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US trade tariffs to dominate investor sentiment. RBA will leave rates unchanged on Tuesday but will GDP figures offer any more clues for the AUD?

By Nick Parsons

The most well-known US stock market index, the Dow Jones Industrial Average, fell over 1,500 points in just a few days last week. When new Fed Chair Jerome Powell delivered his maiden semi-annual monetary policy testimony, the DJIA stood at 25,800. By Friday afternoon it was down at 24,260. Lower asset markets and higher volatility are usually bad for the Aussie Dollar. Add in a $20 drop for the gold price and it was no surprise to see the AUD weaken. From an opening level in Sydney last Monday morning around 0.7830, AUD/USD fell to a low on Thursday around 0.7715 before a recovery late on Friday to 0.7770.

In terms of economic data, the last week of February was something of a mixed bag. According to the Australian Bureau of Statistics, Capital Expenditures fell by 0.2% to $29.57 billion in the final quarter of last year, missing forecasts for an increase of 1%. Despite the lower than expected headline number, total CAPEX grew by 4% over the year, the strongest increase in five years. In more timely data, the Commonwealth Bank PMI index – a composite indicator designed to measure the performance of the manufacturing economy – edged slightly higher to 55.6 in February, from 55.4 in January, signaling a strong rate of improvement in the health of the manufacturing sector. Separately, the value of credit extended to Australia’s private sector grew by just 0.3% in January and over the year, total credit grew by 4.9%, the equal-lowest increase since May 2014.

The two main events for the Aussie Dollar this week will be Tuesday’s RBA Board meeting and then Wednesday’s Q4 GDP report. It would be one of the biggest surprises ever if the RBA changed interest rates and there’s no great need for any change of signaling from the Central Bank on future policy intentions. Ahead of this, we’ve been highlighting the lack of consensus on Australian interest rates from the ‘Big Four’ banks locally. The divergence narrowed somewhat last week as NAB revised their outlook. They wrote that, “Weak wages growth and slow progress reducing unemployment means it is now less likely that the RBA will raise rates twice in 2018. We now see the RBA raising rates only once in late 2018 – with November 2018 as the most likely start date for a gradual RBA rate hiking cycle”. The AUD opens in Asia having closed on Friday evening at USD0.7770, with AUD/NZD at 1.0715 and GBP/AUD1.7770.

The New Zealand Dollar continues to defy analysis or even explanation. On Friday ten days ago, it was bottom of our one-day performance table without any incoming news. Last week, it was top on Monday; again with no fresh incoming data or news catalyst. Both Tuesday and Wednesday it was bottom of the pile and on Thursday it was back in top spot. NZD/USD hit a low in Sydney on Thursday of 0.7190 but ended the day at 0.7250 and went on to a best level on Friday of 0.7275 before closing around 0.7240. Seemingly random swings from top to bottom place are frustrating for everyone but show the importance of placing orders in advance to benefit from volatility in offshore centres.

Just as New Zealand’s dollar is volatile, so too are some of its economic statistics. Last week, we saw that in January 2018, New Zealand recorded its largest deficit for a January month since 2007. This deficit contrasts with last month’s surplus, which was the largest ever for a December month. In separate data, ANZ’s monthly business survey turned less pessimistic, their jobs advertisement numbers turned down from recent highs yet consumer confidence rose. We also saw that New Zealand's visitor arrivals dropped for the first time in five years in January as fewer Chinese tourists visited the country, although though statistics officials said that was largely due to the timing of Chinese New Year, which this year fell in February.

It’s not just across the Tasman Sea where analysts are firming up their estimates of G4 GDP. Locally in New Zealand, the GDP numbers are not out until March 15th but this week there are three of the ‘partial data’ which feed in to the calculation. On Wednesday it is Building Work Put in Place and Wholesale Trade whilst Thursday is the quarterly Survey of Manufacturing. For the moment, early estimates of the GDP number are for growth around 0.4-0.6% in the December quarter. The New Zealand Dollar opens in Asia this morning having closed in New York on Friday at USD0.7240 and AUD/NZD1.0715.

