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USD hits fresh 3 year low overnight before modest recovery. Stocks calm as 10-year bonds hit 2.90%.

By Nick Parsons

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, index futures were signaling the DJIA 200 points higher around 25,150. An hour later the market had dropped 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 finished at the day’s low of 88.25. Overnight in Asia, the USD index fell below 88 for the first time since November 2014 but has subsequently rebounded to 88.35 with index futures suggesting the DJIA around 50 points up at the open.

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

Coming up today, the early focus will be on the US housing market with statistics on housing starts and building permits. Perhaps of more interest given the sensitivity around inflation will be the University of Michigan consumer confidence survey at 10am local time. This includes a question on inflation expectations and will be closely watched to see if the recent stories around prices and earnings have had an impact on the public perception of future trends. Ahead of all this, the USD index opens in North America around 88.30.

USD/CAD has traded in a high-low range of almost two full cents over the past 48 hours as investors grapple with the implications of higher US inflation and interest rates at the same time as US government debt is soaring and the current account deficit is widening. Throw in uncertainty around NAFTA and an oil price which has fallen more than 10% over the past couple of weeks and its easy to see why the foreign exchange market has been so choppy. USD/CAD opens this morning at 1.2475 having been as low as 1.2450 in Europe earlier this morning; its lowest level since February 5th.

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. Today brings the monthly survey of manufacturing where consensus looks for a +033% m/m increase in sales. The Canadian Dollar opens in North America at USD/CAD1.2475, AUD/CAD0.9930 and GBP/CAD1.7550.

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 this morning in Europe, it traded up through the 2018 high of 1.2515 reached on February 2nd to reach a best level of 1.2550; its highest since November 2014.

Speaking in Macedonia this morning, ECB Council Member Benoit Coeure said volatility was a fact of life and the ECB had to live with it, though it was keeping an eye on financial conditions to see if there is a broader impact of the recent market correction. Not deviating one inch from the collective script of the Governing Council, he reiterated in remarks to journalists the unanimity on policy sequencing and said the ECB will discuss policy language in early 2018. Mr Coeure’s speech itself focused on automation and what he called the fourth industrial revolution which has the power to turn global supply chains on the head. A fascinating topic, but not one which has much immediate relevance for foreign exchange markets.

Next week will be far more interesting in terms of potentially market-moving news. ‘Flash’ PMI’s are released on Wednesday, on Thursday it’s the minutes of the ECB Governing Council Meeting (remember it was this which triggered the EUR rally back in January) and on Friday we’ll have Eurozone CPI data. The EUR opens in North America this morning at USD1.2485 and EUR/CAD1.5580.

The British Pound was the quickest of all the major currencies to reverse its losses after US CPI numbers midweek, gaining more than a full cent from 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 as the day’s strongest currency. In early European trading the GBP hit a two-week high just below USD1.4140. It has subsequently been hit by weaker than expected retail sales figures, however, and has now slumped to the bottom of today’s performance table.

UK retail sales grew just 0.1% m/m in January, well below consensus expectations of a +0.6% m/m increase. It always used to be the case that December and January were best viewed together to see the impact of discounting in the annual New Year sales. In the internet age, with the advent of Black Friday promotions in November, it is probably wiser to take the three months together as a whole. Unfortunately, the total growth in sales volumes over this period was just +0.1% with the annual growth rate at just 1.6%. The official statisticians commented that, “Retail sales growth was broadly flat at the beginning of the New Year with the longer-term picture showing a continued slowdown in the sector. This can partly be attributed to a background of generally rising prices.” With earnings growing below inflation and a recent rise in mortgage rates after November’s BoE rate hike, UK retail sales will likely be very subdued throughout the first quarter of 2018.

A separate 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%. The British Pound opens in North America at USD1.4065, GBP/EUR1.1265 and GBP/CAD1.7555.

The Australian Dollar swung just as wildly as most of the world’s major currencies yesterday. AUD/USD stood at 0.7860 just before the inflation numbers and, as stocks tumbled, it fell almost a full cent. Two hours later, the pair had regained all its losses and more and by the close of business in New York it was back on a 79 cents big figure for the first time since February 5th. This morning in Europe it rose as high as 0.7965; the highest in almost two weeks.

The latest Labour Force figures were released overnight. Employment increased 16,000 to 12,453,500. Full-time employment decreased 49,800 to 8,460,900 and part-time employment increased 65,900 to 3,992,600. Since January 2017, full-time employment has increased by 293,200 persons, while part-time employment has increased by 110,100 persons. Seasonally adjusted monthly hours worked in all jobs decreased by 24.1 million hours (or 1.4%) between December 2017 and January 2018 to 1,708.2 million hours. This follows a decrease of 8.6 million hours (or 0.5%) from November to December 2017, and four consecutive increases up to November. The average number of hours worked per employee per week fell to a new record low of 31.7. Employees are on average working 2.7% fewer hours than a year ago and that will limit the boost to household incomes from rising employment.

CBA have already changed their interest rate forecasts to remove the two hikes they previously had penciled-in for 2018. Westpac haven’t yet done this but note, “the Bank’s forecasts are not entirely out of line with our own view and, arguably, consistent with steady rates over the next few years.” NAB, meantime, still has two 25bp hikes in its forecast profile for H2 2018. Amongst the offshore commentators, Capital Economics today say, “while the continued strength of the labour market will provide at least some support to income and consumption growth this year, without much more wage inflation the RBA isn’t going to raise interest rates. We expect the RBA will keep interest rates at 1.5% until the second half of 2019.”. The Australian Dollar starts in North America this morning at USD0.7920, with AUD/NZD at 1.0735 and AUD/CAD0.9895.

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. This morning in London the NZD made a fresh 2018 high – very marginally - of 0.7434 before falling back to 0.7400.

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.

On Monday morning we’ll January’s Performance of Services Index which stayed pretty strong in December (when the PMI didn’t), with a seasonally-adjusted reading of 56.0. The New Zealand Dollar opens this morning in North America at USD0.7400 and NZD/CAD0.9250.