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NZD just edges past AUD into top spot; USD recovers as stock markets surge; GBP finished at the lows on renewed Brexit concerns.

By Nick Parsons

The Dollar had a very volatile week but its index against a basket of major currencies ended almost exactly where it had begun at 93.50. On Monday the S&P 500 Index ended the day up 0.32% at 2,659, a new record close, led by the telecoms, technology and energy sectors. Tuesday brought the dollar’s high for the week at 93.81 as the Fed began its two-day FOMC meeting but then came news from a highly controversial Senate election in Alabama; a deeply conservative southern State. The Republicans have not lost a seat there for 25 years and in the Presidential Election in 2016, Donald Trump won by 28 percentage points; 62.1% to 34.4%.

Mr. Trump had given enthusiastic support to a former judge, Roy Moore, who faced a series of allegations about misconduct and who has previously said that he does not believe that Barack Obama was born in the US and that Muslims should not be allowed to serve in Congress. Mr Moore was defeated by Democrat Doug Jones; a move which not only questioned the President’s judgment, but reduces the Republican majority in the Senate to just one seat.

The Fed Statement on Wednesday noted, “the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong.” In its new economic projections, it revised up 2018 GDP forecasts from 2.1% to 2.5% with further more modest upgrades to the outlook in 2019 and 2020. Though two of the nine voting members dissented, there were no downward revisions to future ‘dot points’ and the belief that inflation would indeed pick up was again reiterated.

Despite what looked to be a very non-controversial Statement and subsequent Press Conference, the Dollar extended its decline in the last 2 hours of trading in New York, with the index falling to a 1-week low of 93.00. Thursday was pretty uneventful for the USD and Friday also got off to a sluggish start. From the opening of trading on Friday, however, stocks began to surge on news that the last Republican hold-out on tax reform was now going to offer his support after being offered some concessions on child care provisions. The S+P 500 index jumped 25 points to a fresh closing high, dragging the USD index up three-tenths to end a volatile week exactly where it had begun at 93.30.

The Canadian Dollar spent the first few days of the week in a fairly narrow range, pulled up and down solely by movements in crude oil prices. It began at USD1.2855, reached a high of 1.2884 on Tuesday evening and a post-FOMC low of 1.2798. The highlight of the week, however, was a keenly-anticipated speech from Bank of Governor Stephen Poloz which had the fascinating title “Things that keep me awake at night”.

Mr. Poloz is always a wonderfully thought-provoking speaker, never afraid to go against the prevailing G7/BIS consensus and full of insight into the policy-making process. He is a very under-estimated Central Banker; erudite but self-deprecating in equal measure. His speech to the Canadian Club in Toronto is worth reading in full. It can be found at here.

To summarize briefly here, the three issues were cyber threats, high house prices and “The tough job market for young people”. He also threw in a wonderful dismissal of bitcoin: “the term “cryptocurrency” is a misnomer: “crypto,” yes, but “currency,” no. For something to be considered a currency, it must act as a reliable store of value, and you should be able to spend it easily.

These instruments possess neither of these characteristics, so they do not constitute “money.” Overall, the context of his speech was that the Canadian economy is doing extremely well and is at a “sweet spot” in the economic cycle. “The economy has made tremendous progress over the past year, and it is close to reaching its full potential. We are very encouraged by this, and we are growing increasingly confident that the economy will need less monetary stimulus over time.”

Needless to say, currency markets loved this speech. USD/CAD tumbled a full cent to a one-week low of 1.2735. On Friday, however, the CAD was unable to resist in the face of the US Dollar’s late surge and USD/CAD ended the week very little changed from where it had begun at 1.2870.

The Australian Dollar had its best week for several months, rising for four consecutive days then only finally giving ground to a resurgent US Dollar in the last few hours of trading in New York on Friday. After the very poor performance of the AUD over the previous few weeks and the general softness in many of the incoming economic indicators, there is no doubt that investors were either outright short of the currency or underweight relative to their neutral benchmark weightings. When the NZD began to squeeze sharply higher on Monday morning (see below) so it appeared that traders were also taking profits and closing out their Aussie positions too, for fear of a similar squeeze.

