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GBP awaits economic data and Brexit progress. USD supported by higher yields but will stock market suffer?

By Nick Parsons

The pound generally struggled on Tuesday and ended the day the second-weakest of the major currencies after the euro. Overnight in Asia it is bottom of the pile; down against all the currencies we track here and within 20 pips of its New year low against the US Dollar.

After the poorly-received Government reshuffle, it is now time for those Ministers who kept their jobs to do some work. Two of them with the highest profiles – the Chancellor of the Exchequer and the Minister for Exiting the EU are in Germany today to make a direct appeal to business leaders to help secure the future of Britain’s financial services within a Brexit deal. They said they were seeking a bespoke deal with the EU described as “the most ambitious in the world that should cover the length and breadth of our economies including the service industries — and financial services”.

In a joint article for the German newspaper Frankfurter Allgemeine, Philip Hammond and David Davis argue that Britain and Germany should use “imagination and ingenuity” to craft a “bespoke solution” to maximise economic co-operation. The EU’s Brexit negotiator Michel Barnier warned the UK last month, however, that “There is no place for financial services. There is not a single trade agreement that is open to financial services. It doesn’t exist.” Yesterday he said that, “Britain’s financial services cannot benefit from a passport in the single market nor from a system of generalised equivalence of standards”. This issue is not just a debating point, it is key to whether the UK can make a success of its post-Brexit status. The Pound’s fortunes should closely track the progress that either side makes in the negotiations around the inclusion of financial services in a new free trade agreement.

There is plenty of UK economic data to look forward to today with manufacturing and industrial production figures, the November trade balance and the NIESR’s estimate of GDP over the previous three months. Ahead of all that, the pound opens in London this morning at USD1.3520, AUD1.7295 and NZD1.8860.

We have been expressing our puzzlement at the Dollar’s decline in late December and early in the New Year given the strength of the US stock market, the rise in yields across all parts of the maturity spectrum, the passage of a historic tax reform bill and the prospects for upward revisions to growth forecasts in 2018. Last Wednesday we wrote that, “For the moment, it seems just that the dollar is falling because it is falling. The technical tail is wagging the fundamental dog. When price action itself is such a dominant feature of trading, investors seek confirmation of the prevailing trend by seeking out the bits of news which support a continuation of the move rather than viewing the incoming information more objectively”.

Over the last few days, there does finally seem to have been some more objective assessment of the fundamentals. The Dollar’s index against a basket of major currencies reached a 14-week low of 91.44 last Wednesday, January 3rd. Friday’s low was 91.50, Monday’s was 91.56 and from that point it has moved steadily higher to make it back on to a 92 ‘big figure’ for the first time in more than a week. Yesterday morning in New York it reached 92.27 and though it is too early to say with confidence that a decisive turning point has been made, the USD bulls seem winning the argument in the near-term.

US 10-year Treasuries now yield more than 2.50% for the first time since March last year, rising 6bp yesterday to 2.54%. The yield curve from two to 10 years steepened by 5.4 basis points yesterday, the most in over a year, to 57.4bp. For the moment, stock markets have shrugged off this development but don’t be surprised to hear it as an explanation the next time that equity indices end lower. And on that subject, a fascinating study from BoA Merril Lynch shows that, “Since March 16, 2016, the S&P 500 has gone for 386 trading sessions without a 5% drawdown. If the trend persists, in just 10 more days this will be the longest stretch without such a drawdown in history.” Wow…

The Dollar’s index against a basket of major currencies opens in Europe this morning around 92.15.

 

The EUR had a poor day on Monday, slumping to the bottom of the one-day performance table despite further upbeat survey indicators. Yesterday, also, it shrugged off a very solid set of German industrial numbers as markets continue to fret about the political situation in Germany. EUR/USD slipped to a 2018 low of USD1.1919; its lowest since December 28th and has only recovered around 10 pips of its losses in the overnight session in Asia.

Aside from the political concerns which we’ve been flagging up over the past few days, the interest rate differential between core European bonds and their US equivalents is now beginning to weigh on the Single European Currency. As mentioned above, 10-year US Treasuries hit a 10-month high of 2.54% yesterday but their German equivalents were up only 2.5bp to 0.45%. For sure this is still well above the December lows of 0.30% but the differential with the United States is back over 200bp at the 10-year maturity.

