FX Commentary - August 6, 2018
Following last week’s flurry of central bank activity and data releases, this week’s focus will be on the remaining monthly indicators of economic activity pending release.
The most important releases for the U.S. will be July’s price indicators. Headline CPI is expected to increase 0.1-0.2% month-over-month for a 2.9% annualized gain while producer prices are expected to increase 0.3% month-over-month but may see a higher chance of upside risk due to recent trade tariff escalation. Barring temporary shocks to inflation, as the economy maintains growth and employment remains strong inflation is expected to mildly overshoot the Federal Reserve’s target. Despite last week’s jobs report coming in below estimates, the U.S. economy remains in good form and has done enough to support the Fed’s current course of action. Keeping benchmark rates unchanged following last week’s meeting, the Fed seemingly upgraded its view of the economy, remarking that “economic activity has been rising at a strong rate” and that labor markets remained “strong”. The statement and recent data give little reason to change the current consensus of further gradual rate hikes by the Fed. With the near term U.S. interest rate outlook seemingly in place, the biggest short term risks to the dollar will likely arise from ongoing trade disputes.
While there may be no immediate resolution in sight for the trade tariff war with China, the U.S.’ immediate neighbors are hopeful to soon conclude their own trade concerns with NAFTA negotiations. Improvements in discussions between the parties have relaxed pressure on the Canadian dollar which managed to perform the best amongst G10 currencies in July. The Canadian dollars’ outperformance has continued into the current month largely owing to a strong GDP print for May which saw the economy grow 0.5% month-over-month. Amidst the backdrop of NAFTA negotiations, attention will turn to July’s employment report due Friday.
In contrast to the Canadian dollar, the British pound has been one of the worst performing majors over the past month. A unanimous decision by The Bank of England (BoE) to raise policy rates by 25bps to 0.75% did little to reverse the course of the pound as the move was widely expected and the Bank otherwise left key forecasts mostly unchanged. Interestingly, in terms of market reaction the hike was strikingly similar to last year’s, which also saw the pound sold in the wake of the decision. As several analysts had remarked during last year’s rate hike, BoE had raised rates simply because they had said they would, suggesting the Bank and by extent the economy had done little to win over confidence from markets in spite of the hike. With pessimism still surrounding the UK economy, markets will carefully scrutinize June’s GDP figure released this Friday. Although expectations are for monthly growth to moderate to 0.2%, any further downside surprise may upend the BoE’s credibility, dampen rate outlook expectations, and extend the pound’s downside risk.
In a noticeable development The Bank of Japan (BoJ) introduced forward guidance for its policy rates at last week’s meeting, essentially committing to low rates until the consumption taxes hikes next year. However, its statement that “Japanese Government Bond (JGB) yields may move upward and downward to some extent” indicated perhaps the biggest change for the central bank, as the indication for greater flexibility around long term yields sets the stage for a gradual dilution of the Bank’s longstanding yield curve control policy akin to the current tapering of the Bank’s quantitative easing. While the recent changes do not necessarily suggest a dovish or hawkish policy bias, the sharp selloff in JGB’s and BoJ’s new tolerance for higher yields may lead to some Japanese yen appreciation over the medium term.
The Reserve Bank of Australia (RBA) releases its latest rate decision following the close of North American Markets on Monday. The central bank is expected to keep rates on hold as it continues to maintain a relatively dovish stance as other major central banks have either already began raising rates or opening the path for such adjustments. So far, the RBA has provided little clear guidance on the timing of its next move and markets are only pricing a 10bps increase over the next year. The rate divergence with the U.S. could pose to threaten Australian dollar inflows as the formerly popular G10 carry currency now enjoys a lower policy rate than the U.S. dollar.
Sources: Bloomberg, Wall Street Journal, Reuters, Barclays, Bank of America, Econoday, 4cast
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