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Equity markets remain very volatile but USD is at a 2-week high. EUR/USD lower on profit-taking, GBP awaits new Bank of England economic forecasts.

By Nick Parsons

The relationship between stocks and the USD seemed to change subtly on Wednesday. During the previous few days of extreme equity market volatility, the USD tended to do well as stock markets fell, with its best session (the European morning on Tuesday) coming as equities were smashed and US 10-year yields fell back to 2.70%. As the US indices recovered sharply Tuesday afternoon, so the US Dollar gave back all of its morning gains. This pattern continued into Wednesday, as the early call for the DJIA to open 200 points lower helped underpin the USD. But, as stocks extended gains and bond yields rose back to 2.83%, so the US Dollar continued to rise and finished the day at the top of our one-day performance table. As the DJIA shed all its gains and more into the close, so the USD index is now above 90 for the first time since Treasury Secretary Mnuchin spoke in Davos two weeks ago.

Dallas Federal Reserve Bank President Robert Kaplan Kaplan said Wednesday, the recent selloff is "basically a market event and these things can be healthy." Federal Reserve Bank of St. Louis President James Bullard said the latest market decline was no surprise given the elevated valuations of technology stocks and absence of any recent drops. “This is the most predicted selloff of all time because the markets have been up so much and they have had so many days in a row without meaningful down days”. Federal Reserve Bank of New York President William Dudley, meantime, said recent stock-market declines weren’t that big and don’t yet change his outlook for the U.S. economy. “The stock market had a remarkable rise over a very long time with extremely low volatility… My outlook hasn’t changed just because the stock market’s a little bit lower than it was a few days ago. It’s still up sharply from where it was a year ago.” There’s certainly no sign here either of concern about a deeper stock market correction, nor any desire at all to signal rates won’t be raised at the March FOMC meeting.

There are no top-tier US economic data releases scheduled for the rest of the week in the US, though it will be interesting to see if weekly jobless claims this morning can extend their recent decline even further into record-setting territory. The USD index opens in North America at 90.15 with 10-year US bond yields at 2.83%.

Stepping back from the minute-by-minute movements and taking a bigger picture view, since the beginning of 2018, USD/CAD has been in a range from 1.2260 to 1.2600 even though we have seen extreme volatility in equity markets, a 25bp rate hike from the Bank of Canada and ongoing uncertainty over the renegotiation of NAFTA. Given all these major events, a 3 ½ cent high-low range for the currency doesn’t seem very dramatic at all. Overnight, USD/CAD is probing the top end of this range, both on continued strength of the USD and on crude oil prices which are down almost $5 per barrel over the past week.

Statistics Canada yesterday reported monthly and annual figures for building permits. The municipalities issued $8.1 billion in building permits in December, up 4.8% following a 7.3% decline in November. The December increase stemmed from higher construction intentions in the residential sector. Across Canada, all components climbed in 2017, up 10.4% from the previous year. The value of permits in the residential sector has increased every year since 2009. In 2017, the residential sector increased 7.8%, pushed up primarily by the multi-family component (+13.7%).

There’s more housing data this morning when we get the December house price numbers. In November, prices had risen 0.1% m/m and were up 3.4% y/y with Vancouver up 8.7% and London 7.1% higher. Later today, Bank of Canada Senior Deputy Governor Carolyn Wilkins will give a speech tomorrow which might the next clues on the outlook for interest rates. The Canadian Dollar opens in North America at USD/CAD1.2590, AUD/CAD0.9825 and GBP/CAD1.7495.

FX markets in the Northern Hemisphere on Wednesday were much livelier as investors tried to digest news of the new Coalition government in Germany. We have seen what happened in the VIX market in the US when investors in a very crowded trade all tried to pile through the exit at once and there were some tentative signs in EUR/USD that the same might be happening in foreign exchange. Perhaps the most ‘crowded’ trade over the last few months has been long of EUR/USD as incoming economic news in the Eurozone continues to improve and investors have continually revised up their expectations for growth and the exchange rate. Yesterday, however, the EUR fell over a full cent in the late European afternoon; its first time back on a 1.22 handle in two weeks. This morning in Europe it has traded down to a low around 1.2225.

ECB Chief Economist hosted a Q&A session on Twitter this morning; an innovative and transparent method of improving central bank communication. He said the salary increase secured by Germany’s largest trade union this week is “fully in line” with the European Central Bank’s inflation forecasts. His comments dampened speculation that the 4.3% pay rise negotiated by labor union IG Metall and the Suedwestmetall employers’ federation in Germany - which we spoke about here earlier in the week - would prompt the ECB to raise its inflation forecasts and to tighten policy faster. Asked what he would choose if he could pick just one measure of inflation, he said, “If I really had to pick one, I would take the simplest one: core inflation.” Asked about economic models, he said, “Models are important to help us think about economic developments in a structured way, but the real economy is always more complex than models. Always to be complemented by other approaches, conjunctural analysis, and even anecdotal evidence!”

Mr Praet even displayed a great sense of humour for a central banker. One questioner asked, “Peter, how do we pronounce your name? Is the 'e' silent?” and received the classic reply, “In Praet indeed, but not in Peter.” Not to be outdone, his colleague and Executive Board member Yves Mersch said at an event in London that, “At these speeds, if you bought a bunch of tulips with Bitcoin, they may well have wilted by the time the transaction is confirmed”. Let’s hope that their peers around the world can make similarly witty and interesting observations as they try to explain the somewhat arcane business of monetary policy. The EUR opens in North America this morning at USD1.2245 and EUR/CAD1.5410.

