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After turmoil in US stocks, currencies are relatively quiet. GBP steady at lower levels, RBA leaves rates unchanged. All eyes again on equity markets.

By Nick Parsons

The pound had a bad day on Monday as the combination of domestic political uncertainty, the resumption of formal Brexit negotiations and poor incoming economic data finally took its toll. By early afternoon it was down below USD1.4000 and though it managed to find some support around last week’s low, the subsequent bounce was far from impressive. As the sell-off in US equities accelerated and the USD was bid, GBP/USD closed in New York at a near 2-week low and finished firmly at the bottom of our one-day performance table.

In economic data, the UK service sector PMI fell from 54.2 in December to just 53.0 in January; the slowest upturn in services output for 16 months. Growth was reportedly curtailed by the loss of existing clients and lingering concerns surrounding the UK’s exit from the EU. January data pointed to a slowdown in growth of services activity across the UK, which stemmed from relatively weak gains in new work. Job creation nonetheless picked up as companies retained positive expectations surrounding the outlook. Although the latest results revealed an easing of inflationary pressures, rates of increase in both input costs and output charges remained above their long-run trends.

In a meeting at Downing Street between UK Brexit Minister David Davis and Chief EU negotiator Michel Barnier, Mr Davis claimed with a completely straight face that, “the UK government has published a great deal about what it wants. It wants a comprehensive free trade agreement, and a customs agreement, allowing trade to be as frictionless as possible. It is perfectly clear what the UK wants”. For his part, Mr Barnier said, “Without the customs union, outside the single market, barriers to trade and goods and services are unavoidable… the time has come for the UK to make a choice”. This, of course, is the very opposite of what the Prime Minister wants. Any clear choice or hard decision will immediately inflame half her Cabinet and will heighten pressure for her to quit as Prime Minister. There is no ‘unity candidate’ waiting in the wings because there is no unity on the Government side in the House of Commons. At some point, if the UK political situation continues to deteriorate, a ‘Corbyn discount’ may even have to be priced into the pound.

After Friday’s 666 point drop for the Dow Jones Industrial Average, Monday was a day of utter carnage in the US equity market. An initial 300 point decline in the DJIA was almost fully reversed by lunchtime but in the last few hours of trading the index went into freefall, losing well over 1,000 points to end the day down 1175; the biggest ever points drop, albeit in percentage terms only the 112th largest drop in the 122 years since inception. The VIX index of volatility, meantime, had its biggest ever daily jump and will go down in the history books along with Lehman, the ‘flash crash’ and the US downgrade. Amidst the turmoil, the US Dollar was steadily bid throughout the day and its index against a basket of currencies is now more than a full point above last Thursday’s low. It still hasn’t recovered all the losses from Davos but it looks in technically much better shape than it did just a few days ago.

In the latest economic news, the ISM non-manufacturing index jumped 3.9% in January from an already-high 56.6 in December. This was the 96th consecutive month of expansion in activity and if the headlines were good – the index was at its highest level since August 2005 - the details were even better. New orders jumped over 8 points to 62.7; the highest since January 2011 whilst employment surged to 61.6; the highest since records began in 1997. Overall, the majority of respondents’ comments were positive about business conditions and the economy. They also indicated that recent tax changes have had a positive impact on their respective businesses.

New Federal Reserve Bank Governor Jerome Powell was sworn in yesterday and there was no shortage of analysts pointing out comparisons between the situation today and when new Chairman Alan Greenspan took office on August 11th 1987; barely two months from the stock market crash of Black Monday, October 19th, that year. There are plenty of Mr Powell’s colleagues set to give speeches this week; Messrs. Bullard, Evans, Dudley, Kaplan and Harker will all be offering their views on the economy. It will be interesting to see if the speakers have soothing words for stock market investors or focus, instead, on the continued normalization of US monetary policy.

EUR/USD began the week quite well, but from a best level in the high 1.24’s during the European morning, it then turned lower throughout the rest of the Northern Hemisphere day and amidst the turmoil across asset classes in New York, it finished the day on a 1.23 handle. ECB chief Mario Draghi addressed the European Parliament in Strasbourg saying, “Our confidence that inflation will converge towards our aim of below, but close to, 2 per cent has strengthened, but… we cannot yet declare victory despite little indication that generalised imbalances are emerging”. Of more interest to FX markets were his remarks that recent volatility in the single currency was also a potential cause for concern, requiring “close monitoring” of the implications for price stability. In truth, there was nothing new whatsoever in these comments but on a day when the USD was finding some support, they were an excuse to knock EUR/USD a bit lower.

