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FOMC expected to hike rates 25bp on Wednesday. USD firm as stocks fall but GBP is top performer on hopes for UK-EU Brexit deal

By Nick Parsons

The US Dollar fell for 2 ½ days, rallied for 2 ½ days and ended a week of high political drama with its index against a basket of major currencies almost exactly unchanged at 89.75. Overnight in Asia and this morning in Europe, the USD initially pushed ahead a couple of tenths to 89.95 but a rally in the GBP and a recovery for the EUR have subsequently seen its early gains erased. Somewhat weaker stock markets globally are offering some support to the USD in a classic ‘risk-off’ reaction function; with the main indices in Europe and the UK more than 1% lower in early trading.

Perhaps the only thing we can say for certain is that nothing is certain any more. As we look at calendars, diaries and schedules and try to pick out the highlights for financial markets, they can be quickly overtaken by events or one short Tweet from President Trump. The economic and political agenda is now more fluid and rapidly changing; something which itself will lead to an increase in volatility across asset classes. With this caveat in mind, the week’s main event that we thus far know of is the two-day FOMC meeting beginning on Tuesday. A new Statement, dot-points and economic projections will be available at 2pm Eastern Time on Wednesday and markets are pricing a 94.4% probability of a 25bp hike in rates; the sixth time rates have been raised since December 2015. Half an hour afterwards will be Jerome Powell’s first post-FOMC Press Conference, and he’s sure to be grilled on his views on inflation, growth, tariffs and trade.

It’s not a busy week in terms of the regular flow of incoming economic data and until Wednesday’s existing home sales numbers the calendar is pretty much empty. After last week’s news on residential construction and industrial production, the Atlanta Fed yet again revised down its so-called ‘Nowcast’ estimate for Q1 GDP, this time nudging it down to 1.8%; the lowest it has been at any point this quarter and significantly down from the peak estimate of 5.4% back in early February. The USD index opens this morning in North America around 89.65.

The Canadian Dollar had a very poor time last week, the worst performer amongst the six major currencies we follow closely here. After Tuesday’s speech from Bank of Canada Governor Stephen Poloz, USD/CAD jumped more than a full cent to 1.2970 and after a very soft set of housing numbers on Thursday and more talk of US tariffs, it broke 1.30 for the first time since June last year to register its biggest weekly gain since May 2016. GBP/CAD hit 1.82; its best level since the EU referendum 20 months ago whilst AUD/CAD and NZD/CAD both registered 9-month highs.

In its latest report on Canada, credit ratings agency Moody’s warns that while the end of NAFTA would be worse for Canada than for the US, the impact on Canada's overall economy would be "marginal" - although there would be winners and losers in terms of different industries and regions of each country. “Sector- and company-level impacts would vary, as certain industries would have to adjust to higher barriers to trade." It identified New Brunswick and Ontario as having the highest exposure in terms of trade with NAFTA partners based on their output and export mix and said that of all the provinces, New Brunswick's exports to the US account for the largest share of its gross domestic product — nearly 30 per cent overall — with "significant exposure to higher-risk" food, agricultural commodities and forestry sectors. Meantime, Ontario exports more to the U.S. than any other province, largely because of its significant exposure to the manufacturing industry, including the auto sector.

Most of the important Canadian events come at the end of this week. On Thursday afternoon Senior Deputy Governor Carolyn Wilkins is scheduled to speak whilst on Friday we have retail sales and CPI numbers; a good chance to see just how much room Mr Poloz has to let the economy run a little hotter without tightening monetary policy. The Canadian Dollar opens in North America at USD/CAD1.3080, AUD/CAD1.0175 and GBP/CAD1.8265.

The EUR ended last week marginally lower against the USD, having followed the pattern of all the major currencies by rallying for the first half but then falling persistently through Thursday and Friday. From its best level on Wednesday of 1.2410, EUR/USD fell almost three-quarters of a cent on Thursday and on Friday afternoon it hit an 8-day low of 1.2260 before then rallying around 30 pips into the New York close. Overnight in Asia and this morning in Europe, the EUR has again tested Friday’s lows but has subsequently rallied around a quarter of a cent into the high-1.22’s.

With trade figures very much in the spotlight recently, Eurostat this morning announced that in January 2018 compared with December 2017, as seasonally adjusted exports decreased by 0.7%, while imports increased by 1.1%. The seasonally adjusted balance was +€19.9bn, a fall compared with December (+€23.2bn) and lower than most observers had been expecting. The EU’s trade surplus with the United States widened to €10.3bn from €9.7bn in the same month a year ago. President Trump has long been critical of this surplus and it will be interesting to see if his new economic team specifically call this out.

With a still very subdued inflation backdrop, the main data for the week ahead will be survey-based. On Tuesday we have Germany’s ZEW survey of investor expectations, and on Thursday it’s the ifo Survey which has recently been incredibly upbeat in its numbers and commentary. Sandwiched between these are the so-called ‘flash PMI’s’ for manufacturing and service sector activity in France, Germany and the Eurozone. The ECB will publish its monthly Economic Bulletin on Thursday; something to which markets never used to pay attention but will which now be pored over for any signals hinting at a shift in monetary policy settings. The EUR opens in North America today at USD1.2285 and EUR/CAD1.6075.

