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USD index falls to lowest since November 2014 even as 10-year bond yields hit 2.91%. GBP/USD back at 1.41 ahead of UK retail sales.

By Nick Parsons

After the dramas around US CPI earlier in the week, the pound was then the quickest of all the major currencies to reverse its losses and went on to a day’s high just below 1.4000; more than a full cent above where it had been prior to the US data release. On Thursday it built on these gains, reaching an intra-day high just below 1.41 to finish top of our one-day currency performance chart. Overnight in Asia the USD index has hit a fresh 3-year low and the GBP is back in the 1.41’s for the first time since February 5th. It is also up against the CAD and NZD but down a little against both the EUR and AUD.

A fascinating report on the UK housing market is published today by the Institute for Fiscal Studies. It shows how huge increase in house prices above income growth has severely limited the ability of the younger generation buy their own home. For 25- to 34-year-olds earning between £22,200 and £30,600 per year, home ownership fell to just 27% in 2016 from 65% two decades ago. Over the past 20 years, average house prices have grown about seven times faster than the average incomes of young adults, according to the IFS study. Average house prices have increased by 152% when taking account of inflation since 1995, though wages for 25- to 34-year-olds have only risen by 22% in real terms over the same period. Overall owner occupation rates in Britain have been steadily declining since 2003, when the proportion of people owning their home reached its peak of 71%, and has now fallen to just 61%.

This morning brings UK retail sales figures. It always used to be the case that December and January were best viewed together to see the impact of discounting in the annual sales. In the internet age, with the advent of Black Friday promotions in November, it is probably wiser to judge the three months as a whole. Thus, we saw a 1.1% monthly increase in November followed by a -1.5% m/m drop in January which left the annual rate of growth for 2017 at just 1.9%; the weakest since 2013. We’ll see today how the new year 2018 began for UK retailers.

Thursday was another day of sharp reversals for the US stock market and its currency; albeit within narrower trading ranges than seen recently. Ahead of the opening bell, futures markets were signaling the DJIA 200 points higher around 25,150. After the cash market had been open for just an hour, these gains had evaporated and the index then fell to 24,870; a drop of 280 points from the high. Two hours after that, it had regained 200 points of the drop and was back over 25,000 even as 10-year bond yields hit a fresh 4-year high of 2.90%. For the Dollar, its index against a basket of major currencies hit a low of 88.30 in the European morning, rose to a high of 88.65 and then finished back at the day’s low. Overnight in Asia the USD index has fallen below 88 for the first time since November 2014.

In economic news, US. factory output was flat for the second straight month in January, raising questions about the manufacturing outlook. Manufacturing output was held back by monthly declines of -0.2% at aerospace factories, -0.5% for those producing plastics and -0.4% in food industries. Output rose modestly overall for primary metals, computers and motor vehicles. What’s more, the statisticians had previously estimated a small increase in output for December but revised the data to show no gain in that month. Separate Fed surveys of manufacturing from New York and Philadelphia showed big increases in Prices Paid. The New York prices index surged from 36.2, to 48.6, the highest in six years, while according to the Philly Fed, their prices paid index increased 12 points to 45.0, its highest reading since May 2011 or in nearly 7 years.

There are no further US economic statistics scheduled this Friday though whether that is a good thing or not for markets remains to be seen! The USD index opens in Europe this morning around 87.95

After trading on three different ‘big figures’ on Wednesday, the EUR had a much calmer day on Thursday, albeit one in which it managed to gain against most of the major currencies. EUR/USD spent most of the day in the high 1.24’s but overnight in Asia it has traded up through the 2018 high of 1.2515 reached on February 2nd and opens in London at its highest level since November 2014.

In economic news, the trade surplus in the Eurozone rose to €23.8bn in December from a revised €22.0bn in November, above the consensus, €22.3bn and continuing a run which has seen the 3-month average (a better guide to trend than m/m numbers) in surplus for the entire period since 2012. This comes on the back of figures midweek which showed the Eurozone economy expanded 0.6% in Q4 (at an annualized pace of 2.4% to quote it in comparable terms to the US numbers). Healthy growth but a general absence of inflationary pressures leaves 10-year German government bond yields at just 0.77% with the spread between Germany and the US at 216bp; its widest since last April. A year ago, this would have offered some support to the USD; there was a clear relationship between yield differentials and the EUR/USD exchange rate. This has broken down quite dramatically over the past few months, however, and a 10-year US yield of 2.91% today is not helping the USD at all.

Whilst US trade deficits are most of spoken in the context of US-China or US-NAFTA, Thursday’s figures from Eurostat show the EU had a trade surplus with the United States of 120.8 billion euros ($150.9 billion) in 2017, up from 113.1bn in 2016. Exports from the EU to the US increased to 375bn in 2017 from 363.5bn euros the year prior, while imports from the US grew to 254.2bn from 250.4bn in 2016. There doesn’t seem any need yet to worry about a stronger EUR hitting the value of Eurozone exports. The EUR opens in London this morning at USD1.25 and GBP/EUR1.12.

