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USD rallied on Friday but sentiment remains very negative. Wages data on Wednesday are key for RBA and AUD.

By Nick Parsons

With stock markets enjoying their biggest weekly gain since December 2011, volatility lower and gold up more than $30 from its recent low, many of the conditions were in place for a rally in the AUD last week. With the US Dollar hitting a fresh 3-year low against a basket of major currencies, AUD/USD ended the week more than a cent higher at 0.7910, having at one point on Friday morning reached a 2-week best of 0.7985.

Last week’s Australian labour force figures did nothing to boost investor appetite for the AUD. Employment increased 16,000 on the month but seasonally adjusted monthly hours worked in all jobs decreased by 24.1 million hours (or 1.4%) between December 2017 and January 2018 to 1,708.2 million hours. This follows a decrease of 8.6 million hours (or 0.5%) from November to December 2017. The average number of hours worked per employee per week fell to a new record low of 31.7. Employees are on average working 2.7% fewer hours than a year ago and that will limit the boost to household incomes from rising employment. RBA Assistant Governor Luci Ellis last week noted, “Australia has had especially strong employment growth over the past year - more than double the rate of growth in the working-age population… But that hasn’t translated into strong consumption growth. Household income growth has been weak for a number of years, and that has weighed on consumption growth.”

As the RBA has made very clear that it is watching wages and aggregate household incomes, then investors around the world are going to be doing exactly the same thing. On Wednesday this week the Australian Bureau of Statistics releases its quarterly wage price index, as it has done every three months since September 1997. The last set of numbers in November showed a +0.5% q/q increase to leave the annual rate at 2.0%; well-below its long-run average around 3¼%. Consensus looks for a similar pace of growth in these Q1 numbers and the read-across to the currency from the data should be pretty straightforward: stronger numbers = stronger AUD and, of course, vice-versa. The Australian Dollar opens in Asia this Monday having closed in New York at USD0.7910, with AUD/NZD at 1.0705 and GBP/AUD1.7750. Within the Asian time zone, Chinese markets remain closed until Wednesday for the Lunar New Year holidays.

The New Zealand Dollar began last week around USD0.7250 and moved steadily higher, interrupted only by a sharp drop and equally sharp reversal higher on Wednesday after the release of the US CPI figures. By Friday morning, the pair touched a fresh 2018 high of 0.7434 before slipping back to close more than a cent higher at 0.7390. Against its Aussie cousin, the NZD reached a 6-month high with the AUD/NZD cross falling to 1.0705; its weakest since August 5th.

In economic news, last week’s highlight was arguably the RBNZ's March quarter survey which showed firms lifted their two-year inflation expectations to 2.11% from 2.02 % in the prior period, while one-year inflation expectations remained steady at 1.86%. New figures on house sales from the Real Estate Institute of New Zealand, meantime, showed sales volumes nationally rose when compared to the same time last year for the first time in 19 months.

The week ahead has another RBNZ survey on Wednesday; this time of households rather than businesses. This survey often runs higher than the business numbers, and is calculated to only one rather than two decimal points. In the December quarter, household expectations of inflation in one year’s time rose from 2.5% to 3.0%; well above comparable survey results from businesses and professional forecasters. Before then, today brings the performance of services index which – like the manufacturing PMI survey – is published out of synch with all the other global PMI numbers. As at Friday’s New York close, the NZD stood at USD0.7390 and AUD/NZD1.0705.

The GBP had a very good week despite the softness of economic activity data. It began on Monday around USD1.3820 and moved higher on Tuesday after CPI figures showed the UK inflation rate stuck at 3.0% rather than falling to 2.9% in line with consensus expectations. From a high on Wednesday morning of USD1.3920, the pound tumbled to 1.3830 after stronger than expected US CPI figures. Within ninety minutes, however, it had more than reversed all its losses to close just under 1.40. On Thursday and Friday, it extended these gains to a 2-week high just below 1.4140. Then came news that UK retail sales grew just 0.1% m/m in January, well below consensus expectations of a +0.6% m/m increase and by the close of business the GBP had lost more than a cent to USD1.4045.

With the balance of incoming economic data generally soft – especially in those areas linked to the housing market, consumer confidence and expenditure – the GBP continues to be buffeted by alternating hopes and fears around Brexit negotiations. There are only a little over 4 weeks to a key European Council Summit on March 22-23, and UK Cabinet members are currently embarked on a series of speeches which are designed to put a little more flesh on the bare bones of its negotiating position. Last Wednesday it was the turn of Foreign Secretary Boris Johnson and on Saturday the Prime Minister gave a speech in Munich about Britain and European security policy.

For the week ahead in markets, the focus will be on the major UK banks which all report annual profit numbers. In economics, Wednesday brings the latest unemployment and average earnings figures and, just as in Australia, currency investors will be watching closely for any sign of pick-up in wage growth. Futures markets are currently reflecting a 70% probability of a 25bp hike at the May MPC meeting. 32 of 57 analysts polled by Reuters last week said the BoE would raise its Bank Rate to 0.75 percent in May, up from only 13 of 71 economists in a similar survey in January. The pound opens in Asia this morning having closed on Friday at USD1.4035, GBP/AUD1.7750 and GBP/NZD1.8990.

