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GBP extends gains on Brexit talk, Aussie Dollar has few friends

By Nick Parsons

In the absence of fresh fundamental news, the Kiwi Dollar was always going to find it difficult to sustain the pace of Monday’s surprisingly sharp squeeze. From the recent highs around USD0.6940, it eased back towards 0.6900 at Tuesday’s New York close and spent the whole of Wednesday in the Northern Hemisphere in a range 0.6883-0.6922 to finish pretty much unchanged on the day against the US Dollar. Elsewhere, it gained against the CAD, EUR and AUD but gave ground against a surging GBP which is now up more than 3 ½ cents from Tuesday’s low. Indeed, the GBP/NZD cross is now within 30 pips of the November 21st high of 1.95 and if this were to break it would be a fresh high for 2017. The OECD report on New Zealand was pretty upbeat: “Economic growth should increase to over 3% in 2018-19, reflecting stronger investment and exports. Capacity constraints, high profitability, low financing costs, housing shortages and government demand should support investment, while agricultural exports should recover following adverse weather and temporary price weakness. Inflation is projected to rise to 2.4% by late 2019”. But whereas the RBNZ chose to announce some loosening of macroprudential lending rules after its FSR, the OECD says, “House prices and household debt have soared in recent years to high levels in relation to incomes. Households are highly exposed to interest rate risk. Macro-prudential regulation should be tightened if there is a resurgence of debt-fuelled house price inflation. A maximum debt-to-income ratio should be considered if expected benefits exceed costs”. This morning in New Zealand brings business confidence and building permits data with household credit numbers later in the day.

The Australian Dollar continues to trade lower and against the USD has now given back all of its gains of the past week. It now stands at just 0.7570 having spent the whole of the last 12 hours back on a 75 US cents big figure and been as low as USD0.7556 during the London afternoon. It has lost ground against all the major currencies apart from the already-weak Canadian Dollar and appears generally friendless in foreign exchange markets. This lack of love comes despite a generally upbeat semi-annual OECD report on Australia: “The economy will continue growing at a robust pace. Business investment outside the housing and mining sectors will pick up, with exports boosted as new resource-sector capacity comes on stream. The strengthening labour market and household incomes will sustain private consumption, and inflation and wages will pick up gradually”. That said, their analysis also reflecting the concerns we outlined here yesterday about the housing market: “The prolonged period of low interest rates has fuelled high house prices in large metropolitan areas. Substantial mortgage borrowing has resulted in households being highly indebted. To contain risks associated with potential large house-price corrections and financial stress, macro-prudential measures should be maintained. Australia is also vulnerable to “too big to fail” risks, due to its highly concentrated banking sector”. This morning’s Q3 capex numbers are going to have to be pretty robust if the prevailing negative sentiment around the AUD is to be reversed.

The pound’s remarkable Tuesday was followed by an equally impressive Wednesday as it made further upside progress against every major currency. GBP/USD has been up to 1.3436 whilst GBP/AUD is now on a 1.77 handle and GBP/NZD is close to making a fresh high for 2017 above 1.95. The two sticking points in Brexit negotiations thus far have been the size of the payments the UK will make to leave the European Union and the Irish Border question. Financial markets were beginning to fear that failing to agree the Divorce Bill would increase the risk of a disorderly Brexit with no trade deal and be GBP negative. The UK had initially suggested €20bn whilst the EU demanded €60bn. According to news reports in London on Wednesday, the final figure will be €45-55bn though it will not be confirmed in writing and will not be settled as an upfront bill. According to one EU negotiator quoted in The Times, “All we need is four extra words.... At Florence Mrs. May said, ‘the UK will honour commitments we have made during the period of our membership’. All we need is the phrase, ‘when they fall due’, added to the end of the sentence. That’s it. No numbers, just those words.” This sounds straightforward – and indeed is what the UK has basically offered – though it remains to be seen whether Parliament will get more details or even a vote on the final settlement. For the moment, anything which is seen as keeping Brexit negotiations alive but whilst prolonging or postponing the process through a ‘transitional’ arrangement on trade is viewed as a clear GBP positive.

