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US stock markets reach record high, USD hits fresh 3-year low as government shuts down. AUD back at 80 cents, GBP/USD nears 1.40

By Nick Parsons

The hard numbers show that the USD index against a basket of major currencies fell only 0.2% over the course of the week, even though it felt much worse than that. The pattern of trade was such that the USD made four fresh lows on different days at 89.99, 89.96, 89.92 and 89.89 which all gave rise to a flurry of Press headlines about the drop. But, just reading through the actual index levels, we can see that only one-tenth of a point separated all four. Sometimes its important to look at the scale on the charts rather than to rely on the headlines alone. The biggest volatility in US markets was seen not in the dollar, but in equities. On Tuesday as cash markets played catch-up with futures after their holiday closure on Monday, so the 26,000 milestone for the DJIA was duly passed in the New York morning; just 8 trading days after it first reached 25,000. The index then failed to hold on to 26k and from 10.40am Eastern Time in the US, it erased all its prior gains to end down on the day. Moreover, the VIX measure of equity market volatility jumped to a 5-week high of 12.1. By Wednesday the DJIA was back at a record high and closed the week at 26,071 for a net gain around 300 points. Just as familiar as the stock market rally and dollar decline is that both came despite yet another good set of economic numbers. The previous week had seen higher core inflation and retail sales numbers. On Wednesday, industrial production surged +0.9% in December as very cold weather at the end of the month boosted demand for heating. Thursday, we learned that weekly jobless claims decreased by 41k to 220k; their lowest level since February 1973 and the biggest weekly biggest drop since April 2009. At midnight on Friday, the US government began to shut down; the first time ever that a party which controls the White House, Senate and House of Representatives has overseen a government shutdown. It is the 19th such occasion in the last 40 years. Four of these 19 have lasted just one day with the longest in 1995 lasting 21 days. During the last government shutdown in October 2013, 850,000 federal workers were furloughed, equal to nearly 40% of the government workforce. The shutdown lasted for 16 days, triggered by a disagreement over Obamacare. According to Standard & Poor’s, it cost the economy $24 billion. Happy anniversary, Mr President!!

Trading in the Canadian Dollar was completely dominated by Wednesday’s first Bank of Canada monetary policy meeting of the year. Back in December, a January rate hike was only a 50-50 call. After the second strong monthly employment report, the probability of a 25bp hike jumped to 90% but after the uncertainties over what changes to NAFTA might mean, it was back down to just 60% before rising back to 85%. In a Reuters poll on Monday, just eight of 31 analysts surveyed said they expect the BoC to hold rates steady on Wednesday. The majority forecast was a 25bp hike then one further rate increase in each of the third and fourth quarters, bringing the benchmark to 1.75 percent by the end of 2018. Analysts predicted another hike in the first quarter of 2019. Economic growth was expected to average 2.2 percent this year, slightly higher than the 2.1 percent forecast in the previous poll in October. In line with the majority expectation, BoC raised rates 25bp to 1.25%. The initial reaction in FX markets was the usual mix of algorithm-driven stop-loss and stop-entry orders as the headlines flashed across the screens. Your author was watching a tick-chart of prices and in the space of less than 20 seconds, USD/CAD moved up from 1.2420 to 1.2540, down to 1.2375 and back to 1.2500. The main points from the BoC Statement were that, “Recent data have been strong, inflation is close to target, and the economy is operating roughly at capacity. However, uncertainty surrounding the future of the North American Free Trade Agreement (NAFTA) is clouding the economic outlook.” On the domestic economy, “Consumption and residential investment have been stronger than anticipated, reflecting strong employment growth. Business investment has been increasing at a solid pace, and investment intentions remain positive. Exports have been weaker than expected although, apart from cross-border shifts in automotive production, there have been positive signs in most other categories”. Looking forward, “consumption and residential investment are expected to contribute less to growth, given higher interest rates and new mortgage guidelines, while business investment and exports are expected to contribute more. The Bank's outlook takes into account a small benefit to Canada's economy from stronger US demand arising from recent tax changes. However, as uncertainty about the future of NAFTA is weighing increasingly on the outlook, the Bank has incorporated into its projection additional negative judgement on business investment and trade.” The challenge now is to decide whether the references to uncertainties over NAFTA will be enough of take at least one of these hikes off the table. There doesn’t yet appear to be any consensus amongst the local banks on this so we may have to wait until the next round of weekly and monthly analysts’ notes to see if views have changed. By Friday’s New York close, the Canadian Dollar stood at USD/CAD1.2495, AUD/CAD0.9980 and GBP/CAD1.7310.

