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USD ends the week on a high, GBP slumps, EUR dragged lower, NZD was the week’s worst whilst the AUD was torn between higher commodity prices and a weak labor report

By Nick Parsons

The US Dollar ultimately had a very good week, finishing top of the major currency league table. It wasn’t a linear performance, however. Its index against a basket of major currencies opened on Monday at 89.35 and dipped as low as 88.80 by Tuesday morning in Europe. From then on, a combination of soft economic data in the UK and Eurozone and much higher US bond yields pushed the USD index up to a two-week high of 90.0 before closing in New York on Friday at 89.90.

In a week of very little US economic data, the Federal Reserve’s Beige Book on Wednesday drew a lot of attention. This reported that activity remained at “a modest to moderate pace” in March and early April, the same rate as earlier in the year. Overall wage growth was said to be modest, and price gains seen as moderate. Wage pressures “did not escalate,” although labour markets were seen as tight, with continued reports of shortages for high-skilled workers. Contacts in nine of the dozen Fed regional banks expressed concerns about trade tariffs — with 36 mentions of the word in the report, whilst business owners were upset with the price rises for metals in the wake of the Trump administration’s decision to place penalties on steel and aluminum imports.

On Thursday, the Philadelphia Fed Business Survey rose very slightly from 22.3 to 23.2 though the details were much less rosy with the new-orders index tumbling by 17 points to 18.4 while the workweek jumped by 8.8 points. Given the recent focus on inflation and what it might mean for the Fed, the prices sub-indices made interesting reading for interest rate bulls. “Price increases for purchased inputs were reported by 59 percent of the manufacturers this month, up notably from 44 percent in March. The prices paid diffusion index increased 14 points to its highest reading since March 2011. The current prices received index, reflecting the manufacturers’ own prices, increased 9 points to a reading of 29.8, its highest reading since May 2008.” The USD index ended the week around 89.90.

The Canadian Dollar started the week pretty well ahead of the Bank of Canada Meeting but finished it on a downbeat note after softer than expected economic data on Friday. Overall it gained against the GBP and NZD, was little changed against the AUD but lost out to the EUR and US Dollar. It opened the week with USD/CAD at 1.2605 and moved to a low of 1.2535 on Tuesday; its lowest level (CAD stronger) since mid-February. Unchanged interest rates from the Bank of Canada on Wednesday lifted the pair to 1.2650 and after soft local data in a strong USD environment on Friday, USD/CAD ended the week up at 1.2765.

As expected by the vast majority of analysts, the Bank of Canada left its overnight target rate of interest unchanged at 1.25%. Its Statement noted that, “interest rates remain very low relative to historical experience. This is because the economy is not yet able to remain at full capacity on its own. Furthermore, the sustainability of this level of activity is not assured; although we expected the economy to moderate in the second half of 2017, that moderation has extended into early 2018 and has been more pronounced than expected.” Blaming this on two exceptional factors – changes in mortgage rules and transport bottlenecks – the BoC said, “Accordingly, we expect a strong rebound in the second quarter after a lacklustre first quarter, with an average growth rate of about 2 per cent in the first half of the year and a return to near-potential growth thereafter. Fiscal stimulus, both provincial and federal, is playing a role in this forecast. We will be monitoring the data for the second quarter very closely in the weeks ahead.”

In terms of forward guidance, and though Governor Poloz personally doesn’t like the concept, the Statement went on to say that, “Assuming our forecast remains on track, it is Governing Council’s view that interest rates will need to move higher over time to keep inflation on target… Most of our deliberations, therefore, concerned the appropriate pace of interest rate increases. As we have said repeatedly in the past, this is an intensely data-dependent process of risk management.” Weighing up the risks around capacity constraints, inflation dynamics, wages and the sensitivity of the economy to interest rates given the high level of household debt, The BoC concluded that, “higher interest rates will be warranted over time… but the Governing Council will remain cautious with respect to future policy adjustments, guided by incoming data.” Friday’s incoming data was softer than consensus expectations. Core retail sales were unchanged in March against forecasts of a +0.3% increase whilst headline inflation edged up only to 2.3% versus the 2.4% which had been expected. The Canadian Dollar ended the week at USD/CAD1.2765, AUD/CAD0.9790 and GBP/CAD1.7870.

The EUR had a mixed week, falling against a quite buoyant US Dollar but up against all the other major currencies to take silver medal spot on the league table. It opened on Monday around 1.2330 and reached a high on Tuesday just above 1.2410; its first time back on a 1.24 ‘big figure’ since March 28th. It slipped on Wednesday after lower CPI figures, fell further after the Fed Beige Book then tumbled on Friday after comments from ECB President Draghi sent EUR/USD down to a low of 1.2265; its weakest since Monday April 9th.

