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USD index hits a fresh 3-year low as stock markets have biggest one-week rise since December 2011. Higher bond yields offer USD no support as sentiment turns increasingly negative.

By Nick Parsons

The US Dollar had a very poor week with its index against a basket of currencies falling below 88 for the first time in a little over 3-years. Its fall came as equity markets enjoyed their biggest one-week gain since December 2011 and despite the yield on US 10-year Treasury bonds hitting a 4-year high of 2.91%. Analysts have been falling over themselves to advance new reasons for the USD decline, in some cases citing the very factors which caused them to be bullish in early 2017. Thus, the strength of the US economy we are now told is a bad thing because it will suck in imports whilst the rise in bond yields is due to deficit-financing which will leave the US at the mercy of foreign investors. Never underestimate the ability of analysts to fit a narrative around the prevailing price action!

After the surprise in average hourly earnings two weeks ago which triggered the sharp drop in US equity markets, investors were understandably worried about the latest CPI data, even though the Fed (unlike the RBA, RBNZ or BoE) doesn’t have a CPI target in its mandate. January CPI figures came in higher than consensus expectations which were for a m/m gain of +0.3% which would have taken the annual rate down from 2.1% to 1.9%. Instead, CPI rose 0.5% m/m and the annual rate was unchanged at 2.1%. The so-called ‘core’ rate of inflation which excludes food & energy prices and is seen as a better measure of underlying inflation trends, was one-tenth higher than expected at +0.3% m/m (the biggest monthly increase since last January) which lifted the annual rate from 1.7% to 1.8%. Indeed, the actual unrounded figure for core inflation was just 1/1000th of a point from being rounded up to 0.4% m/m. Immediately after the data release, the DJIA fell 460 points and the USD strengthened against all the currencies we follow here. Within 2 hours, however, the stock market was back in positive territory on the day and the USD had a stunning turnaround; losing almost a full point by the time European traders headed for home and hitting the lowest level in 10 days.

With stock markets recovering, a 25bp rate hike at the March FOMC meeting is now priced with greater certainty than at any point this year. Three weeks ago, with the stock market at a record high, the market-derived probability of a hike was 76%. Today, it is at 83%. Indeed, Fed funds futures put the probability of the Fed raising rates four times this year at 25 percent versus just 17 percent immediately before the US CPI release. None of this helped the US Dollar this week, however, and though Friday saw a half-point gain for the USD index, sentiment and price action remain very negative. Next week we will see whether the release of the FOMC Minutes and another round of Fed speakers do anything to reverse investor psychology.

The Canadian Dollar began the week around USD/CAD1.2595 and having traded in a high-low range of almost two cents, the pair ended the week a net half a cent lower (stronger CAD). Investors are grappling with the implications of higher US inflation and interest rates at the same time as US government debt is soaring and the current account deficit is widening. Throw in uncertainty around NAFTA and an oil price which has fallen more than 10% over the past couple of weeks and it’s easy to see why the USD/CAD has been so choppy.

Local media reported that according to Canada's chief negotiator Steve Verheul, the ongoing effort to rescue and revamp NAFTA has made only limited progress because US officials at the table find themselves hamstrung by the demands of the Trump White House and the talks are taking place too quickly. Verheul described the current NAFTA talks as the most unusual negotiation he's ever been involved in. "This is being driven to a large extent from the top, from the administration, and there's not a lot of flexibility," the veteran negotiator told the Canadian Global Affairs Institute. Canada will stay at the negotiating table for as long as it takes, Verheul said, but it's impossible to predict the next move of a notoriously unpredictable president. Even though three chapters have been closed, the pace has amounted to "fairly limited progress overall because there hasn't been enough time between rounds to re-evaluate positions… The pace has been a bit too fast to do a lot of the kind of homework that needs to be done domestically to allow further progress to be made." The seventh round of NAFTA talks is set to begin later this month in Mexico City.

There were no major economic statistics published in Canada this week, but there was a very interesting speech from Bank of Canada Deputy Governor Lawrence Schembri in which he reviewed the success of Canada’s inflation targeting monetary policy regime. Whilst winning no prizes for humility, he noted, “Three main factors have contributed to the framework’s credibility and success. First, we have a clear, simple and well-understood inflation target, whose focal point is 2 per cent. Second, the framework has political legitimacy, is coherent with other public policies and is implemented with effective tools. And third, we have a formal review process for continually improving the framework that is widely admired by many of our peers and was cited as one of the factors that earned us the Central Bank of the Year Award we received recently”. The Canadian Dollar ended the week at USD/CAD1.2555, AUD/CAD0.9935 and GBP/CAD1.7625.