The final Markit Composite PMI Index posted 58.8 in January, its highest level since June 2006 and above the earlier flash estimate of 58.6. The headline index has signalled expansion for 55 successive months. There was a better than expected services PMI in Germany (57.3) which offset a marginal French services PMI of 59.2 which was a touch lower than the initial estimate. Growth of manufacturing production continued to outpace that of service sector activity in January. Although easing over the month, the rate of expansion in manufacturing output stayed close to December’s near-record high. The performance of the service sector continued to strengthen, with business activity growth accelerating to its best since August 2007. Whilst German services activity is at an impressive 81-month high, Italy is the highest for 139 months.

As well as his remarks on the European economy, Mr Draghi also contributed to the Brexit debate, saying that without clarity regarding the shape of the UK’s future relationship with the EU, “well-managed preparations are . . . essential for dealing with frictions in the transition from the current situation to the eventual new equilibrium especially in the event that no transitional agreement is reached between the EU and the UK”. There would have been uproar in the UK if BoE Governor had said something similar! On the economic slate today, we have just German factory orders whilst ECB Board member and Bundesbank President Jens Weidmann is speaking at an event in Frankfurt.

The Aussie Dollar had a much better day than many people had feared on Monday, rising against all the major currencies we track closely here apart from the resurgent US Dollar. Indeed, this was the sixth consecutive day of declines for the AUD/USD pair, dropping a total of 2.2%. Context Analysis point out that in the 737 trading days since 2 April 2015, the sequence of falls has extended to 7 days only once; on 23 December 2016.

The highlight of the Asian session was obviously the Statement released after first RBA Board meeting of the year. Overall it was pretty upbeat. “The Bank's central forecast for the Australian economy is for GDP growth to pick up, to average a bit above 3 per cent over the next couple of years. The data over the summer have been consistent with this outlook. Business conditions are positive and the outlook for non-mining business investment has improved… Employment grew strongly over 2017 and the unemployment rate declined. Employment has been rising in all states and has been accompanied by a significant rise in labour force participation. The various forward-looking indicators continue to point to solid growth in employment over the period ahead, with a further gradual reduction in the unemployment rate expected.” The currency comment was reframed to mention the trade-weighted value of the AUD, which “remains within the range that it has been in over the past two years.”

Although the RBA made its usual reference that, “An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast”, there was no sense at all in which this was a deliberate attempt to talk down the AUD. We’ll now have to wait for any further clues until Friday when it releases its latest Quarterly Statement of Monetary Policy.

The Canadian Dollar gave up its hold on US 81 cents on Friday immediately upon publication of the US employment report and by early afternoon in North America yesterday, it had lost its hold on 80 cents too. With the US Dollar generally well-bid, and as WTI crude oil is more than $1.50 per barrel down over the last three days, so enthusiasm for the CAD has faded noticeably.

There were no Canadian economic statistics on Monday and very little in the way of political news either. Trade data for December is due on Tuesday and might be a reminder for some that Canada runs a trade surplus with the United States between €3-4bn per month, exporting roughly $35bn and importing around $31bn of goods. The former US ambassador to Ottowa made a very good point on Sunday that, “The term NAFTA is a toxic term, and I would leave that term and put it aside and not talk about it. I think that unfortunately it’s become a political punching bag of sorts and if we can replace that name with something else that we wouldn’t get stuck on it”. Now we just need to find a friendly new acronym that won’t upset President Trump…

Away from trade, the biggest event in domestic economic news this week will be Canada’s employment report on Friday. Two consecutive blockbuster jobs numbers prompted the Bank of Canada rate hike in January, though a third strong print would be a genuine surprise.

After the dramas of the last couple of weeks, the Kiwi Dollar had a relatively quiet Monday, with the entire range against the US Dollar from the low to high only slightly more than half a cent. Measured against its Australian cousin, AUD/NZD rose around 20 pips from Friday’s closing level whilst GBP/NZD was down a full cent.

In economic data, the ANZ Commodity Price Index - when measured in global terms - rose 0.7% m/m in January, after a 3-month slide. The lift was broad-based with meat, dairy, forestry and aluminium prices all rising; the only fall was seen in milkfat products. Because the NZD continued to squeeze higher against major trading partners in January (NZD TWI up 1.8% m/m), this pushed the NZD commodity price index down 2.9% m/m. Only aluminium prices managed to increase in local currency terms. Whether measured globally or locally, the annual rates of price growth were 4.1% and 4.8% respectively.

Today in New Zealand is the Waitangi Day national holiday which marks the signing on February 6th 1840 of a treaty whose effect was to secure British sovereignty over the islands of New Zealand, which was proclaimed on May 21st that year. Markets were closed locally, though the NZD was traded elsewhere in the Asia-Pacific region. The first RBNZ policy meeting of the year is on Thursday this week. Analysts are unanimous that there will be no change in interest rates. Nor are they generally expecting much change to the Central Bank’s forecast track for interest rates, though the markets’ view on the timing of the first hike in early 2019 is a bit later than the RBNZ has so far penciled-in.