The Pound had a very good week, even though incoming economic data was generally soft and there has been no progress at all in Brexit negotiations. It opened on Monday morning in Sydney around USD1.3730 and made a whole series of fresh 2018 highs. In the immediate aftermath of the EU referendum back on June 23rd 2016, GBP had fallen from 1.48 to 1.32 so there is no obvious point of technical resistance to cap the current up-move. Chart specialists will point to the February 2016 low around 1.3850 and the low in April that year of 1.4080 as possible hurdles but investors have been piling in to a currency which looks fundamentally inexpensive and has plenty of positive momentum. The GBP’s gains came despite news of the collapse of one of the UK’s largest construction companies which employs around 43,000 people and has been working on a host of government-funded projects such as the high-speed rail link between London and Birmingham as well as many contracts for hospitals, schools, prisons and the Army. In total, Carillion has around 450 contracts with the UK government, equivalent to 38% of its 2016 revenue. In a statement to the House of Commons, the government announced emergency moves to underwrite the cost of the collapsed construction company’s public-sector contracts to ensure that “vital” services continue but insisted that the move was not a “bailout” for the company. UK CPI figures on Tuesday showed the first fall in the annual rate since June last year. The Office for National Statistics said the fall in inflation from 3.1% to 3.0% came mainly from air fares, along with a fall in the prices of a range of recreational goods, particularly games and toys. It’s only a tiny fall in inflation, but the figures do at least give some hope that the peak in CPI might now have been seen. Friday brought the December’s retail sales figures. As in the US and Canada, there has been a significant shift in buying habits as a result of Black Friday promotions a month before Christmas. Sales volumes ex-fuel rose +1.2% in November but then fell -0.9% in December. The ONS commented that, “the longer-term picture is one of slowing growth, with increased prices squeezing people’s spending”. Having reached a high of USD1.3935 on Friday, the pound ended the week at USD1.3855, GBP/AUD1.7345 and GBP/NZD1.9040.

A fortnight ago, the Australian Dollar stood on the sidelines as the rest of the non-US currency world partied, but this last week it’s been out there on the dance floor, hitting 80 US cents for the first time since September and falling just 20 pips short of what would have been its best level in 32 months. World commodity prices have certainly help lift the AUD, as too has the very low level of volatility across asset classes which makes the currency’s yield advantage more attractive. In the one-month period to the middle of the week, gold had risen almost $100 per ounce to $1,242 per ounce; an increase of almost 9%. Over the same period, aluminium was up 13% and platinum was 12% higher. Coal has been steady recently but was still up more than 30% from last Summer. The big event of the week locally was the December labour market report. According to the Australian Bureau of Statistics (ABS), employment rose by a seasonally adjusted 34,700, beating consensus expectations of a 15,000 increase. Employment has now increased in each of the past 15 months, which equals the longest consecutive streak on record. One more positive month in January, would be the longest uninterrupted period of jobs growth since the survey began in 1978. Full-time employment increased 15,100 to 8,518,900 in December and part-time employment increased 19,500 to 3,921,800. The ABS noted that, "Full-time employment has now increased by around 322,000 persons since December 2016, and makes up the majority of the 393,000 net increase in employment over the period," It was the fastest growth over a calendar year on record, and the second fastest over any 12-month period, only beaten by a 409,300 increase in August 2005. The only note of caution was news that the unemployment rate rose to 5.5% from 5.4%. This was due to much stronger labour-force participation which might indicate some further spare capacity in the labour market and therefore a lack of wage pressure. But, unlike the UK or US, Australia doesn’t release earnings numbers with the employment report. We’ll still have to wait for that and with the Australia Day holiday coming up on Friday, there might not be too much activity locally in the week ahead. The Australian Dollar ended the week at USD0.7985, with AUD/NZD at 1.0975 and GBP/AUD1.7345.

