Timothy Fox - Head of Research & Chief Economist
Mohammed Al Tajir - Manager, FX Analytics and Product Development
Published Date: 17 December 2017
Central banks fulfil expectations
The dollar is performing well following the interest rate rise announced by the Fed last week, the third hike of the year, taking the target rate to 1.25-1.50%. The Fed also projected three more rate hikes for 2018, which stands in contrast to the steady policy outlook for most of the other leading central banks. The ECB stuck to its dovish tone at last week’s council meeting, while the Bank of England was also less hawkish than expected. A similar message is expected from the Bank of Japan when it meets this week.
Markets are now beginning to wind down into the holiday period amidst optimism that solutions to a number of outstanding issues might be on their way. The U.S. Congress is expected to pass the USD1.5 trillion tax reform package this week, perhaps as early as Wednesday, and send it to President Trump before the weekend to sign off. Agreement between the EU and U.K. about the financial terms of Brexit has also been made, paving the way for Brexit talks to move to the second stage, with trade talks likely to begin next March.
Source: Bloomberg, Emirates NBD Research
Markets remain uncertain about the likely impact of tax cuts on U.S. growth, with most expectations being for only a modest benefit. The Fed raised its 2018 growth forecast to 2.5% on the back of the likely passage of the tax bill, but this is still somewhat below the view of the Treasury which is hoping to achieve a 3.0% growth rate in coming years. Corporates look likely to get the biggest stimulus with a corporate tax cut from 35% to 21%, with the hope being that this will ‘trickle down’ to benefit the wider economy. Individuals will also benefit but the impact may be less clear as there will still be seven tax brackets.
The most important economic data of the month have already been released leaving the calendar quiet in the coming days. Housing reports, revised Q3 GDP, regional manufacturing surveys, personal income and spending data, and durable goods orders will all be published but it is unlikely if they will materially change assumptions about the outlook for growth but with still low inflation. The dollar is expected to remain relatively steady in 2018 against this backdrop, but the risks to it are more likely to come from political events than economic ones. The Muller Inquiry has the potential to destabilize perceptions about the Trump White House, while the mid-term elections near the end of next year could result in the Republicans losing power in at least one of the Houses of Congress, hampering policy-making over the second half of Trump’s term.
In a week which saw price action driven equally by technical and fundamental factors, the Dollar Index rose by 0.35%, closing at 93.93. Over the last trading sessions, the index found resistance at the 23.6% one-year Fibonacci retracement (94.30) before breaking below the 50-day moving average (93.80). Further declines were halted when support was found at the 100-day moving average (93.36) and the index was able to break back above the 50-day moving average with a firm close. Provided that economic data this week does not disappoint, there is a short-term risk for further USD appreciation. We look for a break of 94.03 level to pave the way for further gains towards 95.00, a level not seen since November 7, 2016. This risk is compounded by the possibility of further investor optimism on the U.S. tax reforms, as well as by seasonality which traditionally favours the greenback in Q4. Furthermore, with the market positioned short USDs through most of the year, the significance of these positions being unwound as the year ends should not be overlooked.
Europe’s year is also coming to a close in better shape than might have been imagined a few months ago. The Eurozone economy appears to be on a high right now, even though inflation remains relatively dormant, with the preliminary December manufacturing index rising to 60.6 from 60.1 in November. The services PMI also rose to 56.5 from 56.2. Political pressures also seem to be receding, although the Catalonia election still remains a risk this week, and may renew concerns about what to expect in Italian elections next year. ECB President Draghi may in fact be holding back from normalizing monetary policy in part because of the risk that political uncertainties return.
EURUSD declined 0.20% last week to close at 1.1749, reversing earlier gains that saw the exchange rate trade as high as 1.1863. The price action of the previous week has a degree of technical significance as although there was a break and daily close above the former resistive 100-day moving average (1.1805), this break proved to be a false one and in fact the cross went on to close the week below its 50-day moving average (1.1762) and test the supporting baseline that has held since April 2017 (see chart below). A break of this level could result in further declines towards the 76.4% one-year Fibonacci retracement (1.1679) in quick succession. Given tight liquidity, seasonality and ECB President Draghi's comments on low inflation, the case for this scenario is probably a strong one.
The Swiss National Bank also kept the interest rate on hold at a record low of -0.75% at its meeting last Thursday. The SNB also emphasized that the Swiss franc remained ‘highly valued’ and that it still needed to keep interest rates negative and to intervene in the currency markets as necessary. With the ECB reducing, but not halting net-asset purchases next year the SNB is unlikely to move first and risk a renewed appreciation of the CHF.
Progress on Brexit is of course also something that was not anticipated just a few weeks ago, and has been a welcome fillip to both UK and Eurozone markets. Negotiations on a post-Brexit trade deal are being billed as an even bigger challenge than the financial settlement, but these talks are unlikely to begin until March. A big uncertainty for GBP is that the final deal will still have to get the approval of the UK Parliament, something that is likely to keep PM May’s position precarious. The Bank of England last week also provided little ground to believe that interest rates will be raised further any time soon. The MPC voted unanimously to leave Bank Rate unchanged at 0.5%, as expected, with little alteration to the guidance contained within the minutes.
GBP underperformed over the last week to depreciate against most of the other major currencies, with GBPUSD falling 0.48% to close at 1.3326. Despite these losses, however strong support can be expected at 1.3260, a level close to the 50-day moving average (1.3261) and the 76.4% one-year Fibonacci retracement (1.3263). While cable continues to trade above these levels, medium-term risks remain to the upside and we stick to our forecasts for GBPUSD to finish the year above 1.34 and to appreciate over the course of 2018.
USDJPY was also under pressure last week, falling 0.76% to 112.60. Following a sustained break and daily close below the 50-day moving average (112.87) the currency is trying to consolidate with this key level now acting as resistance for two consecutive days. From a technical perspective, we expect strong support to be found at the 111.60-111.70 range, a zone which includes the 100 and 200-day moving averages as well as the 38.2% one year Fibonacci retracement. The headline Tankan index for large manufacturers rose to 25 in Q4 from 22 in Q3, although the equivalent for large non-manufacturers was unchanged at 23, and capital spending intentions were muted. In the coming week the Bank of Japan meeting is unlikely to result in any change to policy rates, although the BOJ is widely perceived to have been normalizing by stealth in recent months even as inflation underperforms.
Finally NZDUSD is worthy of mention since despite being last week’s outperformer, we feel that the currency’s fortunes are about to reverse. It is noteworthy that last week’s gains were principally driven by a short squeeze in the aftermath of the announcement of Adrian Orr as the new RBNZ Governor rather than a change in the underlying economy. When looking at the larger picture, further gains for the Kiwi seems unlikely. From a technical perspective, NZDUSD was unable to sustain its break above 0.70 and analysis of the daily candle charts shows a death cross forming on the 100 and 200-day moving averages indicating that further losses may lie ahead. Fundamentally the currency is vulnerable to disappointing economic data in the week ahead with reports expected to show a trade deficit of NZD 550m in November, a Q3 2017 Balance of Payments account of NZD -4.2bn and Q3 GDP slowing to 0.6% q/q from 0.8% in Q2. We look for a break below the 50-day moving average (0.6935) to open the possibility of a retest towards the one year lows of 0.6781.
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