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USD/CAD holds near 2-month high just below 1.28.

By Nick Parsons

Ahead of the Federal Budget, the Canadian Dollar had another poor day on Tuesday, kept off bottom spot in our one-day performance table only by the weakness of the NZD. As the US Dollar caught a bid on rising money market rates and higher bond yields, USD/CAD moved up through Monday’s high and on to a best level of 1.2755; a fresh high for 2018 and the highest since December 22nd. Overnight in Asia and in Europe this morning, the pair has extended the move by a further 20 pips but has so far stopped short of moving on to a 1.28 ‘big figure’.

The 2018-19 budget, presented in Ottawa yesterday, hd a fiscal track largely in line with what Canadian Finance Minister Bill Morneau forecast in his last fiscal update in October. One major change is C$7.2 billion less infrastructure spending through 2019, an amount that has been allocated to other departmental spending, largely for veterans, indigenous Canadians, women and research. The economy is forecast to average growth of 2 percent between 2017 and 2022, including a 3 percent expansion in 2017 whilst forecasts for debt and the deficit are overall little changed from October’s fiscal update with deficits over the six years including 2017-18 projected to total C$98 billion. The ratio of debt to gross domestic product will drop to 28.4 percent by 2022 from 30.4 percent in 2017-18.

A day after the latest round of NAFTA negotiations began in in Mexico City, US President Donald Trump told a meeting of governors at the White House that when it comes to trade, Canada is "very smooth…. We lose a lot with Canada. People don't know it. They have you believe that it's wonderful, and it is - for them. Not wonderful for us, it's wonderful for them." An eighth round of talks is already planned in Washington next month but any statement the President makes at the moment serves only to increase nervousness for the Canadian Dollar which opens in North America at USD/CAD1.2765, AUD/CAD0.9965 and GBP/CAD1.7715.

The highlight of the day on Tuesday was new Fed Chair Jerome Powell’s first Congressional monetary policy testimony. Ahead of this, both stock index futures and the US Dollar traded pretty flat with the DJIA around 26,700 and the USD index at 89.60. The testimony was a two-stage process with the text released around 08.30 Washington time but the hearing not beginning until 10.00am. In many ways, the market reaction was similarly two-staged: stocks and bonds initially decided there was nothing fresh at all in the prepared remarks but by the end of the testimony, markets had decided Mr. Powell’s comments were a bit more hawkish. The USD index hit 90 for the first time in 2-weeks whilst 10-year bond yields backed up to 2.92% and the DJIA closed down more than 200 points. This morning in Asia and Europe, stocks and the USD are little changed from last night’s closing levels.

Mr Powell said that, “While many factors shape the economic outlook, some of the headwinds the US economy faced in previous years have turned into tailwinds: In particular, fiscal policy has become more stimulative and foreign demand for US exports is on a firmer trajectory. Despite the recent volatility, financial conditions remain accommodative. At the same time inflation remains below our 2 per cent longer-run objective [although] some of the shortfall in inflation last year likely reflects transitory influences that we do not expect will be repeated. Consistent with this view, some of the monthly readings were a little higher toward the end of the year than in earlier months… The FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE price inflation to 2 per cent on a sustained basis.”

Though rising long-term interest rates and recent equity market volatility have tightened financial conditions, Powell said, “we do not see these developments as weighing heavily on the outlook for economic activity, the labor market and inflation.” Rather, “the robust job market should continue to support growth in household incomes and consumer spending, solid economic growth among our trading partners should lead to further gains in U.S. exports, and upbeat business sentiment and strong sales growth will likely continue to boost business investment.” By the end of his Congressional appearance, 2-year yields had risen 5bp to 2.27% whilst the number of implied rate hikes this year had risen from 2.8 to 2.9. The USD index opens this morning in North America around 90.0; more than two points up on the February 15th low.

After the data disappointments of last week in the Eurozone, it seems investors finally exited long EUR currency positions on Tuesday and by the end of the day, EUR/USD had fallen more than a full cent to a low of 1.2230. We said here yesterday that, “Mr. Draghi has often shown himself to be a master of market expectations… and he might well be actively trying to push the EUR lower ahead of the ECB meeting.” If he was, he’d certainly be happy with yesterday’s price action and an overnight session in Asia and European morning which has so far brought no bounce off the lows. Instead, the pair has traded down to 1.2205; the lowest in 6 weeks.

German inflation slowed more than expected to hit a 15-month low in February. Harmonised CPI rose by just 1.2% year-on-year after an increase of 1.4% in the previous month, the data showed. That was weaker than the 1.3 percent consensus estimate, the lowest reading since November 2016 and marked the third consecutive fall in the headline figure. Although the German numbers raised fears of a weaker than consensus outturn for the Eurozone CPI this morning, they were no softer than expected. The rate of price growth slowed to 1.2% this month from 1.3%, dropping to its weakest since 2016. A fall in energy inflation and a big fall in fresh food inflation were the main drivers of the headline dip this month. The core measure was unchanged at 1.0%.

The softness of inflation both in Germany and the Eurozone overall help take some of the pressure off ECB President ahead of next Thursday’s Council Meeting. He said to the European Parliament this week that an expansionary policy is still warranted even as the economic situation is “improving constantly” and there’s no sense of urgency around communicating a withdrawal of monetary stimulus. Bundesbank president Jens Weidmann said in a Bloomberg Television interview that guidance on interest rates is “rather vague” and should be strengthened. “This could probably be one part of our discussion - whether to complement any decision on the asset-purchase program and on communication regarding the asset-purchase program with a bit more specificity with respect to the interest-rate guidance. ‘Well past’ is a rather vague time dimension.” The EUR opens in North America this morning at USD1.2220 and EUR/CAD1.5600.