The volatility in the New Zealand Dollar shows no sign of abating. Of the six major currencies we follow closely here, its position on the one-day performance charts over the past week has been first, last, second, first equal and last equal. On Monday, NZD/USD got back on a US 73 cents big figure for the first time since the day after the General Election back in late September and was up over 5 cents from the November 8th low. The main economic news of the week was the Quarterly Survey of Business Optimism published by the New Zealand Institute of Economic Research (NZIER) which has conducted a comprehensive quarterly survey of business opinion ever since 1961. This latest QSBO shows a sharp drop in business confidence following the General Election, with a net 11 percent of businesses expecting economic conditions to deteriorate over the first half of 2018. Business confidence had fallen in the previous quarter ahead of the General Election, and it appears uncertainty over new Government policies have made businesses even more downbeat. The decline is more modest when it comes to businesses’ own demand. A net 10 percent of businesses reported a lift in own trading activity in the December 2017 quarter, an easing from the net 13 percent in the previous quarter. As the NZIER puts it, “Businesses may be worried about the outlook for the New Zealand economy under the new Labour-led Government, but for now this is not reflected in demand in their own business”. The decline in business confidence was broad-based across the sectors, with retailers and manufacturers particularly downbeat. However, the pessimism was not reflected in activity indicators. Domestic sales remain solid in the retail and manufacturing sector. The building sector also reported solid output and new orders. Across the regions, the pessimism was evident in the urban regions including Auckland, Wellington and Canterbury. In particular, a net 33 percent of Wellington businesses expected a worsening in economic conditions over the coming months. Despite the disappointing QSBO, the NZD benefitted from a sharp dive in the USD on Wednesday evening to reach a fresh 2018 high of USD0.7330. By Friday’s New York close, however, and after a poor NZD manufacturing PMI survey earlier in the day, it was down to USD0.7275 for a net gain of a quarter of a cent on the week.

The euro ended the week just 20 pips higher than its starting point on Monday of USD1.2200. With US markets closed for the Martin Luther King holiday on Monday, buying in thin liquidity conditions helped push EUR/USD to a fresh high for the new year of 1.2285. On Wednesday morning in Sydney the USD had a very quick spike lower which lifted the EUR to 1.2302; a 60 pip jump in EUR/USD and a 40 pip jump in GBP/USD which was entirely unexplained by any news story or headline. Given the changed regulatory environment these days in wholesale FX markets, there was no chat around what client flows may have triggered it. It is as much of a mystery now as it was at the time. We’d been highlighting the lack of any push-back from ‘ECB sources’ and on Wednesday we finally got it. According to a Reuters story, “three sources on or close to the ECB’s policy-making Governing Council said any fundamental change to the guidance was likely to come only later, with the March meeting, when policymakers get updated economic forecasts, seen as a more likely option. ‘We need more thorough analysis before making any change,’ one of the sources said”. In an interview with Italy’s La Repubblica newspaper, ECB Vice President Vitor Constancio said “I am concerned about sudden movements which don’t reflect changes in fundamentals… Looking at fundamentals, inflation declined slightly in December.” The next ECB Governing Council meeting is on January 25th and Constancio signaled little prospect of a change in the guidance on policy at that gathering, saying officials should be careful not “choke off growth too soon.” As if to reinforce the message, ECB council member Francois Villeroy de Galhau said, “The only question is how long it will take to meet our inflation target. On this issue, the recent evolution of the exchange rate is a source of uncertainty which requires monitoring with regard to its possible downward effects on imported prices.” Wednesday’s high of USD1.2302 was not seen again and falling to 1.2165, the EUR could recover only to 1.2280 before ending the week at USD1.2215, AUD/EUR0.6535 and NZD/EUR0.5955.