The euro had a good week, keeping pace almost tick-for-tick with the GBP to end the week with EUR/USD almost 2 cents above Monday’s opening level. With German politics fading as a concern for investors and sentiment towards the USD uniformly negative, incoming economic data in the Eurozone continued to support the Single Currency.

Figures released from Eurostat on Wednesday confirmed the January 30th preliminary estimate that GDP in the Eurozone rose 0.6% in Q4 last year. Growth slowed a little in Germany and Italy, while the pace of expansion accelerated in the Netherlands and Portugal. Germany’s upswing - despite a slowdown in quarterly output - continues to be a key ingredient for growth in the euro area. Momentum at the end of last year was driven by a strong increase in exports, according to a national report. Government consumption and equipment investment increased, while private spending remained largely unchanged and construction slipped. The Dutch economy also benefited from buoyant global trade. GDP increased 0.8% in the fourth quarter, exceeding consensus estimates. Italian growth slowed to 0.3%, leaving it lagging behind France and Germany and providing a note of caution ahead of general elections next month while GDP increased 0.7% in Portugal.

As analysts raised the spectre of ‘twin deficits’ in the United States as a reason to be bearish the US Dollar, the timing of the latest EU trade figures was especially propitious for the EUR. The Eurozone aggregate surplus rose to €23.8bn in December from a revised €22.0bn in November, above the consensus, €22.3bn and continuing a run which has seen the 3-month average (a better guide to trend than m/m numbers) in surplus for the entire period since 2012. Moreover, a detailed look at the figures showed the EU had a trade surplus with the United States of 120.8bn euros ($150.9bn) in 2017, up from 113.1bn in 2016. Exports from the EU to the US increased to 375bn in 2017 from 363.5bn euros the year prior, while imports from the US grew to 254.2bn from 250.4bn in 2016. EUR/USD hit a best level on Friday morning of 1.2550 – its highest in more than 3 years - before ending the week at USD1.2415, AUD/EUR0.6370 and NZD/EUR0.5950.

The GBP had a very good week despite the softness of economic activity data. It began on Monday around USD1.3820 and moved higher on Tuesday after CPI figures showed the UK inflation rate stuck at 3.0% rather than falling to 2.9% in line with consensus expectations. The Office for National Statistics noted that, “The largest downward contribution to change in the rate came from prices for motor fuels, which rose by less than they did a year ago. The main upward effect came from prices for a range of recreational and cultural goods and services, in particular, admissions to attractions such as zoos and gardens, for which prices fell by less than they did a year ago.” It’s not often that the cost of looking at giraffes and penguins moves international foreign exchange markets, but the GBP got a lift from the fact that inflation didn’t fall as had been anticipated.

From a high on Wednesday morning of USD1.3920, the pound tumbled to 1.3830 after stronger than expected US CPI figures. Within ninety minutes, however, it had more than reversed all its losses to close just under 1.40. On Thursday and Friday, it extended these gains to a 2-week high just below 1.4140. Then came news that UK retail sales grew just 0.1% m/m in January, well below consensus expectations of a +0.6% m/m increase. It always used to be the case that December and January were best viewed together to see the impact of discounting in the annual New Year sales. In the internet age, with the advent of Black Friday promotions in November, it is probably wiser to take the three months together as a whole. Unfortunately, the total growth in sales volumes over this period was just +0.1% with the annual growth rate at just 1.6%. With earnings growing below inflation and a recent rise in mortgage rates after November’s BoE rate hike, UK retail sales will likely be very subdued throughout the first quarter of 2018.

A fascinating report on the UK housing market was published on Friday by the Institute for Fiscal Studies. It shows how huge increase in house prices above income growth has severely limited the ability of the younger generation buy their own home. For 25- to 34-year-olds earning between £22,200 and £30,600 per year, home ownership fell to just 27% in 2016 from 65% two decades ago. Over the past 20 years, average house prices have grown about seven times faster than the average incomes of young adults, according to the IFS study. Overall owner occupation rates in Britain have been steadily declining since 2003, when the proportion of people owning their home reached its peak of 71%, and has now fallen to just 61%. The pound ended a turbulent week at USD1.4035, GBP/AUD1.7750 and GBP/NZD1.8990.

