion progresses as currently expected, substantial net asset purchases beyond the announced amount do not seem to be required”. As for the currency, ““The recent appreciation of the euro seems unlikely to jeopardise the expansion… Research suggests that the exchange rate pass-through, which is to say the impact of exchange rate movements on inflation, has declined.” The EUR ended in New York on Friday at USD1.2250, AUD/EUR0.6375 and NZD/EUR0.5920.

The Canadian Dollar began last Monday around USD/CAD1.2430 but as the week progressed and the USD was persistently well-bid, so USD/CAD moved sequentially higher. On both Thursday and Friday, it briefly broke through the upper end of its 2018 trading range from the mid 1.22’s to the high 1.25’s but settled back to 1.2580 by the New York close.

In truth, there were few highlights in a generally dull week for Canadian news and the Canadian currency. Bank of Canada Senior Deputy Governor Carolyn Wilkins gave an interview to Reuters Thursday evening saying Canada’s high household debt is the biggest vulnerability facing the economy, while uncertainty about NAFTA is weighing on the outlook. “Every household is going to find it more or less difficult, so some households might find it extremely difficult, others will just need to tighten their belt a bit, but overall as you can see from our projection, we expect the economy to continue to grow, we expect consumption to continue to grow. I think we are being very clear that the biggest vulnerability to the Canadian economy is coming from high household indebtedness.” Wilkins declined to give “a running commentary” on recent economic data, but said that although GDP growth in the fourth quarter got off to “not the strongest start,” the latest data remained in line with forecasts.

The only important data point was Friday’s employment report where consensus looked for a 10k rise after a 78k gain in December. Instead, Stats Canada reported employment fell by 88,000 in January. Part-time employment declined (-137,000), while full-time employment was up (+49,000). At the same time, the unemployment rate increased by 0.1 percentage points to 5.9%. On a year-over-year basis, employment grew by 289,000 or 1.6%. Gains were driven by increases in full-time work (+414,000 or +2.8%), while there were fewer people working part time (-125,000 or -3.5%). Over the same period, hours worked rose by 2.8%. USD/CAD surged to 1.2645 when the numbers were announced as computer-driven algorithms responded to the headlines but within a few minutes, nearly all the gains had evaporated when it was realised that all the job losses were in part-time and seasonal employment. The Canadian Dollar ended the week at USD/CAD1.2580, AUD/CAD0.9830 and NZD/CAD0.9125.