The US Dollar had a very poor week with its index against a basket of currencies falling below 88 for the first time in a little over 3-years. Its fall came as equity markets enjoyed their biggest one-week gain since December 2011 and despite the yield on US 10-year Treasury bonds hitting a 4-year high of 2.91%. Analysts have been falling over themselves to advance new reasons for the USD decline, in some cases citing the very factors which caused them to be bullish in early 2017. Thus, the strength of the US economy we are now told is a bad thing because it will suck in imports whilst the rise in bond yields is due to deficit-financing which will leave the US at the mercy of foreign investors. Never underestimate the ability of analysts to fit a narrative around the prevailing price action!

With stock markets recovering, a 25bp rate hike at the March FOMC meeting is now priced with greater certainty than at any point this year. Three weeks ago, with the stock market at a record high, the market-derived probability of a hike was 76%. Today, it is at 83%. Indeed, Fed funds futures put the probability of the Fed raising rates four times this year at 25 percent versus just 17 percent immediately before the US CPI release. None of this helped the US Dollar last week, however, and though Friday saw a half-point gain for the USD index, sentiment and price action remain very negative.

Today is the third Monday in February so US markets are closed for the President’s Day holiday. Originally established in 1885 in recognition of President George Washington and celebrated on February 22, the holiday was moved in the 1971 Uniform Monday Holiday Act; an attempt to create more three-day weekends for workers. The highlight of the working week will probably be Wednesday’s release of the Minutes of the February 1st FOMC; just one day before the 666-point drop for the Dow Jones Industrial Average and the subsequent surge in volatility. It is otherwise a pretty quiet week for economic statistics. Existing home sales and Markit’s version of the PMI survey are out on Wednesday and there are a few Fed speakers scheduled but no top-tier data. The USD index closed on Friday at 88.30 having earlier in the day hit a fresh 3-year low of 87.95.

The euro had a good week, ending with EUR/USD almost 2 cents above Monday’s opening level. With German politics fading as a concern for investors and sentiment towards the USD uniformly negative, incoming economic data in the Eurozone continued to support the Single Currency, albeit there was no standout positive surprise.

Figures released from Eurostat confirmed that GDP in the Eurozone rose 0.6% in Q4 last year. Growth slowed a little in Germany and Italy, while the pace of expansion accelerated in the Netherlands and Portugal. Germany’s upswing – despite a slowdown in quarterly output – continues to be a key ingredient for growth in the euro area. The Dutch economy also benefited from buoyant global trade. GDP increased 0.8% in the fourth quarter, exceeding consensus estimates. Italian growth slowed to 0.3%, leaving it lagging behind France and Germany and providing a note of caution ahead of general elections next month while GDP increased 0.7% in Portugal.

After a slow start today, Tuesday brings Germany’s ZEW Survey of professional forecasters and the so-called ‘flash PMI’s’ are published on Wednesday. Markets have hitherto never been bothered with Minutes of the ECB Council Meetings but it was the last set of Minutes published on January 11th which dropped the bombshell about the need to change the language around monetary policy. EUR/USD was trading down at 1.1950 at the time and it was this – rather than anything Mr. Mnuchin said at Davos – which really sent the euro soaring. The Minutes will be very closely watched this time around on Thursday ahead of Friday’s Eurozone CPI numbers. The EUR opens in Asia this morning having closed in New York on Friday evening at USD1.2415, AUD/EUR0.6370 and NZD/EUR0.5950.

There’s been lots to digest in the last few weeks for the Canadian Dollar. Investors are grappling with the implications of higher US inflation and interest rates at the same time as US government debt is soaring and the current account deficit is widening. Throw in uncertainty around NAFTA and an oil price which has fallen more than 10% over the past couple of weeks and it’s easy to see why the USD/CAD has been so choppy. Over the past week it ended on net firmer against the US Dollar but weaker against all the other FX majors with AUD/CAD, for example, up a full cent to 0.9930 and now just 70 pips away from parity.

We covered here on Friday the very interesting speech from Bank of Canada Deputy Governor Lawrence Schembri in which he reviewed the success of Canada’s inflation targeting monetary policy regime. In response to audience questions afterwards, he went on to say that Bank of Canada’s cautious approach to further rate hikes does not mean rates will stay low forever, as policymakers also have to weigh inflationary pressures. “There’s a balance between the two - being cautious and recognizing that there’s important uncertainties facing the Canadian economy, but at the same time recognizing and monitoring inflationary pressures and how they develop.”

The Bank of Canada has raised rates three times since July 2017 and has said less monetary policy stimulus is likely going to be required over time, but maintains it will be cautious and watch incoming data as it considers more hikes. The next BoC monetary policy meeting is on March 8th; two days after the RBA and the same day as the ECB and though money markets are indicating around a 70% probability of another hike by May, it is not expected to come before then. This week brings official data on retail sales on Thursday then on Friday it’s earning, hours worked and the CPI numbers. Before then, wholesale trade numbers are out Tuesday but its otherwise a very quiet start to the week. The Canadian Dollar opens in Asia this morning having finished on Friday at USD/CAD1.2555, AUD/CAD0.9930 and NZD/CAD0.9280.