The British Pound had a good week, finishing up against a generally well-bid US Dollar and gaining against every one of the major currencies we follow here. After hitting a best level of USD1.3995, the GBP finished only half a cent down from the week’s high and almost a cent up from Monday’s opening level. GBP/AUD hit 1.80 for the first time since June last year, whilst GBP/CAD hit a fresh post-referendum high of 1.8290. Overnight in Asia and this morning in Europe, the pound has extended its gains and sits at the top of our one-day performance table. GBP/USD is back at 1.40 for the first time since February 26th whilst GBP/CAD is up another half a cent to 1.8340.

For the week ahead, two main events look set to dominate financial markets. After its none-too-subtle warnings of a rate hike in May, the voting patterns at Thursday’s Bank of England MPC meeting will be scrutinized for further hints on signaling. Also beginning on Thursday is a two-day EU Summit in Brussels. The European Council is expected to officially sign off an agreement effectively extending Britain’s membership of the EU’s single market and customs union until December 31, 2020. Though there are still plenty of threats coming from both the UK and EU about what would happen in the event of no deal being agreed, many of the differences which existed over the terms of the transition period have been removed by the UK agreeing to all the demands made from Brussels on freedom of movement and citizens’ rights.

As we write this commentary, Britain’s Brexit secretary David David is meeting with chief EU negotiator Michel Barnier and there are rumours that the two men will announce that the ‘broad’ terms of a transition deal have been agreed. They are due to hold a press conference at around 12.45pm Brussels time. The British Pound opens in North America at USD1.4015, GBP/EUR1.1415 and GBP/CAD1.8350.

The Australian Dollar rose for three days of last week then fell for the final two with a net loss from the previous Friday’s close around 1 ¼ cents. After a high for the AUD/USD exchange rate of 0.7910, however, the AUD managed to stay on a US 79 cents ‘big figure’ for less than two hours and by Thursday afternoon in New York it was trading on a 77 handle. Its closing level on Friday just above 0.7710 was the lowest since Christmas and this morning in Asia it is in the high-76’s for the first time since December 21st.

After the mixed messages from surveys of business activity and the GDP report – explained in part, by the different time periods which they covered – investors will now be focusing solely on Q1 data. The most important of those this week will be the February labour market report on Thursday. Last time around, there was a 16k increase in employment comprised of a 50k drop in full-time employment and a 66k increase in part-time work. The unemployment rate fell one-tenth to 5.5%. For the February numbers, consensus estimates are for a 20k increase in employment which just about keeps pace with demographic change to leave the jobless rate steady at 5.5%. Sadly, we don’t get monthly wage price data from the official statisticians so we’ll get only a partial answer to the question of how household expenditure is likely to be holding up.

Before the labour report, on Tuesday we’ll get to see the Minutes from the latest RBA Board meeting. There’s unlikely to be any great surprise here, as the key message from the Central Bank recently has been one of steady and gradual improvement towards its goals on inflation and economic growth. The currency won’t have been causing any problems, there are no imminent financial stability risks from the housing market and though trade tensions globally are on the rise, Australia is not one of the countries most threatened by them. The Australian Dollar opens in North America this morning at USD0.7695, with AUD/NZD at 1.0675 and AUD/CAD1.0080.

The New Zealand Dollar had very similar price action to its Aussie cousin last week, though its peak on Wednesday came somewhat earlier during the day and the sell-off against the US Dollar on Friday was less marked; allowing the AUD/NZD cross to trade down on to a 1.06 ‘big’ figure by the New York close. Indeed, whilst AUD/USD fell to its lowest since Christmas, NZD/USD only eased back to the lowest in 10 days, closing in New York around 0.7215; around 1 ¼ cents below its midweek peak. This morning in Europe, the Kiwi has struggled to hold on to US 72 cents and a break through technical support around 0.7190 could open the way for a return to the 2018 low at 0.7080.

In economic data released this morning, New Zealand's Performance of Services Index experienced a slight slip in expansion levels during February with a 0.7 point drop to 55.0; but still just above its long-term average of 54.4. The fourth quarter GDP numbers out last week showed the service sector grew around 1.1% but on the evidence of the first two months of 2018, it seems the pace of expansion in Q1 may be somewhat slower. Indeed, local experts BNZ who co-produce the PSI have a preliminary estimate of 0.6% penciled-in for GDP.

On Thursday this week (Wednesday afternoon NY time), the RBNZ Board meeting will be the last under the interim leadership of Grant Spencer. Incoming Governor Adrian Orr takes up his post on March 27th and the big focus of attention will be the new Policy Targets Agreement. In an interview last week, Finance Minister Grant Robertson said, “I understand the limits of monetary policy, so we want [the Reserve Bank] to be considering maximizing employment but, unlike a particular inflation target, we would not be seeking a particular employment target through monetary policy.” The current PTA between the Government and Central Bank outlines the RBNZ’s commitment to keep inflation between 1% and 3% on average over the medium term, with a focus on keeping future average inflation near a 2% target midpoint. The 2% target was added when Graeme Wheeler took over in 2012; mainly to signal a symmetry of tolerance around a mid-point but also to underscore that a number persistently just under 3% would not be a desired outcome. Before the RBNZ meeting, on Tuesday we get Westpac’s consumer confidence report and Wednesday brings the net migration numbers. The Kiwi Dollar opens in North America at USD0.7205 and NZD/CAD0.9445.