By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It was a tough week for the U.S. dollar. A number of Federal Reserve officials were scheduled to speak but none of them said anything to help the greenback, which had been falling since the central bank raised interest rates last week. The calendar was light leaving the U.S. health-care vote as the main focus. In the eleventh hour, the House pulled the vote and according to House Energy and Commerce Chairman Walden, the bill is done — it will not come up at a later date. President Trump also said that the health-care bill finished. Although the dollar jumped on the news, the bill’s failure raises many questions about how the president's plans to fund his tax reform, the centerpiece of the new administration’s fiscal spending plans. Without the prospect of major tax cuts and the corresponding growth that comes with it, September looks more likely than June for a rate hike. Don't forget that even if the House approved the bill, it would have met stiff resistance in the Senate. With the vote canceled for now, investors will be looking for Trump’s Plan-B, which means that fiscal policy will remain in focus and a key driver of U.S. dollar flows.
Meanwhile, the dollar received no help from Federal Reserve officials last week. Investors had been hoping for a less-dovish interpretation of this month’s FOMC meeting from Yellen and Dudley, but both members of the Fed leadership failed to make any specific mention of monetary policy or the economy. Instead, the loudest comments came from Fed President Kashkari — the only voting member of the central bank who opted to keep interest rates unchanged at the last meeting. So his dovish views should not be a surprise. He felt that there was not enough improvements in the economy since the last meeting and they “are still coming up short on the inflation target, and the job market continues to strengthen, suggesting that slack remains.” And the latest economic reports justified his concern as data was mixed with existing-home sales falling more than expected, jobless claims rising and durable goods orders slowing. However new-home sales increased and the current-account deficit narrowed. In the coming week, revisions to third-quarter GDP, the trade balance, pending-home sales, personal income, personal spending, Chicago PMI and revisions to the University of Michigan Consumer Sentiment report are scheduled for release. A number of Federal Reserve presidents are also due to speak so traders need to pay attention to any market-moving comments.
Politics will also be in focus in the U.K. Prime Minister May is expected to trigger Article 50 in the next few days, formalizing the U.K.’s divorce from the European Union. We expect GBP/USD to fall quickly when the announcement is made but it should recover swiftly as the inevitable finally happens and investors realize that the negotiation process will be long and filled with delays. Brexit will be the main focus next week with only mortgage approvals and revisions to Q4 GDP scheduled for release. Sterling had a strong performance last week with gains driven by healthy data — consumer prices rose 0.7% in March, beating the market’s 0.5% forecast and recovering all of the past month’s decline. This drove the annualized pace of growth above the central bank’s 2% forecast to 2.3% from 1.8%. Core price growth was just as healthy, rising to 2% from 1.6%. Based on that report alone, Bank of England officials should be thinking about raising interest rates, but combined with a hot retail-sales report, we may start to see more policy makers align with Kristen Forbes, who voted for an immediate rate hike next month. Economists had been looking for retail sales to rebound but they did not expect spending to jump by 1.3%, far outpacing their 0.3% forecast. This is a good sign for growth in the first quarter.
EUR/USD broke above 1.08 on the back of stronger Eurozone data and a good performance by Emmanuel Macron during the first French presidential debate. According to Friday’s PMI reports, manufacturing- and service- sector activity accelerated in the Eurozone, led by gains in Germany and France, the region’s 2 largest economies. The 3-month average PMI composite index rose to its highest level in 6 years as the Eurozone economy recovers on the back of a weak currency and accommodative monetary policy. Two weeks ago, members of the European Central Bank brought up the idea of tightening and while they are in no position to raise interest rates anytime soon, we could start to hear less dovishness from ECB officials. Yet there is one problem, which is inflation — the euro may be weak but price pressures are not rising as evidenced by the slowdown in producer price growth in February. Next week, the German IFO report is scheduled for release along with consumer prices and unemployment. The IFO, which measures business confidence, should rise after the strong PMI reports and the same is true for the Eurozone confidence reports and job growth. According to Germany’s flash PMI, job creation was the strongest since March 2011 and the second highest since the series began in January 1998. Inflation on the other hand should remain low but collectively, next week’s reports should help more than hurt the euro.