Brexit manages to be simultaneously a very fascinating and extremely tedious subject! Unfortunately, it is also the key driver of the GBP which ebbs and flows according to whether any final deal is seen to be good for the UK trade (soft Brexit) or something which leaves the country more isolated from the Continent of Europe but free to strike global trade deals (hard Brexit). Sentiment can shift strongly from day-to-day and even intra-day and last week was a very good example of how sensitive the GBP can be. From an opening level around USD1.3980 in Sydney last Monday, the GBP hit a best level around 1.4060 in the London morning but it was then downhill pretty much all the way to a low point on Thursday of 1.3720; the lowest since January 12th (the day after the ECB first spoke about changing forward guidance) A bounce was seen late Friday evening but the pound couldn’t hold on to a 1.38 ‘big figure’; closing around 1.3795.

The Prime Minister’s major speech on Friday – moved from Newcastle because of the extreme winter weather which gripped the UK last week - was high on aspiration but low on detail, even if it did acknowledge for the first time that totally frictionless trade with the EU will be a future impossibility. The good news in terms of domestic politics is that both wings of the Conservative Party have welcomed Theresa May’s new approach. The threat of losing a vote of confidence in the House of Commons appears much less likely than it did just a few days ago. However, what we haven’t yet seen is any reaction from Brussels which on Friday was busy crafting a response to President Trump’s trade tariffs. The GBP will now be driven by the extent to which the EU will seek to harden its own negotiating position ahead of the EU Summit in just over two weeks’ time.

For the week ahead, the main economic statistics come at the beginning and the end. Today we have the service sector PMI survey and on Friday it’s manufacturing and industrial production and the overseas trade balance numbers. In politics, as the BBC pithily notes, “There will be a flare-up in the Brexit phoney war on Monday when Theresa May takes questions from MPs about the policies in her big Brexit speech but after that things quieten down, with sporadic guerrilla activity in various select committees.” The pound opens in Asia this morning having closed on Friday at USD1.3795, GBP/AUD1.7770 and GBP/NZD1.9060.

The US Dollar had very much a week of two unequal halves: up for the first three and a half days and down for the remainder. Its index against a basket of major currencies opened on Monday morning at 89.50 and as stock markets fell, volatility rose, and Fed Chair Jerome Powell hinted at the possibility of four 25bp hikes this year, so the USD index hit a high on Thursday of 90.50; back to where it was before US Treasury Secretary Mnuchin’s remarks in Davos in late January. On Thursday afternoon, President Trump announced tariffs of 25% on imported steel and 10% on aluminium products. This surprise move sent stocks plunging once more, with the DJIA down more than 500 points and the VIX index above 20. This time, however, the USD did not respond positively. Amidst fears of retaliatory action from other countries, the index gave back around half a point to 90.00 and fell further on Friday to 89.60.

President Trump tweeted on Friday that, “When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win. Example, when we are down $100 billion with a certain country and they get cute, don’t trade anymore-we win big. It’s easy!”. In response, most countries - including Canada, China and much of Europe - have issued statements condemning Trump's decision and threatened retaliatory action. The European Union vowed to “react firmly” with World Trade Organization-compliant countermeasures in the next few days. An EU Commission spokesman said that the EU already has counter-measures ready against US tariffs and stands ready to respond, whilst Canada, which is the biggest foreign supplier of steel to the US was furious: Ottawa said the US measures were “unacceptable.”