For the moment, annual CPI inflation in the euro zone remains stubbornly low at 1.4%, or just 1.1% when volatile food and energy prices are stripped out. This is well below the ECB’s target of an inflation rate of close to but just under 2 percent. Though ECB Council member Ewald Nowotny said in an interview published on January 2nd that QE could end in 2018 if the euro zone economy continues to grow strongly and on Sunday, the Bundesbank’s Jens Weidmann said the ECB should set a date to end QE, the market is still not fully pricing a rate hike until early 2019. Strong economic data are certainly helping the EUR but the yield differential is now creating quite a headwind for the exchange rate against the US Dollar.

The EUR opens in Europe this morning at USD1.1930 and GBP/EUR1.1335.

The Australian Dollar didn’t have a great day on Tuesday though it did manage a 10th consecutive day on a US 78 cents ‘big figure’. The high point of USD0.7863 came during the Asian session but it then lost around half a cent in London before a rally around midday which was subsequently reversed in New York trading. Overnight in Asia it has struggled to gain traction despite a very good set of job vacancies numbers. It’s a very old saying in foreign exchange markets that “a currency which doesn’t go up on good numbers is a currency which is not going up…” In Asia overnight, AUD/USD has printed a low of 0.7810 and we’ll see if it can hold on to 78 cents through the Northern Hemisphere day.

As for the economic numbers, job vacancies in Australia climbed to their highest on record in the three months to November, a sixth straight quarter of gains. Total job vacancies rose 2.7% to 210,300 in the Sep-Nov quarter, from 204,800 in the previous quarter. That was the highest reading since the series began in 1979 and left vacancies a healthy 16 percent higher than a year earlier. Vacancies in the private sector climbed 3.8% to 192,000, again the highest on record. That was up 17.3% on the previous year. In contrast, public sector vacancies fell back 7.6 % in the November quarter to 18,300.

The AUD opens in Europe this morning at USD0.7815 with GBP/AUD at 1.7295.

The Canadian Dollar had a great start to the New Year 2018. USD/CAD tumbled at one point on Friday to 1.2372; the lowest since September 27th. On Monday it mostly consolidated these gains in a range 1.2385-1.2435 but on Tuesday in the face of a generally stronger US Dollar, investors were beginning to have second thoughts about pushing the Canadian Dollar much higher. USD/CAD touched 1.2475 and has held around that level for much of the overnight session in Asia.

After Friday’s Canadian employment report, the market-derived probability of a rate hike at the Bank of Canada’s next meeting on January 17th surged to 70%, from 40% earlier in the week. On Monday, those rate hike odds hit 86% after the Bank of Canada published its Q4 Business Outlook Survey; the last real chance for the Central Bank to communicate something dovish ahead of next Wednesday’s monetary policy meeting. Indeed, five of the six major Canadian banks are forecasting a 25bp hike.

The first point to make, therefore, is that a rate move is almost fully discounted. We then need to look at risks. There’s realistically a zero probability of a 50bp hike, so the risk is BoC does nothing. A risk, of course, is not the same as a prediction though BoC Governor Poloz has previously spoken about the benefits of surprising financial markets rather than flagging its plans well in advance.

We’ll get to see data on Canadian building permits and new house prices later this week. Ahead of that, the Canadian Dollar opens in Europe this morning at USD1.2475, GBP/CAD1.6860 and AUD/CAD0.9750.

Once again the New Zealand Dollar was top of the one-day performance table on Tuesday, though on this occasion it had to share the honours with the US Dollar. It has now topped the table for three of the past four trading days even though, once more, there was no domestic economic or political news to drive the currency. The flightless bird couldn’t quite make it on to a US 72 cents big figure but did reach an intra-day high of 0.7194; its highest since October 17th. Overnight in Asia the pair traded down to a low of 0.7144 before rallying back up to 0.7172.

On the basis that ‘if there’s nothing to say, then don’t say it’, our NZD commentary will necessarily be somewhat shorter today. After extensive research using a popular internet search engine, we could reveal the most rejected baby names in New Zealand in 2017 (spoiler alert: Royal and Prince) or what New Zealanders complain most about but these are literally the top stories in the news. Other than that, absolutely nothing of interest.

There’s no economic news scheduled for release locally on Wednesday, with the first private sector numbers of the year the QV house price data and ANZ job advertisements on Thursday. The official statisticians told us last night that there are an estimated 1,734,800 households in New Zealand and 1.855,500 private dwellings but there are no market-moving data until well into next week.

The Kiwi Dollar opens in Europe this morning at USD0.7165 with AUD/NZD at 1.09210 and GBP/NZD1.8870.