The month kicked off with Trump’s state of the union address and the expectation that Theresa May will formally trigger Article 50 mid-month. World First takes a look at the key trends of February 2017 and a look at the events shaping global currency markets in February.
AUD: Not Trumped Yet
Month in Review
As Chinese New Year festivities continued into the early days of February, the Australian dollar remained relatively quiet, particularly since iron ore was waiting for markets to resume trading when the holiday came to an end. The RBA and the Fed kept rates on hold, with the latter noting that it was waiting to see greater details from the Trump administration’s proposed fiscal policies before making a move. Speaking of Trump, he once again brought back the possibility of the reflation trade, that being the belief that Trump’s policies will lift US inflation and growth, hurting bonds. This continued to help the US dollar, and kept the Aussie under consistent pressure.
The Key Trends
The Australian dollar yo-yoed due to Trump and iron ore over February, and to a lesser extent, the ‘usual suspect’ of interest rate predictions. While data caused infrequent dips and highs, the surge in iron ore propelled the Aussie higher, with the sporadic and raw commentary of Trump ensuring it didn’t move too far ahead of itself. During February Trump commented that “something phenomenal in terms of tax” will be delivered by his Administration. Overall, his bullish tone and commitment to infrastructure and military reforms and tax and reflationary policies are keeping the USD strong. Iron ore, was also bullish during the month and reached the highest levels since August 2014. In justifying the climb, analysts mainly put it down to increased demand after the Chinese Lunar New Year and a strong sentiment in the Chinese iron ore futures market.
In determining the course of US interest rates, Fed Chair Yellen noted that that the Fed could continue to raise interest rates, yet it would be “unwise” for them to wait too long. Furthermore, other Fed members commented that a March hike is being “seriously considered.” There is also the potential for a downturn in iron ore, with Chinese regulators now investigating suspicious trading in the Chinese futures market. Finally, Trump is at a point where he will have to detail his administration’s fiscal policy and spending plans. The Aussie will then have to suffer through the prospective negative implications of these three factors and rely on a strong GDP figure at the start of March and a firm RBA, if it is to grind higher.
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USD: A return to fundamentals
Month in Review
Whilst politics continued to dominate headlines, towards the end of the month markets started to get “Trump Fatigue”, with focus returning to some market fundamentals. The US Dollar index was up over 2% in the month, but down 3% from the multi-year highs seen in mid-December 2016. The FOMC met at the beginning of the month, and while US interest rates were expectedly kept on hold, the committee expressed their view that interest rates would be raised “fairly soon”.
The Key Trends
The ducks appear to be lining up in a row for the Fed in terms of the seemingly inevitable rise in US interest rates. As wage and job growth continue, the Fed is retaining its three-hike stance, especially given rising concerns about getting behind the curve on inflation. An early hike would give it more space to follow through on this. Against this backdrop, the market through the Fed funds futures is still under-pricing such a move.
Trump delivered his long-awaited speech to a joint session of Congress on Wednesday 1st March (AEDST). Although market attention was keenly focused on the speech, new details regarding fiscal stimulus, tax reform and trade policy were weak. The administration intends to push fiscal reforms forward before August, according to Treasury Secretary Mnuchin, but details on tax policy are likely to come after March, when Congress finishes working on repealing and replacing the Affordable Care Act. The 15 March meeting of the FOMC has been priced as a ‘live’ meeting since comments by Fed members that interest rates would be raised “sooner rather than later”.
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GBP: Brexit’s Back!
Month in Review
With Parliament back in session Brexit is back to being the number one concern for the pound. A year ago David Cameron strode out of 10 Downing Street and announced that the referendum date for the UK’s membership of the EU would take place on June 23rd. The pound has had a steady decline this month and is still a little over 10% lower than it was 12 months ago. Of course, Article 50 is yet to be triggered, let alone a formal Brexit, but passage of the government’s EU bill will now hit the Lords.
Governor Carney emphasised that “the Brexit journey really is just beginning” and therefore we think it rash that the Bank of England would countenance raising rates yet. That is not to say that some of the more hawkish members of the Committee will not give speeches and even vote for increasing borrowing costs in the near future, but a majority will unlikely be swayed while Dr Mark Carney occupies the Governor’s seat.
The Key Trends
General concerns were that UK retail sales would slip in January after an exuberant November and a poor December. While these month-on-month figures can be volatile, the 3 month trend suggests that the UK consumer is not waving, but drowning. Indeed, this month’s slew of increasing inflation and slowing wage growth is kryptonite for the High St and UK GDP as a whole.
