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USD slumps after Fed rate hike. GBP/USD at a 7-week high. EUR awaits ‘flash’ PMI data

By Nick Parsons

Although on Tuesday GBP/USD couldn’t maintain its hold on a 1.40 handle, yesterday it traded as high as 1.4075 ahead of the FOMC and was up against four of the five other currencies we track closely here. The exception was the Canadian Dollar, with GBP/CAD down more than half a cent to 1.8245. Once the Fed Statement was released and the USD sold off despite a somewhat higher forecast profile for official interest rates in 2019, GBP/USD extended its gains to 1.4150 though slipped back against the Aussie Dollar to be almost three quarters of a cent down from its earlier high near 1.8310. Overnight in Asia, the pound has traded up to a near 3-week high of 1.4170 before easing back to last night’s closing level.

There was arguably something for everyone in the UK labour market report, though on balance the message was definitely a positive one. Unemployment rose by 24,000 in the three months to January to 1.45 million yet there were 32.25 million people in work, 168,000 more than for the previous 3-month period and 402,000 more than for a year earlier. The Office for National Statistics noted the employment rate (the proportion of people aged from 16 to 64 who were in work) was 75.3%; higher than for a year earlier (74.6%) and the joint highest since comparable records began in 1971. The unemployment rate, meantime, was 4.3%, down from 4.7% a year earlier and the joint lowest since 1975.

We wrote here yesterday morning that, “In its February inflation report, the Bank of England suggested that a 4.4% unemployment rate would begin to put upward pressure on wages. If this happens today, then the GBP might well find some more support.” This is exactly what transpired. The new figures show that average weekly earnings for employees in Great Britain in nominal terms (that is, not adjusted for price inflation) increased by 2.6% excluding bonuses, and by 2.8% including bonuses, compared with a year earlier. The squeeze on real earnings hasn’t officially ended as today’s numbers were for January whilst the CPI data are for February. But, if the wage data are repeated next month, then the 12-month run of negative earnings growth will finally come to an end; a relief not just for workers, but also for the UK Government and the Bank of England whose forecasts of a return to real pay growth have lately been consistently too optimistic.

Late on Tuesday evening, the USD index against a basket of major currencies was back at 90 for the first time in almost three weeks. Wednesday saw the USD slip around a quarter of a point to 89.75 before the Fed announcement and then extend its losses by a further half-point late in to the New York afternoon despite a somewhat higher forecast profile for official interest rates in 2019. By the close of business, the USD was at the bottom of our one-day performance table.

A very uncontroversial FOMC Statement noted, “the labor market has continued to strengthen and economic activity has been rising at a moderate rate. Job gains have been strong in recent months, and the unemployment rate has stayed low. Recent data suggest that growth rates of household spending and business fixed investment have moderated from their strong fourth-quarter readings. On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.”

There had been some speculation ahead of the FOMC meeting that the Fed would signal a total of four rate hikes in 2018 rather than the three which had previously been forecast. It didn’t do that (which may explain some of the subsequent USD weakness) but it did raise its median estimate for 2019 by 25 basis points. Looked at another way, it was previously penciling-in seven more rate hikes until the end of 2020 but has now added an extra one, with two more to come in 2018, three more in 2018 and another two in 2020. Quite why this should have been taken as a trigger to aggressively sell the USD is something of a mystery but we’d always caution against reading too much into immediate post-FOMC moves which are often prone to re-appraisal and reversal. The US Dollar index opens in Europe this morning around 89.25.

The euro continues its rather lacklustre performance and though on Wednesday it rallied off the Asian lows from USD1.2245, it couldn’t get back on to a 1.23 ‘big figure’ before the Fed announcement; reaching a high of 1.2295 in the European afternoon before then falling around a quarter of a cent immediately pre-FOMC. It fell against the CAD, AUD and GBP, was unchanged against the NZD and rose against the USD. After the Fed Statement and Press Conference, the EUR rallied in line with all the other non-USD currencies, reaching almost 1.2330 by the New York close and overnight in Asia has extended its gains by another 20 pips.