The NAB Business Survey on Tuesday was solid rather than spectacular but with most of the components of activity above their long-term averages, it proved enough to offer further support to the AUD ahead of Wednesday’s US FOMC meeting. It was a struggle to find anything particularly negative in the Fed Statement but the US Dollar nonetheless sold off sharply and AUD/USD got back on to a 76 cents big figure for the first time in a week; closing at 0.7635. Thursday brought the November labour market report. Consensus estimates were for a 19,000 increase in employment with the jobless rate steady at 5.4%.

According to the Australian Bureau of Statistics (ABS), employment actually jumped by 61,600 to 12.4 million in November. It was the largest monthly increase since October 2015, whilst the previous month’s figure of +3,700, was also revised up to show a gain of 7,800. Full-time employment jumped by 41,900 to 8.5 million, beating a 19,700 increase in part-time employment which rose to 3.9 million. Over the last 12 months, full-time employment has increased by 304,600, far outpacing a 78,700 increase in part-time employment. Combined, total employment increased by a huge 383,300. Reflecting the strong rise in employment, the total number of hours worked by all Australians increased by 9.8 million hours, or 0.6%, to 1.7409 billion hours.

AUD/USD jumped to 0.7668 immediately after the figures and then onto a high of 0.7689 on Friday; its best level since November 10th. As it seemed the US tax reform bill would be passed, US equities had a huge late session rally with the S+P 500 index up almost 1%. This dragged up the USD in its wake to leave the AUD at USD0.7641 at the New York close. Over the course of the whole week, the Australian Dollar was the second-best of all the major currencies we track here; just knocked off top spot by its trans-Tasman cousin.

The New Zealand Dollar ended the week at the top of the pile; the best performer amongst all the major currencies. The move began early on Monday with the appointment of a new Governor of the RBNZ. Finance Minister Grant Robertson announced Adrian Orr – a well-respected and highly experienced professional economist, former head of financial stability at the RBNZ and currently head of the NZ Superannuation Fund - will take up the post in the New Year. The new Labour-led government in New Zealand wants to add full employment to the bank’s inflation-fighting mandate and change its governance structure, including the appointment of outside experts to its policy committee.

The appointment of a classically-trained insider to be the new Governor helped calm investor fears about a too-radical shift of direction which have weighed on the NZD ever since the election on September 23rd. NZD/USD began at 0.6838 and jumped almost a full cent to 0.6930 during the first Asian session of the week. Late in the US session, the pair broke above the late November high of 0.6943 and the much improved technical chart picture left it well positioned to capitalised on the USD weakness after the FOMC Statement on Wednesday evening. By the NY close, NZD/USD was on a 70 cents handle for the first time since October 19th. Thursday saw a reversal lower in the NZD as the Government released its Half-Year Economic & Fiscal Update. It forecast that economic growth would average close to 3 per cent over the next five years, peaking at 3.6 per cent in 2019. Unemployment is also forecast to fall to 4 per cent, despite hikes in the minimum wage pushing wage growth significantly higher. forecast that economic growth would average close to 3 per cent over the next five years, peaking at 3.6 per cent in 2019. The forecast sees revenue growth rising sufficiently to see net debt fall to below 20 per cent of gross domestic product by 2022, a core promise of Finance Minister Grant Robertson.

Responding to criticism, that the forecasts were too optimistic, Treasury secretary Gabriel Makhlouf said the forecasts assumed the sharp drop in business confidence since the election was assumed to be only temporary and would soon rebound. Whatever the case, the NZD soon rebounded and by lunchtime in London on Friday it reached a fresh high for the week of USD0.7027 before succumbing to the US Dollar’s late surge to finish the week ain New York at 0.6990. With the AUD/NZD cross falling very modestly from 1.0975 to 1.0930, this meant the Kiwi Dollar took the prize as the strongest currency of the week.

The British Pound had a very volatile but ultimately pretty poor week. It began at USD 1.3385 but was weighed down by concerns over whether Conservative MP’s would accept the deal agreed in Brussels the previous Friday by UK Prime Minister Theresa May. It ended Monday half a cent lower at 1.3335. CPI figures are always a good test of sentiment for the Pound. When it is performing well, analysts tend to view higher inflation through the prism of monetary policy and argue that higher prices will bring higher interest rates which is good for the currency.