Yesterday in Europe, GBP/USD made another attempt to get back on to a 1.40 ‘big figure’ but fell short by just a few pips before then losing more than a full cent against a strongly recovering US Dollar to a low in the mid-1.38’s. Despite the weakness in the ‘cable’ rate, the British Pound actually ended the day higher against NZD, AUD and the EUR, whilst little changed against the CAD. This morning in Europe, the GBP is a bit firmer as investors look forward to what’s become known as ‘Super Thursday’; a Bank of England MPC meeting with a rate announcement, published Minutes then a Press Conference to introduce the new Quarterly Inflation Report.

In his appearance before a House of Lords Select Committee last week, BoE Governor Carney hinted that the Bank is preparing to upgrade the forecasts in its Inflation Report. “I would expect that in 2019 we will see a pick-up in this economy all things being equal – strong global growth, greater certainty... A disorderly Brexit, not a likely scenario at all, is less likely than at the time we did the assessment in the fall.” The easiest call to make is that Bank Rate will be kept unchanged at 0.5%. The interest rate market currently prices between two and three 25bp hikes over the next three years. Looking at a selection of forecasts from the major banks, there’s quite a split of views. Barclays say, “Overall we expect the Bank to remain in wait-and-see mode after its November hike and refrain from revising its communication in the absence of relevant events or data since the last inflation report. We retain our call for a next hike in November 2018.” Citi say, “New forecasts may show stronger growth and higher inflation rates, although the Bank will likely remain cautious due to Brexit uncertainty. We currently expect a Bank Rate hike by 25bp in Aug-18 and one hike per year until 2020”. UBS, meantime, say the BoE will hike rates during the May meeting.

The wide split of views amongst analysts all looking at the same data and with little genuine consensus on rates or the economy, there is the prospect of plenty of volatility in the GBP from midday onwards London time when a barrage of headlines hit the newswires and then during the Press Conference at which the new Quarterly Inflation Report will be discussed in detail. The British Pound opens this morning in North America at USD1.3900, GBP/AUD1.7810 and GBP/CAD1.7505.

The Australian Dollar resumed its slide yesterday as commodity prices moved lower and volatility remained elevated across asset classes. These are two of the three main drivers (along with interest rate differentials) of most of the valuation models of the currency. Gold has fallen $40 per ounce since last Thursday whilst in the base metals, aluminium is down more than 4% over the same period. AUD/USD is now down over 3 cents from its recent high of USD0.8130 and is now flirting with a US 77 cents ‘big figure’ for the first time since late December.

NAB’s Quarterly Business Survey was released today. The bank notes that, “The business conditions index (an average of trading/sales, profitability and employment) rose 1 point, to +15 in the December quarter – which is well above the long-run average – driven by improvements in employment, while trading conditions eased slightly and profitability was steady. Employment conditions have been holding up at levels that suggest we are likely to see further improvement in unemployment over coming quarters. Meanwhile, the business confidence index eased slightly to +6 points in the quarter, which is only a little above the average.” Almost all industries reported very elevated levels of business conditions for the December quarter, but despite some improvement since Q3 (inching back into positive territory), the retail sector continues to lag well behind the rest. NAB says, “The health of the retail sector remains quite critical to the economic given that consumption makes up the lion’s share of the economy. If subdued business conditions are telling us something about the mindset of the consumer, then faster and more sustainable growth will be more of a challenge if things don’t improve.”

In his speech earlier this morning Eastern Time to the A50 Australian Economic Forum dinner, RBA Governor Phil Lowe did not sound a man in any hurry to raise interest rates. He said, “given recent developments in Australia and overseas, it is likely that the next move in interest rates in Australia will be up, not down. If this is how things play out, the likely timing will depend upon the extent and pace of the progress that we make. As I have discussed, while we do expect steady progress, that progress is likely to be only gradual. Given this, the Reserve Bank Board does not see a strong case for a near-term adjustment in monetary policy. It will of course keep that judgement under review at future meetings.” The Australian Dollar starts in North America this morning at USD0.7805, with AUD/NZD at 1.0825 and AUD/CAD0.9825.

The NZD couldn’t sustain Tuesday’s strength yesterday, even before the RBNZ interest rate announcement which came around 5pm eastern Time in North America. The AUD/NZD made an early attempt to probe into fresh 6-month lows but having reached the mid-1.07’s, it then reversed more than a full cent higher. Against the US Dollar, the NZD has fallen quite sharply overnight and is now more than 2 cents below its recent peak. It has fallen on to a US 71 cents ‘big figure’ for the first time since January 11th.

The RBNZ left interest rates unchanged at 1.75% but cut its inflation forecasts and predicted it won’t reach the 2-percent midpoint of its 1-3 percent target range until late 2020, more than two years later than previously expected. Despite that, it maintained its projection that the official cash rate will remain on hold this year and start to rise in mid-2019. The RBNZ has been weighing the potential impact of Prime Minister Jacinda Ardern’s policies around immigration, housing, welfare and industrial relations on economic activity. The RBNZ said it has reviewed its estimates and “the net impact of these policies has been revised down in the near term.” The economic growth profile is “weaker in the near term but stronger in the medium term”. For the currency specifically, RBNZ said, “The exchange rate has firmed since the November Statement, due in large part to a weak US dollar. We assume the trade weighted exchange rate will ease over the projection period…. Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain and policy may need to adjust accordingly.”

Overall, the RBNZ statement reads pretty dovishly. Assistant Governor John McDermott said the bank’s stance on rates is neutral. “There is a significant probability that the next rate move could be an increase sometime in the future, and there’s also a substantial probability that the next move could actually be a cut.” So, rates could go up or down, inflation expectations are well anchored and will reach the mid-point of target in 2 years’ time; a situation he summed up in the Press Conference by saying “That’s central bank nirvana.” For currency traders, it doesn’t sound like any great reason to buy the New Zealand Dollar which opens this morning in North America at USD0.7205 and NZD/CAD0.9070.