The continued weakness of the US Dollar helped the Aussie reach a high early in the European morning on Thursday of 0.7965; its best level since the day of the US non-farm payroll figures back on February 2nd. Its early strength was not sustained, however, and the Australian Dollar slid steadily throughout the day to be the equal-worst performer (along with the USD) of all the currencies we closely track here. AUD/USD at one point lost almost three-quarters of a cent in Northern Hemisphere trading and was back on a 78 cents ‘big figure’ before climbing into the New York close around 0.7930. Overnight in Asia it has added around half a cent, though its gains have been only in line with all the other non-USD currencies.

RBA Governor Phil Lowe has today been giving his semi-annual testimony to Parliament. He repeated recent comments that the timing of Australia’s first interest-rate increase since 2010 will depend on progress in lowering unemployment and returning inflation to the midpoint of the central bank’s target. “As things currently stand, we expect that progress to be steady, but to be only gradual… Given this assessment, the Reserve Bank board does not see a strong case for a near-term adjustment of monetary policy.” On the labour market, Lowe said, ““Over time, we expect wage growth to pick up as the labor market strengthens further… The pick-up, though, is likely to be gradual. This increase in wage growth and the more general reduction in spare capacity in the economy are expected to contribute to inflation picking up as well. But to continue the theme, this pick-up, too, is expected to be only gradual.”

It is increasingly clear that wages and household incomes hold the key to RBA policy. ““Most households are experiencing only slow growth in their incomes and many expect that this will continue for some time yet. This lowering of expectations about income growth is likely to be affecting spending, especially in an environment of high levels of household debt,” the governor said. “We continue to look carefully at household balance sheets. On balance, our assessment is that there has been some containment of the build-up of risk in this area.” Just as the widening Germany-US 10-year rate differential has not helped the USD, it is perhaps a good thing for the AUD that markets are for the moment ignoring AU-US rate differentials which are now at zero for the first time in almost 20 years and look set to widen, perhaps considerably, over the coming quarters.

The Canadian Dollar ended Thursday pretty much unchanged with USD/CAD in the high 1.24’s. Oil prices had begun to rally sharply on Wednesday afternoon and from a low point for WTI crude of $58.15, hit a high yesterday of $61.40 which offered some support to the CAD.

There were no economic statistics published Thursday, but there was a 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. Whilst winning no prizes for humility, he noted, “Three main factors have contributed to the framework’s credibility and success. First, we have a clear, simple and well-understood inflation target, whose focal point is 2 per cent. Second, the framework has political legitimacy, is coherent with other public policies and is implemented with effective tools. And third, we have a formal review process for continually improving the framework that is widely admired by many of our peers and was cited as one of the factors that earned us the Central Bank of the Year Award we received recently”.

Your author is a particular fan of the BoC and its Governor Stephen Poloz who always has fascinating insights delivered in an interesting and very engaging manner. His deputy’s conclusion that, “We continue to believe that the best contribution the Bank can make to improving the performance of the economy is to ensure that inflation remains low, stable and predictable” could, in all honesty, have been written by any of his peers in G-10 but the speech was thoughtful and interesting. There are no economic statistics released Friday and the Canadian Dollar opens in Europe this morning at USD/CAD1.24 and GBP/CAD1.76.

The New Zealand Dollar had another good day on Thursday, which seemed yet again to have been driven by developments in the key AUD/NZD cross. This moved down to a fresh 6-month low around 1.0710 during the European afternoon; the weakest since August 7th. Even as AUD/USD fell, this meant that NZD/USD was able to eke out a daily advance, just getting back to the US 74 cents level. It opens in London this morning within a few pips of its 2018 high around 0.7430.

New Zealand's PMI survey is not published on the same cycle as the 25-30 numbers released globally at the beginning of each month. Today’s January manufacturing PMI report rose 4.5 to 55.6 after a big drop in December and hasn’t yet returned to levels of expansion typically seen during 2017. The report noted, "The proportion of positive comments in January (50.7%) was down by a fair margin compared with December (63.3%) and November (65.1%). While seasonal factors such as Christmas and holidays are typically mentioned around this time of year, those outlining negative comments have also focused on recent uncertainty that has led to softening activity and a slow start to the year for some". All five of the sub-indices lifted with production up 1.4 points to 54.9, employment up 1 point to 52.5, new orders up 5.9 points to 55.6, finished stocks up 1 point to 53.1 and deliveries up 5.5 points to 55.3.

The Kiwi Dollar opens in London very close to its 2018 high versus the USD and if it breaks through 0.7430 will be at its highest level since the first week in August.