When it is performing badly, higher inflation is viewed from the perspective of the squeeze on real incomes and argue that it will bring slower consumer spending. Tuesday was very much the latter case, and with the market nervous over an upcoming Parliamentary vote on Brexit, the pound slid to USD1.3306. Just as investors were digesting the Fed Statement on Wednesday came news that the UK Government had been defeated on one of the night’s four parliamentary votes on Brexit.

The implications of this for the British Pound appeared to us somewhat mixed. On the one hand, any defeat for the Prime Minister is something which will weaken her authority and arguably put her in a weaker negotiating position in Brussels. On the other, the substance of the 24-word Bill is to give Parliament a vote on the final terms of the Brexit deal. Essentially, it means that MPs could reject the terms of any withdrawal — or amend the legislation to delay Brexit — if they are not satisfied with the deal negotiated. In the event of “no deal” the amendment could be used by MPs to try to reverse Brexit. We wrote on Thursday morning that, “To the extent that it leaves the door open to a rejection of Brexit, this could perhaps be interpreted as a GBP positive, albeit not one which we’d put much weight on right now.”

The pound moved sideways on Thursday as the Bank of England’s MPC voted unanimously 9-0 in favour of no change in Bank Rate. Its accompanying Statement read very cautiously, stressing that the pace of future rate hikes would be very gradual and limited in extent. It reiterated its judgment that that “inflation is likely to be close to its peak, and will decline towards the 2% target in the medium term.”

On Friday, it became clear that Prime Minister May would be unlikely to dictate the terms or the timetable for discussions on Phase 2 of the Brexit negotiations. Her EU counterparts refuse to be rushed and are arguing that no progress can be made until the UK Government sets out definitively what it wants to achieve. With the USD buoyant as the tax reform passage seemed set to pass and US stock markets surged, the British Pound plunged on Friday afternoon, ending the week almost on its lows at USD1.1315. From its recent high against the AUD it is down 5½ cents to 1.7425 whilst GBP/NZD is down just over 7 cents at 1.9055.

The Euro had another disappointing week, failing to gain any upside traction even as incoming data continued to show the economic recovery in the Eurozone to be broadening and deepening. It opened in Asia on Monday morning at 1.1765 but at its best spent barely 15 minutes on a 1.18 big figure before turning lower on Tuesday to the week’s low of 1.1174 as Press reports in Italy reported that President Sergio Mattarella will dissolve Parliament this month and set a March 4 election date.

Recent opinion polls show a centre-right coalition ahead, followed by the Five Star Movement and Gentiloni's Democratic Party, but all of them several points away from the 40% bar which is necessary for one party to govern under the new so-called “Rosatellum” electoral law. Given this uncertainty, 10-year Italian bond yields jumped 10bp. Although there was no contagion into other peripheral Eurozone bonds, investors haven’t recently needed much of an excuse to sell EUR and the Italian news was the trigger for Tuesday’s underperformance. Wednesday’s post-FOMC Dollar sell-off saw EUR/USD jump more than a cent, and on Thursday it reached its best level of the week at 1.1843, helped by very strong purchasing managers surveys: “The eurozone economy picked up further momentum at the end of 2017, with December seeing the fastest growth of business activity for nearly seven years.

The best factory output and order book gains since 2000 pushed the manufacturing headline PMI to a record high, while an upturn in service sector to growth to the highest since early-2011 underscored the broad-based nature of the current surge in activity”. At the ECB meeting, new staff economic projections showed upward revisions to growth forecasts. 2018 GDP is now seen at 2.3% (previously 1.8%) with 2019 at 1.9% from 1.7%. 2018 CPI was nudged up from 1.2% to 1.4% though 2019 and 2020 were left unchanged at 1.5% and 1.7% respectively.

The significance of the CPI forecasts is that on a 2-year horizon, inflation is not yet back at the ECB’s target of “close to but just below 2%”. This provides the justification for continuing the very accommodative monetary policy. By Friday’s close, the EUR had given up all of Thursday mornings gains and more; ending in New York at the session lows of USD1.1751 as the USD surged in a very illiquid market. It’s net loss on the week was only 20 pips, even though to may traders it will have felt a worse performance than it actually was.