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A wild finish to a crazy week with US 10y bond yields at 2.84% and a big fall in stocks after US earnings hit 2.9%. AUD was the worst performer, GBP’s strong run may have come to an end.

By Nick Parsons

Well that was a week of two halves for the US Dollar. On Thursday evening, you’d have been offered very long odds against the USD ending up on the week yet that’s exactly what happened. The USD index against a basket of major currencies opened on Monday at 88.75, with investors focusing on what President Trump might say in his first State of the Union Address on Tuesday evening in Washington. From a best level around 89.25, the USD fell sharply ahead of the speech in which Trump boasted of the extraordinary success of his first year in office and offered a very optimistic vision: “This is our new American moment… There has never been a better time to start living the American dream… Tonight, I call upon all of us to set aside our differences, to seek out common ground, and to summon the unity we need to deliver for the people we were elected to serve.”

Wednesday’s FOMC Statement gave the USD a lift. The Fed said that, “the labor market has continued to strengthen and economic activity has been rising at a solid rate. Gains in employment, household spending, and business fixed investment have been solid, and the unemployment rate has stayed low”. But, whereas last month inflation was expected to, "remain somewhat below 2 percent in the near term", this line has been dropped and instead, "Inflation on a 12-month basis is expected to move up this year”. For choice, your author interpreted this is a slightly more hawkish stance. On Thursday, the incoming data – manufacturing PMI, construction spending and jobless claims - were very strong indeed and 10-y bond yields were by then decisively up through 2.70%. None of this helped the USD, though, and its index dropped to 88.25; just a tiny fraction above its Davos low.

Having spent all week completely ignoring very strong incoming economic data and being totally unmoved by higher US bond yields, the USD finally snapped higher on Friday after the employment report showed that average earnings growth had risen to 2.9%; the highest since 2009. Non-farm payrolls were only around the average of the previous 12 months at 200,000 and the average workweek actually fell. But, with the bond market acutely sensitive to signs of inflationary pressure, the earnings number sent 10-year Treasuries up to 2.84%; a huge rise in yields of 38bp since the beginning of the month. As stocks dumped globally (Germany’s DAX is now down in year-to-date terms and at a 4-month low), the USD index briefly made it back to 89.00 before ending the week very modestly higher at 88.85.

The remarkable weeks just keep coming for the British Pound, though this time it’s remarkable because GBP/USD actually finished pretty much unchanged on the week having traded in a high-low range of 2¾ cents. Having opened around 1.4135 in Asia on Monday morning, the GBP then broke its 11-day streak of never testing the previous day’s low; a sequence which had seen it rally from USD1.3450 all the way up to 1.4330. With that record gone, GBP/USD broke below 1.40 on Tuesday morning but just as it looked set for a big fall, it rallied sharply in line with all the non-US currencies and by Thursday it was back up at 1.4275.

We pointed out on several occasions during the week that there was little or nothing in terms of incoming economic data which would justify a higher GBP. If anything, the news was very much on the negative side of the ledger. On Tuesday, Bank of England Governor Mark Carney appeared before the House of Lords Select Committee on the economy. He refused to comment on the confidential government analysis of the economic impact of Brexit which was reported to have been shown to Cabinet Ministers over last weekend. These had suggested growth would be between 2-8 percent lower over the next 15 years. Instead, he provided the Bank’s own estimates which are that that economic growth by the end of this year will be 'about 2% below what had been expected' prior to the referendum. On Brexit, meantime, the EU could not have made it clearer that the better trade deal the UK wants after 2019 depends crucially on accepting the so-called “four freedoms” of the Single Market: free movement of goods, capital, services, and labour. Yet, speaking with journalists on her China trip, the Prime Minister said that that EU citizens who arrive during the post-Brexit transition period must not have the same rights as those who came before.

Sure enough, within a few hours, the European Parliament’s Brexit negotiator, Guy Verhofstadt, replied that, “The maintenance of EU citizens’ rights during the transition is not negotiable… We will not accept that there are two sets of rights for EU citizens. For the transition to work, it must mean a continuation of the existing acquis [EU law] with no exceptions.” On Friday, international trade secretary Liam Fox said Britain must “take control” by seeking trade deals across the world which are impossible within EU arrangements. “It’s very difficult to see how being in a customs union is compatible with having an independent trade policy”. The weekend Press is unlikely to be kind to the government, and Prime Minister May returns from her China trip with even more uncertainty about her own future and her ability to successfully negotiate a post-Brexit deal. GBP/USD lost more than 1½ cents on Friday and the pound ended the week at USD1.4130, GBP/AUD1.7815 and GBP/NZD1.9340.