On Tuesday, the ZEW Indicator of Economic Sentiment for Germany once again fell sharply, dropping by 13.3 points compared to March and a huge 26.0 points when compared to February. The April indicator stands at minus 8.2 points, falling far below the long-term average of 23.5 points. The assessment of the current economic situation in Germany decreased by 2.8 points, with the corresponding indicator currently standing at 87.9 points. Commenting on their survey, the ZEW said, “The reasons for this downturn in expectations can mainly be found in the international trade conflict with the United States and the current situation in the Syrian war. The significant decline in production, exports and retail sales in Germany in the first quarter of 2018 is also having a negative effect on the future economic development.” On Wednesday, final Eurozone CPI figures showed inflation one-tenth below what had been expected at the time of the ‘flash estimate’ back on April 4th. The statisticians estimated CPI would be at an annual pace of 1.4% in March but the final number showed a rate of just 1.3%.

On Friday, President Mario Draghi acknowledged the region’s slowdown on Friday in a statement at the International Monetary Fund meetings in Washington, but maintained his optimism that the expansion will continue. “Notwithstanding the latest economic indicators, which suggest that the growth cycle may have peaked, the growth momentum is expected to continue.” A Bloomberg story citing anonymous ECB officials said, “European Central Bank policy makers see scope to wait until their July meeting to announce how they’ll end their bond-buying program, according to euro-area officials familiar with the matter… Governing Council members want sufficient time to judge if the economy is overcoming its first-quarter slowdown, the officials said, asking not to be identified because the internal deliberations are confidential. That could mean the June meeting, which would have the advantage of linking the decision to updated economic forecasts, might be too soon.” The euro ended the week at USD1.2290, AUD/EUR0.6245 and NZD/EUR0.5865.

The British Pound had a very disappointing week, kept off bottom spot in our league table only by the New Zealand Dollar. It began at USD1.4240 and after a weekend of Press comment that average earnings figures would hit 3%, raced up to a high on Tuesday morning of 1.4375; its best level since the EU referendum back in June 2016. Soft wage numbers, an even softer CPI report on Wednesday and a TV interview from BoE Governor Carney casting doubt on a May rate hike all served to knock the pound lower and it ended the week down at 1.3995; its first time in a fortnight below 1.40.

Average earnings growth did, indeed, exceed inflation but the 2.8% y/y increase in February was only one-tenth above the 2.7% rise in the CPI and was much lower than Press reports had suggested. The good news is that pay is now growing at its fastest pace since August 2015 but the end of a squeeze on real living standards is still a very different thing to a noticeable and sustained improvement in purchasing power. And, with increases in mandatory pension contributions for many people effective in April, the benefit of higher headline wages will not be matched in take-home pay. On Wednesday, UK inflation figures came in not just lower than consensus expectations, but lower than the whole range covered by most professional forecasters. Prices rose just 0.1% in March to take the annual rate of inflation down from 2.7% to 2.5% against expectations that it would be unchanged at 2.7%. This means that CPI inflation is at its lowest in a year and March’s fall in the annual rate is the 2nd consecutive month in which the annual rate has fallen; we haven’t seen that since August-September 2015.

The question for markets was whether the soft run of economic activity data in the first quarter of the year, coupled with a sharp fall in the rate of inflation, would be sufficient to deter the Bank of England from raising interest rates at its May MPC meeting. For much of the day on Thursday, investors were still inclined to the view that it would not prevent a hike as this would be too great a loss of face for the Bank and its Governor, Mark Carney. Instead, Mr Carney gave an interview to the BBC news in which he bizarrely claimed that Brexit uncertainties might be a reason for holding off on a rate hike. He said there “will be some differences of view” at May’s Monetary Policy Committee meeting and that he is “conscious that there are other meetings over the course of this year." At the beginning of this week, markets were pricing a more than 80% probability of a 25bp interest rate increase at the Bank of England’s May MPC meeting. After Mr. Carney’s interview, this fell to just 50%; no better than the toss of a coin. The pound ended last week at USD1.3995, GBP/AUD1.8250 and GBP/NZD1.9455.

It was mixed week for the Aussie Dollar, which didn’t perform quite as poorly as a simple focus on the AUD/USD exchange rate might suggest. The pair opened on Monday around 0.7770 and traded essentially sideways in a relatively tight range until the close of business on Wednesday. On Thursday, it initially sold off to just below 0.7750 on a softer than expected labour market report but a surge in commodity prices then lifted it back on to 78 US cents for the first time in 6-days. By the end of the session in New York, however, it had suffered what technical analysts refer to as a “key day reversal” with a higher high, lower low and lower close than the previous day. Friday confirmed this reversal with a fall all the way to 0.7660. Despite this drop, the AUD ended the week up against the GBP and NZD, though down against the EUR and Canadian Dollar.