The GBP had another lurch lower on Tuesday morning as the implications of Opposition leader Jeremy Corbyn’s Brexit speech began to be more widely recognized. Even after a late rally, GBP/USD was still down more than half a cent, and this morning in London it has continued to fall and is down against every one of the major currencies we follow closely here. A break through yesterday’s USD1.3865 lows has worsened the technical picture and the GBP is down at a two-week low last seen on the day of the US CPI figures.

This morning, the European Commission has published a detailed draft withdrawal and transition agreement: more than 120 pages made up of 168 treaty articles and two protocols setting out the EU’s terms for Brexit to be negotiated over the next seven months. The document is politically incendiary in the UK whose Government is a Coalition between the Conservatives and the Democratic Unionist Party in Norther Ireland. According to the draft, the territory of Northern Ireland would be considered part of the EU’s customs territory after Brexit, with checks required on goods coming in from the rest of the UK, under the text produced by the European commission. “A common regulatory area comprising the Union and the United Kingdom in respect of Northern Ireland is hereby established… The common regulatory area shall constitute an area without internal borders in which the free movement of goods is ensured and North-South cooperation protect.”

The Prime Minister’s office has spent the morning briefing that she will not sign up to “anything that threatens the constitutional integrity of the UK.” Indeed, if she were to do so then she would likely lose the support of her Coalition partner and be unable to command a majority in the House of Commons; leaving the possibility of a defeat in a no-confidence motion and another General Election. Little wonder, then, that the GBP is the worst-performing currency so far today. It opens in North America at USD1.3830, GBP/EUR1.1325 and GBP/CAD1.7665.

From Monday’s high of USD0.7885 - its highest since last Tuesday – the Aussie Dollar has spent the last 48 hours moving lower, with the move accelerating in North America on Tuesday on a combination of stronger USD, much lower gold prices and a pick-up in volatility which has seen the VIX index more than a point higher at 17.6. This morning in Europe it has bounced off technical support in the 0.7780-90 area and has clawed its way back on to a US 78 cents big figure but still looks vulnerable to any further downturn in global risk appetite.

According to data released by the Australian Bureau of Statistics earlier today, the value of credit extended to Australia’s private sector grew by just 0.3% in January. Over the year, total credit grew by 4.9%, the equal-lowest increase since May 2014. The details of the report showed it was yet again housing credit that drove the increase. It rose by 0.5% in seasonally adjusted terms, up from 0.4% in December, leaving the increase on a year earlier at 6.2%. Despite the small pick-up, the annual rate was still the weakest since May 2014. Credit extended to business fell by 0.1%, the first decline since February last year whilst personal credit rose just 0.1% with an annual rate of -0.9%.

We’ve been highlighting the lack of consensus on Australian interest rates from the ‘Big Four’ banks locally. The divergence has narrowed somewhat overnight as NAB have 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… By late 2018, growth should be near 3% and the unemployment rate approaching 5%. That, together with increasing tightness in employers’ ability to find suitable labour, may finally see private sector wages start to moderately edge up.” Over at Westpac, meantime, the team has re-iterated its view of a considerable widening in the US / Australia interest rate differential as the RBA remains on hold. Markets are currently pricing in a yield differential between US and Australian overnight rates of negative 45 basis points by end 2018 whereas Westpac expects minus 63 basis points. Markets are expecting a differential of minus 42 basis points compared to Westpac’s forecast of minus 112 basis points by end 2019. The Australian Dollar opens in North America this morning at USD0.7810, with AUD/NZD at 1.0820 and AUD/CAD0.9975.

Over the past three trading days, the New Zealand has finished top, bottom and bottom of our one-day performance table. Yesterday, after a worse than expected set of merchandise trade figures, NZD/USD was back on a US 72 cents ‘big figure’ and a break down through technical support in the 0.7275-80 area, has seen the Kiwi extend the its weakness down to a low around 0.7215. This has pushed the AUD/NZD up on to a 1.08 ‘big figure’ for the first time in a little over two weeks.

ANZ’s monthly business outlook is published today. A net 19% of businesses are pessimistic about the year ahead, versus 38% in December. All five sectors improved this month with retail firms the closest to a positive outlook at -4%. Firms’ views of their own activity (which has the stronger correlation with GDP growth), lifted from +16 to +20. The analysts note, “A slower housing market, a small dip in net migration, difficulty finding credit and already stretched construction and tourism sectors are making acceleration hard work from here. But strong terms of trade and a positive outlook for wage growth are providing a push… Our composite growth indicator, which combines business and consumer confidence, suggests growth around 2-3%. Although we are constructive on the medium-term outlook (with incomes supported by the strong terms of trade and higher wage growth), we are conservative in our productivity growth assumptions and believe households need to rebuild their saving. We accordingly see downside risk to both the Reserve Bank’s and Treasury’s growth forecasts”.

Separate figures show 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. The country's annual net migration also eased off recent highs as government regulations introduced in the middle of last year came into force. On an annual basis net migration was 70,100, down from a record high of 72,400 in July. However on a monthly basis, the country posed a net gain of 6,210 permanent and long-term migrants in January compared to 5,780 the previous month. Statistics New Zealand said there had been a dip in migrant arrivals on student visas from India and China, New Zealand's two largest education markets, down around 8 per cent to 11,100. The overall number of migrants arriving on student visas was 24,100 in the year to January 31, 2018, down just 150 from the preceding 12 months. The Kiwi Dollar opens this morning in North America at USD0.7225 and NZD/CAD0.9225.