It seems a long time ago now, but the Aussie Dollar began the week on a US 81 cents ‘big figure’. This was pretty much as good as it got for the AUD – in total it spent only a few hours of the entire week on 81 cents, even as the USD was increasingly friendless on Wednesday and Thursday. The first big domestic news of the week was Tuesday’s monthly NAB business survey. The business confidence index bounced 4pts to +11 index points, the highest level since July 2017 whilst business conditions were unchanged at +13 which is above the long-run trend of +5. We’ve been pointing out recently that the RBA’s monetary policy stance will likely be determined more by growth in wages and household consumption than what’s happening to business conditions. In this respect there was a bit of disappointment that labour costs rose at an implied quarterly rate of 0.8%; down from 1.2% in the previous month’s survey. AUD/USD dropped very briefly below 0.8050 but just as a big technical breakdown seemed imminent then – along with all the other FX majors – there was a sharp turnaround Tuesday in Europe which saw all the earlier losses reversed.

Wednesday brought the quarterly inflation numbers. To an outsider it always seems a very strange use of professional resources to not produce monthly data but then to produce three different quarterly measures all calculated to three decimal places: headline CPI, the core trimmed mean and the core weighted mean. Without getting too bogged down in the detail, all three measures were a bit softer than consensus expectations; albeit not as big a ‘miss’ as we saw in New Zealand the previous week. In terms of what the CPI data mean for RBA monetary policy, there’s still a split of views amongst the Australian banks. CBA say, “We expect the RBA will be comfortable with today's outcome as it broadly lines up with their projections for both headline and underlying inflation. All in all, there is nothing in today's outcome or the recent economic data to change our view that the cash rate is on hold until late this year”. ANZ are a bit more hawkish, saying “We continue to look for the first of two rate hikes in May, although this is based on our forecast that the wage price index prints a 0.5% quarterly rise for Q4 [when released in late February].” AUD/USD fell a little after the numbers but was then lifted to a best level of 0.8113 as the USD plunged to a fresh 3-year low.

A soft-ish manufacturing report pushed AUD/USD briefly back below 80 cents on Friday morning but the big event was of course the US employment report. The Dollar had not gained any support from rising US bond yields all week, but news of a 2.9% y/y increase in US average earnings (the highest since 2009) pushed 10-year Treasuries to 2.84% and the USD surged as analysts began to pencil in a 4th rate hike in the US for 2018. We’ll see what the RBA has to say – if anything – about the value of the currency when it sits down to its first Board meeting of the new year next Tuesday. For now, the AUD ended the week more than 1 ½ cents lower at USD0.7925, with AUD/NZD at 1.0855 and GBP/AUD1.7815.

The New Zealand Dollar began the week very much on the back foot after the disappointments of the December quarter CPI report. NZD/USD opened around 0.7350 and as a sell-off gathered pace - eventually taking it down to 0.7283 - so the AUD/NZD cross hit 110.70; its highest level since December 5th. From that point on, though, it was good news all the way for the NZD, kicking off with a monthly trade balance in December 2017 of +$640 million. The surplus was the largest ever in a December month, and the largest in any month since March 2015. According to the official statisticians, exports of milk powder, butter, and cheese lifted total exports to a record $5.6bn in December 2017. Monthly exports were $1.1bn higher than in the same month a year earlier.

On Wednesday, credit ratings agency Standard and Poor’s reaffirmed its existing high-level sovereign rating for New Zealand, which is AA when borrowing in foreign currency, and AA+ in local currency. S&P said, "The economy is wealthy and resilient, reflecting decades of structural reforms” and that it had incorporated the new Government's ‘more expansionary’ plans into its forecasts, which now have New Zealand growing at an average rate of 2.8 per cent each year over the next three years. "Our ratings reflect solid fiscal performance and our expectation that higher government spending will not materially weaken the country's fiscal profile." This helped push NZD/USD to its best level of the week at 0.7415.

On Thursday, the NZD received a further boost from an opinion poll showing support for the governing Labour Party surged to its highest level in more than a decade and approval ratings jumped for pregnant Prime Minister Jacinda Ardern. Support for Labour has surged 5.4 points since September’s fiercely contested election to 42.3 percent, its highest since it last held government in 2007. The number of respondents naming Ardern as their preferred prime minister also jumped 8.3 points to 38 percent since the last poll in September, overtaking National Party leader Bill English on 26 percent. By Friday’s New York close, AUD/NZD was down more than 2 cents on the week and with a resurgent US Dollar, the NZD ended the week at USD0.7300 and AUD/NZD1.0855.hen on to a low Thursday around 0.7290. The median published estimates were for a quarterly increase in CPI of 0.4% which would have left the annual rate at 1.9%. Instead, StatsNZ reported that prices rose just 0.1% in the December 2017 quarter. Higher petrol prices, air fares, and housing-related costs were offset by lower prices for vegetables, new cars, and a range of household goods. The relatively flat result this quarter leaves the CPI inflation rate at 1.6% for the December 2017 year.