There had been some doubts over the dovishness of the Bank of England post-Brexit, but Mark Carney emphasised his testimony in front of the Treasury Select Committee that the situation would be worse without the Bank’s decision to cut rates in August. With an ill wind of UK economic data behind him, Carney will be in control of the discussion and would represent a risk to the pound.
The Bank did run their growth expectations for the next year up to 2.0% – 1.2% higher than their thoughts in August of last year – with expectations of inflation topping 2.8% in the coming 18 months. We think that inflation number looks soft and a breach of 3% is likely, something that could happen by the end of the year.
It is our opinion from these predictions that the expected slowing of growth post-2017 and the view that inflation will only drive above inflation means that the markets have been overconfident in pricing in an interest hike from the Bank of England in the next couple of years. Currently, a full rate hike is priced in for the beginning of 2019 and there is slightly more than a 33% chance that rates tick higher by the end of this year.
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EUR: French Politics driving the Euro
Month in Review
February began with Trump’s trade adviser, Peter Navarro telling the Financial Times that Germany was deliberately undervaluing the Euro in an attempt to gain trade advantages, particularly against the US. China, it appears, is not the only one in Trump’s crosshairs. Having said this, it was not consolidated in the markets, as upside risk to the Euro became the theme of the month. An alliance between Bayrou and Macron within the French political landscape has markets pricing in a diminishing chance of a La Pen victory. French-German sovereign yields narrowed, implied volatility moderated, and EUR/USD traded out the month within a 3.5% range, all indicating a more favourable reassessment of the of the upcoming election.
Increasingly, it is politics driving the Euro. Particularly the battle between those open to the Union and the shared currency, and those willing to abandon it in favour of nationalism and protectionism. The French election on the 23rd of April will be the leading indicator as to what the future of the EU will be.
With nationalist and protectionist leaning parties becoming an increasingly influential part of the European landscape, is the demise of the shared currency a likely outcome? This is indeed the view of the man tipped to become Trump’s ambassador to the EU, Ted Malloch. He commented to the BBC that the Euro could “in fact collapse in the coming year and a half” and he’s not alone in this view. Mario Draghi, president of the ECB was typically resilient towards this type of commentary. “With the single currency, we have forged bonds that survived the worst economic crisis since the World War II. This was in fact the original raison d’être of the European project: keeping us united in difficult times, when it is all too tempting to turn against our neighbours or seek national solutions.” Time will tell…
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NZD sticks close to the AUD
Month in Review
The NZD/USD exchange rate has traded erratically over recent weeks – whilst remaining within its defined trading range of 0.7100 and 0.7350, which has been established since the recovery from below 0.6900 in January. The positive and negative forces that drive the Kiwi dollar’s direction appear to be reasonably evenly balanced at this time. The short to medium term outlook for the NZD/USD rate continues to be one of stability in the low 0.7000’s region.
The local domestic economic factors continue to be positive for the Kiwi dollar, despite the Reserve Bank at their statement on 9 February being forced to rebuke the markets for being premature with interest rate increases in late 2017. The Kiwi dollar depreciated two cents from 0.7350 to 0.7150 on the RBNZ’s lower 2017 inflation forecast and maintenance of the OCR at 1.75% for the next two years in their economic outlook/model assumptions.
One reason why the NZ dollar may have very limited upside above 0.7200 over the coming period against the USD is that the Kiwi generally follows the Australian dollar’s movements against the USD. The AUD/USD rate has rebounded back to the top of its trading range at 0.7700, however over the last few years the Aussie dollar has encountered a serious ceiling at this level and has always reverted to lower levels. Positive Chinese economic data has cemented in the commodity price gains for iron ore and copper; however, a downwards correction in these commodity prices on profit-taking from the speculative side of the market may well push the AUD/USD rate lower. Likewise, the AUD/USD is highly correlated to the share price movements of listed mining/resources stocks in Australia and it would not be surprising to see offshore investors selling off both Australian equities and the AUD as they take their profits home.
Whilst all the aforementioned positive and negative forces essentially balance each other out, thus leaving the Kiwi dollar relatively stable, the residual and wildcard variable is always the fortunes of our largest commodity in the form of dairy prices. The spectacular recovery upwards in whole milk powder (WMP) prices from US$2,000/MT to US$3,500/MT late last year has run out of steam in 2017, as supply and demand developments even out. The last two Global Dairy Trade auctions have produced no change in prices after the 7% drop in WMP in early January, with more product volume than expected being placed in the next auction. There are also reports of Chinese import warehouses being full up with milk powder. Therefore, further downwards corrections in WMP prices over coming months may be the one catalyst that propels the Kiwi dollar back to below 0.7000. However, a major WMP price collapse, similar to what occurred in 2014 through to 2016, is not anticipated as supply volumes out of both NZ and Europe have reduced.
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