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Equity index futures remain hugely volatile. USD index holds above 90, GBP and EUR both lower

By Nick Parsons

The volatility across asset classes continues with the Dow Jones Industrial Average down 1,000 points Thursday. The latest move lower came with little or new fresh news, and amidst a general feeling that many of the forced buyers of VIX had already covered their short positions earlier in the week. Instead, there’s now a worry that the so-called ‘risk-parity’ funds might be the next wave of forced sellers, liquidating positions as both equities and bonds are delivering simultaneous negative returns. The US Dollar tends to do well in periods of asset market chaos and so Thursday was another day of general USD strength with its index against a basket of major currencies climbing to a two-week high around 90.25. Futures markets were indicating the DJIA to open around 300 points higher this morning but have fallen over 200 points in the past hour before we go to print. This volatility shows no sign of abating any time soon.

Federal Reserve Bank of Minneapolis Governor Neel Kashkari was speaking yesterday at an event in his home state. He is always worth listening to as the arch-dove on the FOMC who frequently dissented against decisions to raise interest rates. Even though he is not a voting member this year, he still has input into the Fed’s discussions on monetary policy, like any of the 12 regional Fed presidents and he is the only one of the 12 who tweets regularly on economic issues facing the country and the Fed. “We need to be very careful,” he said, when asked about his use of Twitter to comment on the economy. “But it’s the Fed’s responsibility to be transparent as well as faithful to the facts and data when making decisions about the economy and I’m probably blunter than most.”

For Kashkari, studying the economy is not rocket science. He knows this because he was a rocket scientist. In his first career, he was an aerospace engineer, before going back to college for an MBA and moving into finance. He told the business groups that a key to solving the tight labor market that is keeping businesses from expanding is simply “math.” People are having fewer children, which leaves only three alternatives. “Hunker down, subsidize fertility, or embrace immigration. Find ways to encourage more immigrants who can provide the work force needed. At the same time, they will add to the economy with their own home-buying and consumer spending.” Amidst all the volatility in financial markets, it’s certainly encouraging to hear a senior policymaker offer such fascinating reflections on more structural economic matters. There are no top-tier US economic data releases scheduled today and FX traders have never, ever been interested in wholesale sales numbers. However, the inventories number feeds directly into the Atlanta Fed GDP model which will be updated later this afternoon and currently estimates Q1 GDP at 4.0%. The USD index opens in North America at 90.10 with 10-year US bond yields at 2.85%.

Since the beginning of 2018, USD/CAD has been largely contained in a range from the mid 1.22’s to 1.26, 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. In yesterday’s New York session, the pair rose briefly through the top of the range but the break lasted less than two hours and soon returned to the high 1.25’s.

Bank of Canada Senior Deputy Governor Carolyn Wilkins gave an interview to Reuters yesterday evening saying Canada’s high household debt is the biggest vulnerability facing the economy, while uncertainty about NAFTA is weighing on the outlook. “Every household is going to find it more or less difficult, so some households might find it extremely difficult, others will just need to tighten their belt a bit, but overall as you can see from our projection, we expect the economy to continue to grow, we expect consumption to continue to grow. I think we are being very clear that the biggest vulnerability to the Canadian economy is coming from high household indebtedness.” Wilkins declined to give “a running commentary” on recent economic data, but said that although GDP growth in the fourth quarter got off to “not the strongest start,” the latest data remained in line with forecasts.

Ahead of the employment report today, where consensus is looking for only a 10k rise after a 78k gain in December, the Canadian Dollar opens in North America at USD/CAD1.2600, AUD/CAD0.9820 and GBP/CAD1.7455.

We noted here yesterday that there were some tentative signs that investors might have been lightening up their positions in what had been one of the most crowded trades in the investment universe: long EUR/USD. On Wednesday lunchtime in North America, the pair fell on to a 1.22 handle for the first time in two weeks and – remarkably, given the volatility elsewhere – it has stayed on the same big figure for every single minute since then.

The strength in the Eurozone economy is no longer being driven just by Germany. French industrial production rose by 0.5% m/m in December, well ahead of consensus forecasts. The growth in December industrial production was led by higher production in areas such as metallurgy, software and electronics goods. The national statistics agency INSEE also said that manufacturing output advanced by 0.3% in December. Official data at the end of last month showed that the French economy had grown 1.9% over 2017 - its strongest performance since 2011. Official readings of business and consumer confidence have scaled multi-year peaks since the election of President Emmanuel Macron last May on the back of an agenda to reform the economy and help businesses.

Whether the euro can maintain its incredible stability until the close of business remains to be seen, though a thousand points off the Dow Thursday and a three-hundred point rally in futures this morning have hardly moved it at all. The EUR opens in North America this morning at USD1.2245 and EUR/CAD1.5440.