In its last published monetary policy assessment back in early November, the RBNZ saw inflation reaching 2 percent in Q2 2018 as opposed to Q1 2019 which they had previously forecast. It also said it no longer saw headline inflation declining. As that forecast now heads to the shredder, analysts were quick to revise down their interest rate expectations. ANZ said the data have pushed its expectations for the Reserve Bank of New Zealand to hike the official cash rate back from November 2018 to mid-2019. ASB said, “it reinforces that there is no need for the Reserve Bank to raise interest rates anytime soon," whilst amongst the offshore banks Morgan Stanley noted “the weakness seen in 4Q inflation should see the RBNZ on-hold over 1H18, possibly with an added emphasis on the need for a weaker currency”. By Friday’s New York close, the NZD ended the week at USD0.7360 and AUD/NZD1.1025.

The euro had a week full of very positive economic news and, crucially, no attempt from anyone on the ECB Council to try to talk it lower – other than the usual boilerplate language about excessive volatility which traders have learned to take in their stride. EUR/USD began the week around 1.2425 and edged gradually lower but then did not escape the volatility which was the feature of all the major currencies on Tuesday in the Northern Hemisphere. Early in the European morning, it very briefly broke below Monday’s 1.2345 low but just as it looked as though the market was set for a technically-driven drop, the pair reversed to be 110 pips higher at 1.2450 by lunchtime.

Real GDP in the Eurozone rose 0.6% q/q in Q4, slowing slightly from an upwardly-revised 0.7% in Q3, in line with the consensus. It was the 19th consecutive quarter of growth in GDP and put the euro region’s 2017 expansion at 2.5%. That’s better than had been anticipated by the European Central Bank, and it’s a pace the region hasn’t seen since before the financial crisis in 2008. After Germany’s softer than expected CPI, France came to the rescue with an above-consensus 1.5% y/y increase in inflation, largely driven by an increase in service sector prices. This meant that the Eurozone aggregate numbers showed a very small drop to 1.3% which was higher than the median estimate of 1.2%. Final Eurozone Manufacturing PMI printed at 59.6 in January, down from December’s record high of 60.6 and identical to the earlier flash estimate. The PMI has signaled expansion in each of the past 55 months. Markit’s Press Release noted, “The eurozone manufacturing sector made a strong start to 2018. Although January saw rates of growth in output and new orders ease from near-record highs at the end of last year, they remained among the best seen since the survey began in 1997.”

The week’s best level for the euro at USD1.2515 came just before the New York close on Thursday when USD sentiment was at its most bearish extreme. On Friday, it traded either side of 1.25 until the US employment report was released. EUR/USD then tumbled to a low of USD1.2415 but the euro was actually the second best-performing currency on the day; rising against everything except the US Dollar. The EUR ended the week at USD1.2460, AUD/EUR0.6365 and NZD/EUR0.5860.

The Canadian Dollar began the week around USD/CAD1.2325 and initially moved higher to 1.2375 on Tuesday on concerns about NAFTA and what might be said in the State of the Union speech. President Trump’s speech didn’t once mention Canada directly. The passage on trade said, “America has also finally turned the page on decades of unfair trade deals that sacrificed our prosperity and shipped away our companies, our jobs, and our Nation’s wealth. The era of economic surrender is over. From now on, we expect trading relationships to be fair and to be reciprocal. We will work to fix bad trade deals and negotiate new ones. And we will protect American workers and American intellectual property, through strong enforcement of our trade rules.” Cue some sighs of relief North of the border.

Stats Canada reported on Wednesday that real gross domestic product increased 0.4% in November, with widespread growth across industries as 17 of 20 industrial sectors increased. Goods-producing industries rose 0.8% after declining 0.5% in October. November's gain was mainly due to increases in the manufacturing and mining, quarrying and oil and gas extraction sectors, partly as a result of restoration in production capacity. Thursday brought news that Canadian Manufacturing PMI picked up to 55.9 in January from 54.7 in December. An incredibly upbeat Press Release noted, “The manufacturing sector is beginning to show signs of firing on all cylinders, as shown by the broad- based improvement in operating conditions during January… Canada’s manufacturing sector has now seen resurgent new business flows for three months running, underpinned by greater sales at home and abroad. Well balanced demand growth and an ongoing improvement in global economic conditions should help manufacturers sustain a strong rate of expansion in the coming months”. By Thursday evening, USD/CAD had extended its move down to 1.2260; a level not seen since late- September last year.

Immediately prior to the US employment report, USD/CAD stood at 1.2305. By lunchtime in North America, it was more than one cent higher and hit a high for the week of 1.2425. Looking at the week as a whole, CAD was up against the AUD and NZD, down very slightly against the GBP and a little more against the EUR. The Canadian Dollar ended the week at USD/CAD1.2420, AUD/CAD0.9850 and GBP/CAD1.7535.