The US stock market was much calmer this past week – with daily high-low ranges not exceeding 500 points! There were, however, still days such as Wednesday when the Dow Jones Industrial Average had violent swings and reversals and the cumulative intra-day moves (irrespective of sign) totaled much greater than this. Overall, however, after its biggest weekly loss since August 2015, the stock market had its best weekly gain since December 2011. With the US Dollar hitting a fresh 3-year low against a basket of major currencies, AUD/USD ended the week more than a cent higher, having at one point on Friday morning reached a 2-week best of 0.7985.

The NAB monthly business survey was released on Tuesday. The business conditions index jumped 6pts to a strong +19 index points, which is well above the long-run average of +5 index points. The business confidence index also rose by 2pts to +12 index points, its highest level since April 2017. Business conditions were solid to strong across all major industry groups with the exception of retail. Wednesday’s Westpac survey of consumer confidence fell by 2.3% to 102.7 in February from 105.1 in January. The bank noted, “The survey was conducted over the week of February 5-11. That week was marked by a wave of volatility in global share markets. The Australian market, which was more stable than most, still experienced some significant swings, being down a net 4.6% for the week while the US market (S&P 500) was down by a net 7.2%... Extensive media coverage of these developments would have unnerved respondents on two fronts – the impact on their own financial position and concerns for general global stability. These concerns appear to have been acutely felt by retirees whose confidence fell by 13.5%”.

The latest Labour Force figures were released Thursday. Employment increased 16,000 to 12,453,500. Full-time employment decreased 49,800 to 8,460,900 and part-time employment increased 65,900 to 3,992,600. Since January 2017, full-time employment has increased by 293,200 persons, while part- time employment has increased by 110,100 persons. Seasonally adjusted monthly hours worked in all jobs decreased by 24.1 million hours (or 1.4%) between December 2017 and January 2018 to 1,708.2 million hours. This follows a decrease of 8.6 million hours (or 0.5%) from November to December 2017, and four consecutive increases up to November. The average number of hours worked per employee per week fell to a new record low of 31.7. Employees are on average working 2.7% fewer hours than a year ago and that will limit the boost to household incomes from rising employment. CBA have changed their interest rate forecasts to remove the two hikes they previously had penciled- in for 2018, though at the other end of the spectrum, NAB still has two 25bp hikes in its forecast profile for H2 2018. The AUD ended the week just over a cent higher at USD0.7910, with AUD/NZD at 1.0705 and GBP/AUD1.7750.

The New Zealand Dollar began the week around USD0.7250 and moved steadily higher, interrupted only by a sharp drop and equally sharp reversal higher on Wednesday after the release of the US CPI figures. By Friday morning, the pair touched a fresh 2018 high of 0.7434 before slipping back to close more than a cent higher at 0.7390. Against its Aussie cousin, the NZD reached a 6-month high with the AUD/NZD cross falling to 1.0705; its weakest since August 5th.

In politics, New Zealand's opposition leader and former prime minister Bill English announced he was quitting after losing last year's election. Mr English, a long-serving finance minister who took over as prime minister in late 2016 after the resignation of John Key, led the National party to win the biggest share of seats in parliament in last year’s September election but was then unable to form a government. His statement said, “Now is the right time for me to step aside and embark on new professional and personal challenges. I informed the National caucus this morning that I am resigning as leader of the National party… I believe this will give National’s new leader time to prepare the party for the 2020 election.” In economic news, The RBNZ's March quarter survey showed firms lifted their two-year inflation expectations to 2.11% from 2.02 % in the prior period, while one-year inflation expectations remained steady at 1.86%. New figures on house sales from the Real Estate Institute of New Zealand showed sales volumes nationally rose when compared to the same time last year for the first time in 19 months.

New Zealand's manufacturing PMI report rose 4.5 to 55.6 after a big drop in December and hasn’t yet returned to levels of expansion typically seen during 2017. The report noted, "The proportion of positive comments in January (50.7%) was down by a fair margin compared with December (63.3%) and November (65.1%), although all five of the sub-indices lifted with production up 1.4 points to 54.9, employment up 1 point to 52.5, new orders up 5.9 points to 55.6, finished stocks up 1 point to 53.1 and deliveries up 5.5 points to 55.3.” By Friday’s New York close, the NZD ended the week at USD0.7390 and AUD/NZD1.0705.