We warned yesterday to watch out for a choppy day for the pound, not least because there was such a split of expectations on the timing of the next Bank Rate hike that there were bound to be analysts, investors and institutions forced to reassess their own forecasts. In his appearance before a House of Lords Select Committee last week, BoE Governor Carney had hinted that the Bank was preparing to upgrade the forecasts in its Inflation Report and this is exactly what happened; albeit the language was more aggressive than had been expected. GBP/USD surged more than 1½ cents from just below 1.39 to a high just over 1.4050. So far, so easy to explain…. Within the space of four hours, however, as the carnage continued in US asset markets, GBP/USD had reversed all its gains, coming back to its launching point with the precision of a Falcon-Heavy booster. GBP was still the best performer of the day although its 200+ pip gains against both the AUD and NZD were more than halved. This morning in London, GBP has given back early gains after the BoE Deputy Governor appeared to downplay the scale and impact of prospective interest rate hikes.

Speaking about stock market volatility, Dr Ben Broadbent said, “Equity markets go up and down, you have a correction of this size roughly every 18 months on average, so it’s not terrifically unusual....If you’re suggesting that this is somehow parallel to what happened in 2007, then I would say no. I think there are some very big differences and as I pointed out, the equity markets, particularly in the US, have risen a lot over the last 12 months and indeed, even today, we are roughly back where we were a couple of months ago”. On interest rates, he did not think a couple of interest rate hikes in the space of a year should come as a great shock, but added that the central bank had not fixed any path for tightening policy. Asked if he would distance himself from a media report that interest rates are likely to double from 0.5 percent by the end of 2018, Broadbent said: “I don’t know... We do not fix the path of interest rates in advance. What is fixed is our remit and rates change with the economy.”

As we approach the weekend, investor thoughts in the UK will likely turn away from interest rates and stock markets and back on to the in-fighting within the Government over its Brexit strategy, the status of Northern Ireland within a future customs union, and on the future leadership of Prime Minister Theresa May. The British Pound opens this morning in North America at USD1.3840, GBP/AUD1.7775 and GBP/CAD1.7450.

The Australian Dollar continued to fall on Thursday as commodity prices moved lower and volatility remained elevated across asset classes. Gold has now fallen $50 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 on a US 77 cents ‘big figure’ for the first time since late December.

In his speech 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.”

Overnight the RBA released its latest Quarterly Statement of Monetary Policy; a 68-page document summarizing the current state and future outlook for the Australian economy. Essentially, there is hardly any change from the November view though the one-year forecast for unemployment has been revised down 0.25% to 5.25%. The main phrase for interest rate and currency markets was that, “Over the course of 2017, the unemployment rate declined and inflation increased a little. The accommodative setting of monetary policy has played a role here. Further progress on both fronts is expected over the next couple of years. It will be some time, however, before the economy reaches current estimates of full employment and inflation returns to the mid-point of the target”. It is interesting to see the RBA is now stressing the ‘mid-point’ of the inflation target and it is this which has prompted ANZ Bank to change its interest rate forecasts. It was previously looking for 2 hikes this year but now sees the RBA on hold throughout 2018. The Australian Dollar starts in North America this morning at USD0.7785, with AUD/NZD at 1.0780 and AUD/CAD0.9820.

The New Zealand Dollar has not been immune to the volatility seen across all assets and geographies. It was falling even before Thursday morning’s RBNZ interest rate announcement and then proceeded to fall even further as investors reflected on the contents of the Statement and the subsequent Press Conference. AUD/USD rose all the way from the mid 1.07’s to just under 1.09 whilst NZD/USD dropped on to a US 71 cents big figure for the first time in 3 weeks. By the end of the day in Europe, however, AUD/NZD had reversed all its gains and was back on a 1.07 handle and NZD/USD was back on 72 cents which, after a very quiet morning in Europe, is where the Kiwi Dollar opens in North America today.

New Zealand house prices surged for the third month in a row in January, with the commercial centre of Auckland posting its fastest growth in more than a year, the government property valuer said on Friday. Quotable Value’s (QV) residential property price index rose 6.4 percent in the year to January, compared with an annual rate of 6.6 percent in the previous month. Values in the commercial centre of Auckland rose 0.7 percent and have jumped 1.6 percent in the past three months, the highest rate of growth since November 2016. QV said, “The easing of the LVR (loan to value ratio) restrictions for both investors and home buyers this month, along with continued strong net migration, low interest rates, and a shortage of housing supply means it’s likely we can expect moderate value growth to continue during February and March which are annually the busiest months in the housing market”.

The RBNZ’s formal comment on the currency in its monetary policy Statement was, “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.” Speaking to reporters at the Press Conference, Governor Grant Spencer said on Thursday that the bank was not concerned about the New Zealand dollar, "We're comfortable with where it is," adding that the NZD strength was largely on the back of weakness in the US Dollar. The New Zealand Dollar opens this morning in North America at USD0.7220 and NZD/CAD0.9110.