The German Council of Economic Experts (GCEE) slightly revised upwards its growth forecast for 2018. The GCEE now expects real gross domestic product (GDP) to grow by 2.3 % in 2018 and 1.8 % in 2019. The main reason for the upward revision is the renewed improvement of the international economic environment. Its new report says, “After the strong growth of recent years, Germany is experiencing an economic boom. In this situation, the continuing expansionary monetary policy of the ECB contributes to the rise in the degree of overutilisation. Even more expansionary impulses will follow if CDU, CSU, and SPD implement the fiscal measures stated in their coalition agreement”. The GCEE has revised upwards its forecast for GDP growth in the euro area to 2.3% in 2018. It expects a growth rate of 1.9 % next year. Despite the upward revisions, the experts warned that, “Positive growth prospects should not obscure the fact that risks to the economic development have risen in recent times. Next to the election result in Italy and uncertainties about the outcome of the Brexit negotiations, the US announcement to increase customs tariffs on steel and aluminum weighs most heavily. A spiral of protectionist measures would have negative consequences both for the world economy and for the German economy.”

Today we have the ifo Survey of businesses which has recently been incredibly upbeat in its numbers and commentary. It is not unusual to see a divergence between the ZEW and ifo surveys but if the ifo repeats the downbeat message from investors on Tuesday, the EUR is likely to remain subdued. Before then, however, there are the ‘flash estimates’ of the PMI Surveys in France, Germany and the Eurozone. The EUR opens in London this morning at USD1.2350 with GBP/EUR in the mid-1.14’s.

In Wednesday’s trading ahead of the FOMC announcement, the Aussie Dollar very marginally extended Tuesday’s losses against the US Dollar. AUD/USD broke through the previous evening’s low of 0.7680 but fell only a few pips more to a lowest level around 0.7675. The last time it had been there was back on December 21st. A 140-point rise in the DJIA and a $12 rise in the price of gold then helped lift the AUD back on to a 77 cents big figure. With the US Dollar generally on the defensive after the Fed Statement, AUD/USD rebounded to 0.7775 which helped lift the AUD on most of its major crosses with AUD/NZD, for example, extending gains to 1.0740. Overnight in Asia, a slightly softer than expected labour market report has seen the Aussie slip back around a quarter of a cent.

Employment in Australia rose 17,500 in February, slightly below consensus expectations for a 20,000 increase but still the 17th consecutive monthly gain. Full-time jobs rose 64.9k whilst part-time fell -47.4k but this split merely reverses the equally volatile movements seen in January and isn’t really telling us much about underlying conditions. The Australian working-age population has grown around around 27k per month over the past year and a greater percentage of them are available for work. The so-called ‘participation rate’ has risen from around 64.5% to 65.7% over the past 12 months. Putting these two factors together, employment needs to grow almost 30k a month to keep the unemployment rate steady. It clearly didn’t do this in February so the jobless rate rose to 5.555% which was rounded up to show a one-tenth increase to 5.6%.

RBA Governor continues to stress that progress towards what he sees as full-employment rate of 5% jobless will be “slow and gradual”. In February, it actually went very slightly into reverse. Unlike the UK or US, the official statisticians in Australia don’t produce wage numbers in the employment report so we don’t know what’s happening to earnings and whether employers are having to pay up to attract or retain staff as more people find jobs. With the unemployment rate ticking very slightly higher, though, there is certainly no rush to be raising rates. As CBA puts it, “Under-employment and under-utilization rates continue to trend lower but still indicate that spare capacity is available in the job market. We expect that the next move in rates will be up, but we can’t see a change happening until late 2018 at the earliest.” The Australian Dollar opens this morning in the mid-USD 77’s with GBP/AUD at 1.82.