Far from retreating, President Trump instead doubled down on his threats. After hearing that the EU was considering specifically target measures on Harley Davidson motorbikes and Levi Strauss jeans, he tweeted that, “If the E.U. wants to further increase their already massive tariffs and barriers on U.S. companies doing business there, we will simply apply a Tax on their Cars which freely pour into the U.S. They make it impossible for our cars (and more) to sell there. Big trade imbalance!” He went to say, “The United States has an $800 Billion Dollar Yearly Trade Deficit because of our “very stupid” trade deals and policies. Our jobs and wealth are being given to other countries that have taken advantage of us for years. They laugh at what fools our leaders have been. No more!”. We’d note that the last time the US started a trade war over steel in 2002, the S+P 500 fell almost 30% and the USD fell 20% over the next 18 months until the WTO ruled the tariffs were illegal…

EUR/USD ended last week almost exactly unchanged but it was far from dull. Having opened in Sydney on Monday around 1.2310, by Thursday morning it had fallen 1½ cents to 1.2160; its lowest since mid-January. The euro began to rally as soon as President Trump announced his trade tariffs and having gained a full cent by the close of business in New York, it extended gains on Friday to a high of 1.2330 to end the week up against the AUD, NZD, CAD and GBP.

In a speech on Friday night at Harvard University, European Commissioner for Competition, Margrethe Vestager, said the EU will respond to the tariffs, “to defend European industry, and the world trading system”. She called the Trump action, “one-sided protectionist measures, which hurt, not just jobs, but the whole system of rules that makes our global economy work.” According to Reuters, the United States had a $22.3 billion automotive vehicle and parts trade deficit with Germany in 2017 and a $7 billion deficit with the United Kingdom. The United States accounts for about 15 percent of worldwide Mercedes-Benz and BMW brand sales, while it accounts for 5 percent of VW brand sales and 12 percent of Audi sales.

Whilst trade threats will likely dominate the agenda in the early part of this week, we’ve also had the results of the German SPD’s membership vote on whether to enter a so-called “Grand Coalition” - or “Groko” as it’s known locally - with Angela Merkel. A majority of 66.02% of 463,723 eligible SPD members voted in favour of renewing the coalition that has governed Germany for the last four years. As we write this commentary, the results of the Italian General Election are not yet in, though political experts suggest the result appears likely be a hung parliament. The worst outcome for the currency would be a highly unlikely 5SM victory, though if it polls very well and enters a formal coalition, then the EUR will still be pressured. It closed on Friday evening in New York at USD1.2320, AUD/EUR0.6300 and NZD/EUR0.5880.

The Canadian Dollar had another poor week. USD/CAD opened on Monday morning at 1.2645 and moved relentlessly higher to a best level on Friday around 1.2910; its first time on a 1.29 ‘big figure’ since November 30th and the highest level since mid-July. AUD/CAD, meantime, on Friday hit parity for the first time since August 18th and is up 3½ cents since its early-December low.

The announcement of US tariffs hits the Canadian Dollar in two ways. First, and directly, Canada is the world’s number one exporter of steel to the United States, followed by Brazil, South Korea, Mexico and Russia. Canada’s Foreign Minister Chrystia Freeland said it’s “entirely inappropriate” for the US to consider the country a threat to national security. “We will always stand up for Canadian workers and Canadian businesses... Should restrictions be imposed on Canadian steel and aluminum products, Canada will take responsive measures to defend its trade interests and workers.” Second, as a seventh round of NAFTA talks is underway in Mexico City, an escalation of a trade and tariffs war makes for a very difficult backdrop, throwing doubt on the whole process.

The week ahead could be quite busy for the Canadian Dollar, not just in terms of economic data and trade news, but also on Wednesday the Bank of Canada policy meeting. The BoC is unanimously expected to leave official rates unchanged at 1.25% after the 25bp hike in January and the accompanying statement will be closely read for what the Central Bank has to say about trade and the economy. Ahead of that on Tuesday is the PMI survey and on Wednesday morning the housing starts and labour productivity data. On Friday, the Canadian labour market report will be released at the same time as the US employment numbers. The Canadian Dollar opens in Asia this morning having ended the week at USD/CAD1.2880, AUD/CAD1.000 and GBP/CAD1.7770.