The US Dollar index stood at a 2-month low of 92.21 at the beginning of the week but by Tuesday evening had rallied to a best level of 92.98. On Wednesday it extended these gains to a best level of 93.09 before slipping back to 92.85 in the face of a buoyant GBP, rallying EUR and slightly lower US stock markets. In prepared remarks to the Joint Economic Committee of Congress, outgoing Fed Chair Janet Yellen said, “The economic expansion is increasingly broad based across sectors as well as across much of the global economy.” With weak inflation likely to prove “transitory,” she said, “we continue to expect that gradual increases in the federal funds rate will be appropriate.” After US stock markets reached record highs, Dr. Yellen remarked that while asset values were “high by historical standards, overall vulnerabilities in the financial sector appear moderate.” On the future course of the US economy, she said there are structural factors that need to be addressed. Among them are an aging population that has translated to slower labor force growth as well as the “unusually sluggish” productivity growth To generate a sustained boost in economic growth without causing inflation that is too high, we will need to address these underlying causes”. Whilst a 25bp rate hike on December 14th is absolutely baked into market pricing, with a further 2-3 hikes expected in 2018, there’ll still be a good test of USD sentiment on Thursday when the latest PCE figures are released. This is the Fed’s preferred measure of inflation. Though it has consistently fallen short of Fed forecasts in every one of the past four years, and notwithstanding the note of caution in the November Minutes which pulled the rug from under the USD last week, any number no worse than the 1.6% y/y consensus should be OK as long as asset markets hold on to their recent gains.

The EUR had a better day Wednesday after Tuesday’s rather disappointing price action and is up against the AUD, NZD, CAD, and USD though unable to keep pace with the still-soaring pound. It began to move higher in the European morning after the botched release of German CPI numbers about which an inquest seems to be in progress. The stronger than expected numbers of 1.8% y/y were printed by Bloomberg some 3-4 hours of scheduled release then removed from their system in what was claimed to be either a misprint or a wrongly reported number from one of the German States which report their inflation numbers separately. Whatever the case, the error became fact at 2pm European time when the 1.8% number was confirmed. Later in the afternoon, Bundesbank President Jens Wiedmann said German economy is roaring ahead and there are no signs that difficulty in forming a government is noticeably affecting business sentiment. Calling German economic growth “exceptionally good”, he said that the expansion would continue for some time, thanks to solid business sentiment and the highest rate of employment since German unification in 1990. “Updated (euro zone) forecasts come out in two weeks, in December as usual, on the basis of detailed country projections… Indications are that the economic outlook will be at least as good (as previously), if not better. Many short-term indicators have surprised positively”. The Bundesbank head, who also sits on the ECB Governing Council, repeated his long-standing criticism of the ECB’s loose monetary policy, saying that a less expansive stance would be justified. “One thing is clear: even after the end of net asset purchases, euro zone monetary policy will continue to be very expansionary”. The EUR opens this morning around USD1.1850, with AUD/EUR some 25 pips lower at 0.6385 while NZD/EUR at 0.5810 is around 15 pips down from yesterday’s open.

The Canadian Dollar has tracked oil all this week and a full dollar off the price of crude on Wednesday to $57.10 had a very predictable impact on the currency which ended the day as the joint-weakest (with the CAD) of all the major currencies we follow here. USD/CAD hit a near 4-week high of 1.2865 AUD/CAD was unchanged at 0.9732. Ahead of the OPEC meeting, it was reported that Saudi Arabia and Russia (which is not an OPEC member) are trying to reach agreement on extending production cuts into 2018. An agreement first struck a year ago and set to expire in March was aimed at reducing a global oversupply of oil caused in part by US producers and it is said the Saudis want to extend this until the end of next year. Moscow, however, prefers a shorter agreement which would allow it to increase output if prices rise, rather than see all the benefits go to North American shale producers. The Saudi oil minister is quoted on newswires saying it was “too early to talk about a disagreement” and said “a solution” will be reached during talks Wednesday and Thursday in Vienna, where OPEC is based. With few, if any, monetary policy clues in Tuesday’s FSR and with the week’s main economic data in Canada (GDP and the employment report) not out until Friday, the CAD will most likely once again be driven by oil prices and headlines from Vienna.