The Canadian Dollar topped our one-day performance table for a second consecutive day on Wednesday. Prior to the FOMC Statement, USD/CAD was already back below 1.30 for the first time since last Thursday with a one percent daily drop whilst EUR/CAD and NZD/CAD were both down six-tenths and AUD/CAD was three-tenths lower at 1.0020. Post-Fed, USD/CAD extended its losses and was down almost 1 ¼ percent on the day, moving back on to a 1.28 ‘big figure’ for the first time in over a week.

Prime Minister Justin Trudeau reiterated his belief there will be agreement on a renewed North American free trade deal between Canada, Mexico and the United States. Trudeau didn't offer any timeline when questioned about the negotiations on Wednesday, only saying he believed a deal is eminently possible. “We are there working very, very hard and moving forward on trying to get a good deal. We know that there is a good deal eminently possible for Canada, for the U.S. and for Mexican citizen and workers.” According to Bloomberg, there are indications the U.S. is willing to budge on one of its core demands as President Donald Trump pushes to get a deal ahead of looming Mexican elections. One person familiar with the talks, speaking on condition of anonymity, said the Americans are showing flexibility on a demand for a 50 percent, U.S.-specific content requirement, but it hasn’t been formally withdrawn.

Canada’s ambassador to Washington, David MacNaughton, told reporters the U.S. has made suggestions on auto rules that “were actually quite creative” and, if taken “to their logical conclusion,” would eliminate the need for the 50 percent requirement. The Globe and Mail newspaper, citing unidentified sources, reported the U.S. had altogether dropped its demand for 50 percent U.S. content in vehicles. Away from the twists and turns of NAFTA, Bank of Canada Senior Deputy Governor Carolyn Wilkins will deliver a speech today, while domestic inflation data for February is due on Friday. The Canadian Dollar opens in Europe this morning with USD/CAD in the high-1.28’s and GBP/CAD in the mid-1.82’s.

After slumping to the bottom of our one-day performance table on Tuesday, falling against all the major currencies we follow closely here, the New Zealand Dollar didn’t do a whole lot better on Wednesday. Ahead of the FOMC announcement it was down against the GBP, CAD and AUD, and little changed against both the USD and EUR. As the USD then softened against all the majors, so the Kiwi Dollar managed to regain 72 US cents and went on to a best level late in the New York afternoon around 0.7240 and has traded pretty much sideways around that rate in the Asian session overnight.

As expected, the RBNZ today left the Official Cash Rate (OCR) unchanged at 1.75 percent. Its Statement noted, “The outlook for global growth continues to gradually improve. While global inflation remains subdued, there are some signs of emerging pressures. Commodity prices have continued to increase and agricultural prices are picking up. Equity markets have been strong, although volatility has increased. Monetary policy remains easy in the advanced economies but is gradually becoming less stimulatory. GDP was weaker than expected in the fourth quarter, mainly due to weather effects on agricultural production. Growth is expected to strengthen, supported by accommodative monetary policy, a high terms of trade, government spending and population growth. Labour market conditions are projected to tighten further… CPI inflation is expected to weaken further in the near term due to softness in food and energy prices and adjustments to government charges. Tradables inflation is projected to remain subdued through the forecast period. Non-tradables inflation is moderate but is expected to increase in line with a rise in capacity pressure. Over the medium term, CPI inflation is forecast to trend upwards towards the midpoint of the target range. Longer-term inflation expectations are well anchored at 2 percent.”

The RBNZ Statement concluded with the line that, “Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain and policy may need to adjust accordingly” and it was interesting that it made no reference at all to the exchange rate for the first time since 2012. The analysts at Westpac commented, “The RBNZ still expects that the economy will accelerate this year, eventually pulling inflation slowly up towards two percent. We doubt very much that the economy will accelerate as the RBNZ expects, but our expectation of exchange rate depreciation leaves us with an inflation outlook that is similar to the RBNZ’s. The main point is that both we and the RBNZ are much more dovish than financial market pricing, and comfortably so.” The Kiwi Dollar opens in London this morning at USD 72 cents with GBP/NZD in the mid-1.95’s.