Timothy Fox - Head of Research & Chief Economist
Mohammed Al Tajir - Manager, FX Analytics and Product Development
Published Date: 14 May 2017
After a strong start to the week the dollar lost ground on Friday as softer than expected inflation data caused it to weaken ending at 99.25 on its DXY index measure, although this was still up from the beginning of the week. The correction came as 10-year bond yields also fell back from mid-week highs of 2.42% to end at 2.33%. April CPI data showed the core rate falling back to 1.9% from 2.0% in March, while the headline rate slowed to 2.2% from 2.4%. The April headline rate rose by 0.2% m/m while the core index was up 0.1%.
Retail sales were also a bit softer than expected at 0.4% in April against 0.6% expected, but there was also some better news as the University of Michigan reading of consumer sentiment showed confidence was high at 97.7 in May up from 97.0 in April. Also April PPI was rose by 0.5% while the core index was up 0.4%, suggesting that the fall back in CPI might be short lived. On balance the data should not alter expectations about a June rate hike by the Fed, with the Philadelphia Fed President Patrick Harker reiterating his support for two more hikes in 2017, noting that the economy is normalizing and the labor market is at full health. However, the bigger threat might be to expectations of a second rate hike, with the market becoming concerned by President Trump’s political travails, which could derail progress on his economic agenda.
That the dollar had actually recovered in the first place last week is perhaps the bigger story than the setback at the end of it, as it managed to overcome some key technical resistance levels in the process. The EUR’s rally ran out of steam after Emmanuel Macron was confirmed as the President of France at the start of the week. The focus is now turning to the June 18 legislative elections in France, while Italy's next general election remains a potentially bigger problem in 2018. The G7 meeting saw global finance ministers water down their language regarding the promotion of free trade, with US Treasury Secretary Mnuchin reserving the right to retaliate if the US sees trade that it is unfair. More positively, however, the US and China announced a trade accord promoting US exports of gas and beef to China, suggesting that US rhetoric and deeds may be different.
Source: Emirates NBD Research, Bloomberg
Meanwhile Q1 GDP growth accelerated in Germany to 0.6% q/q from 0.4% q/q in Q4 last year and in line with expectations. Both domestic and external demand underpinned the quarterly growth rate as investment growth strengthened. The French result and the firm German data paves the way for Draghi to move to a more neutral stance at the June ECB meeting. Tapering is unlikely to commence before the end of the year though, and the main question is how the ECB will adjust its guidance on normalization steps. Another good round of data in May will strengthen the arguments for a change in the central bank's forward guidance and a move to a neutral stance.
The highlight on the data from this week is German ZEW Investor confidence index which is seen rising to 22.0 from 19.5 reflecting reduced political uncertainty, improving growth and firm equity markets. Other data releases are more backward-looking. Eurozone Q1 GDP is expected to be confirmed at 0.5% q/q and 1.7% y/y, in line with the preliminary estimate. Meanwhile final Eurozone inflation April should confirm the headline rate at 1.9% y/y and the core at 1.2% y/y.
Sterling has remained heavy in the wake of the BoE policy announcement and inflation report, where the central bank said that it had over-estimated growth in Q1 and this quarter, consequently lowering its 2017 growth projection to 1.9% from 2.0%. A -0.5% m/m drop in UK production data also encouraged some selling, with manufacturing output falling by an even greater -0.6%. The next domestic focus will be the release of April inflation data on Tuesday. As the BoE stated, the higher pound and lower oil prices can be expected to contain the rising price trend, although this is more likely to come later (probably next year) while for now the headline CPI is expected to reach a new cycle high of 2.6% y/y in April from 2.3% in March as the impact of past exchange rate weakness is still being felt.
USDJPY drifted moderately lower at the end of the week, with a pause in global stock markets weighing on it. North Korea’s testing of another ballistic missile over the weekend and a global cyber-attack is likely keep risk appetite muted early on, before economic data returns as the main driver. Japanese Q1 GDP is expected to expand by 0.4% q/q, although the risks appear to be on the upside of this. However, it will more likely be US data that has the biggest influence, with any renewed firmness in US interest rates likely to cause USDJPY to rebound.
Despite rallying on the final three trading days, AUDUSD still declined 0.50% last week to close at 0.7387. Inspection of the daily candle chart reveals that further losses may lie ahead. The daily downtrend that has been in effect since 21st of March 2017 remains intact and should provide strong resistance to any advances towards 0.7460. In addition, the 50 day moving average looks poised to perform a “death cut” of the 100 and 200 day moving averages, indicating further losses as the most likely path.
As we go to print, AUDUSD sits exactly at its one year 38.2% Fibonacci retracement (0.7387), a level it has failed to close above since its break below on the 9th of May 2017. With the RBA minutes likely to confirm the dovish tone of the RBA and no improvements expected in the labour market next week, we see further losses, with the first key level of support being 0.7294, the 23.6% one year Fibonacci retracement (not far from our Q2 2017 forecast of 0.73). A break below this level will result in further declines towards the twelve month low of 0.7145. On the other hand, a daily close above 0.7460 would indicate a possible reversal of the daily downtrend, nullifying our view.
NZDUSD fell 0.75% last week to close at 0.6866, just below its one year 23.6% Fibonacci retracement of 0.6867. Despite gains on Friday, the daily downtrend in effect since February 2017 remains firmly intact. Further recovery is likely to be hindered by strong resistance at 0.6965 (both the 50 day moving average and capping trend line from the daily downtrend) and we expect further declines in the coming weeks. A rise and firm close above 0.6965 would nullify this view and potentially lead to a reversal in the trend.
Market expecting Fed to raise rates