The RBA Board Minutes offered no great surprises. Certainly, there was no sense of urgency in changing monetary policy. “Forward-looking indicators suggested that spare capacity in the labour market would continue to decline gradually over 2018. Consequently, wages growth was expected to rise gradually from its current low rate. Low growth in labour costs in combination with strong competition in the retail sector suggested that inflation would remain low for some time before also picking up gradually as the economy and labour market strengthen.” The RBA noted, The RBA noted that, “The low level of interest rates had supported growth over 2017, which had reduced the unemployment rate and brought inflation closer to the target. Further progress on these goals was expected in the period ahead, but this progress was likely to be gradual. Over 2018, GDP growth was expected to exceed potential growth and CPI inflation was expected to increase gradually to be a little above 2 per cent. Members noted that an appreciation of the Australian dollar would be expected to result in a slower pick-up in economic activity and inflation than forecast.” Indeed, a full reading of the whole concluding section revealed the use of the word ‘gradual’ five times in just two paragraphs!

The March labour market report was quite a bit softer than had been expected. Total employment rose by just 4,900 against consensus expectations of a 21,000 increase. More disappointingly, February’s initially-reported 17,500 gain was revised to show a drop of 6,300 which brought to an end what had previously been a run of 17 consecutive monthly increases in employment. The main revisions came in full-time jobs which were now estimated to have gained only 20,100 in February, instead of the initial outsized jump of 64,900. March was even worse with full-time positions falling 19,900. The unemployment rate was steady at 5.5 percent, after a downward revision to February. It has hovered between 5.4 percent and 5.6 percent for 11 months now. On the Australian stock exchange, the ASX Metals & Mining index hit a three-month high last week, driven by sharply higher prices for industrial metals. Australia’s biggest export commodity, iron ore, was up 8.5% in just three days. Whether metals prices can sustain these gains in the face of a stronger USD remains to be seen. The AUD ended last week at USD0.7665, with AUD/NZD at 1.0640 and GBP/AUD1.8250.

The New Zealand Dollar had a very poor week, finishing down against every one of the major currencies we follow here. It was a story of persistent weakness rather than a single dramatic sell-off: for the first four days of this week it finished second from bottom, bottom, third-last and in second-last place on our one-day performance table. NZD/USD began the week around 0.7355 but at no point got higher than 0.7370 and by Friday’s close in New York it was struggling to hold on to a US 72 cents big figure. The AUD/NZD cross, meantime, rose from 1.0560 to a high of 1.0670 before ending around 1.0640.

The long-awaited Q1 CPI figures were finally released this week. In our preview, we noted BNZ had picked a 0.3% quarterly increase, ANZ had gone for +0.4% and Westpac +0.5%. The prize must go to Westpac who correctly forecast both the quarterly increase and the annual rate of 1.1%; down from 16% in the December quarter. Government-influenced price changes had the biggest impact on the numbers, with higher cigarette and tobacco prices being countered by cheaper tertiary education. The annual tobacco tax increase on 1 January 2018 lifted quarterly inflation, with prices up 10 percent. The average price for packet of 25 cigarettes was $35.14 in March, compared with $31.68 in December. Prices for tertiary education fell 16 percent in the March 2018 quarter. This is the first time this series has fallen since 2003; it was due to the introduction of the Government's fee-free first year policy. The policy applies for all New Zealand secondary students finishing school from 2017 onwards, and adults who previously studied for less than half a full-time year of tertiary education or industry training.

Elsewhere in the comprehensive inflation numbers, higher prices for accommodation services and petrol also contributed to the quarterly CPI rise, but they were slightly offset by seasonal falls for international airfares whilst housing and household utility prices increased 3.1 percent in the March 2018 year, led by construction and rents. Inflation in New Zealand is now close to the bottom of the RBNZ’s 1-3% target range though the Central Bank will probably take some comfort from the fact that tradable prices — those largely determined by offshore factors — fell 0.4% over the year, helping to offset a 2.3% increase in non-tradable prices over the same period. Speaking on NZ radio, RBNZ Governor Adrian Orr said he expected, “very benign inflation going forward without doubt, as we’ve forecast”. He added that “what really matters is the confidence and expectation and belief that we are aiming for that midpoint of 2 percent all of the time.” And he pledged that “we are doggedly determined to aim for two percent, but the accuracy around…that is very limited.” The NZD ended the week in New York at USD0.7205 and AUD/NZD1.0640.