ECB, BOC, RBA, RIKSBANK…what else?
In response to an improvement in US macroeconomic indicators, the US dollar firmed up slightly over the course of last week. Q2 GDP growth was significantly revised from its 2.6% estimate to 3.0% and the ADP Employment Report reported a sharp improvement in August with a 237 thousand increase in private payrolls.
Meanwhile, the August Employment Situation Report was disappointing with only 156 thousand job creations. It must, however, be noted that August data is always subsequently revised upwards. Furthermore, job creations remain sufficient in number to absorb new entrants into the labour market. On the whole, US growth remains solid and, importantly, in line with its potential.
With regard to inflation, a study by the Dallas Federal Reserve (DFR) suggested the PCE price index – the deflator for household consumption – should be revised upwards to 1.9% for Q1 2017 and then to 1.55% for Q2 2017. Certainly, these figures should temper concerns expressed by certain Federal Open Market Committee (FOMC) members about the weak inflation.
As for the market, it does not believe inflation will pick up in the future with the US five-year inflation forward remaining low at 2.21%. This is primarily due to the absence of upward pressures on wages – as underlined by the August Employment Situation Report and the fact that average hourly earnings rose by only 2.5%.
However, the market remains very short on US dollar positioning. In fact, there has been another sharp increase in aggregate short positions on the greenback to levels not seen since the European sovereign debt crisis back in 2011-2012. This suggests that the US dollar now has limited downside potential. Finally, the DXY dollar index is also lower than suggested by the spread between the 10-year rate for the US and for other G10 countries.
This week, watch out for the Beige Book, as well as speeches by several FOMC members including Lael Brainard and Robert Kaplan, as well as Loretta Mester and William Dudley. Certainly, these speeches could shed some light on the timing of the Federal Reserve’s (the Fed) balance sheet shrink – perhaps September or October – and the next hike in the Fed Funds rate, which we believe could come as early as December.
As of yet, the sharp improvement in financial conditions (despite the hikes in the Fed Funds rate since the start of the year) points to a further tightening of the Fed’s monetary policy, but at a gradual pace. Meanwhile, the US Congress is back in session with both the 2018 budget and debt ceiling – which needs to be raised before 30 September – on its agenda. Of course, Hurricane Harvey could prompt Donald Trump to move more swiftly to raise this ceiling in order to release funding for reconstruction. In this context, the US dollar will continue to firm.
EUR: EUR/USD heading lower towards 1.18
After a brief foray above 1.20, the EUR/USD pulled back and tested anew 1.18 in reaction to the greenback’s rebound – as well as the concerns of the European Central Bank (ECB) over the sharp appreciation of the euro and its indirect effects on European growth and inflation.
This week, watch out in particular for the meeting of the Governing Council on 7 September. The question is whether, on the occasion of this meeting, the ECB will give details regarding the time span of its QE recalibration in 2018. Also, the latest growth and inflation forecasts produced by the ECB staff will be available. While the growth forecast could be revised upwards, the inflation forecast could be revised downwards. If the ECB puts off any announcement concerning the tapering until October, or even December, then the EUR/USD could rapidly test 1.18. On the other hand, if it announces a six-month tapering, the EUR/USD could go on to test 1.216. Finally, it could also announce a nine-month tapering next week, which could also see the pair weaken towards 1.18.
Be that as it may, any correction of the EUR/USD will be limited as the US dollar itself has little upside potential – this is due to uncertainties stemming from the need to raise the US debt ceiling no later than 1 October and given that hurricane Harvey will have negative effects on growth. Under these conditions, the EUR/USD risks briefly correcting towards 1.18.
JPY: USD/JPY on course towards 111
After briefly breaking above 110.50, the USD/JPY pulled back below 110 in reaction to the US Employment Situation Report. The pair remains correlated to the US 10-year rate, which remains low by past standards at 2.13%. The Japanese yen also appreciated in reaction to the missiles launched by North Korea, which passed over Japan.
Despite this, we remain positive on the USD/JPY that should recover towards 111. Our view is that the US 10-year interest rate now has very slight downside potential as the Fed will press ahead with the normalisation of its monetary policy, while the Bank of Japan (BoJ) will maintain an ultra-accommodating monetary policy aimed at pegging long rates near zero.
GBP: EUR/GBP stable around 0.9150
In the week ended, sterling recovered against the euro and US dollar despite the British and EU negotiators still being at loggerheads. No progress was made last week regarding the terms of the British exit. Under these circumstances, it is likely that sterling drew strength from statements by MPC member Michael Saunders, urging a tightening of monetary policy to contain inflation in a context of fast-ebbing unused capacities.
This week, keep tabs on the Brexit negotiations and look out for the PMI surveys, as well as manufacturing production. As the euro is being penalised by the ECB’s procrastination, the EUR/GBP will struggle to rebound. This will only happen when the euro resumes its uptrend, which is unlikely in the short term. Under these conditions, we see the EUR/GBP holding around 0.9150.
CAD: USD/CAD on course towards 1.23
Spurred by the improvement in Canadian economic activity in Q2 2017 – growth accelerating to 4.5% from 3.7% – and the upturn in the price of Brent to above $52/bbl, the Canadian dollar continued to appreciate.
The currency also benefitted from speculation that the Bank of Canada (BoC) could raise key policy rates as early as this week. That seems rather premature but the central bank may well adopt a hawkish stance by minimising the currently weak inflation. The market will also focus on the latest Canadian employment data. Specifically, if employment held high in August then this should enable the USD/CAD to test 1.23.
AUD: AUD/USD heading towards 0.806
The AUD/USD also appreciated, setting a high at 0.795 in the week ended, spurred by the upturn in commodity prices and by the Chinese PMI. This week, the market will focus on the upcoming meeting of the Reserve Bank of Australia (RBoA), which is expected to maintain the monetary status quo.
Having risen sharply, the Australian dollar is likely to prompt the central bank to keep key policy rates on hold for a prolonged period. In this context, the AUD/USD still has more upside potential towards 0.806 – particularly if macroeconomic indicators such as Q2 GDP and business surveys remain upbeat.
SEK: EUR/SEK to eye 9.35
The Swedish krona held firm against the euro and US dollar, bolstered by the good economic data. The market is jittery ahead of the upcoming meeting of the Riksbank, which will be held on the same day as the ECB meeting. Although Riksbank is likely to keep key policy rates on hold, it may well ratchet up its rhetoric, given the improvement in economic growth and inflation, while also seeking to limit the appreciation of the krona. Even so, we see the EUR/SEK extending its decline towards 9.35.