US, UK GDP data may spur FX volatility

Report prepared by Ahmed

Shibley

THE ICE Dollar Index (DXY) posted another impressive week’s advance through this past Friday. That marks three consecutive weeks that the benchmark currency has climbed to eight-month highs – and at the fastest pace since the November rally back to 12-year highs. Given this performance, traders are left to wonder if the Greenback has changed gears and returned to the bull trend that was waylaid nearly 18-months ago. There are certainly go-to fundamental rationalizations for those looking to jump on the momentum: the Fed is promising a hike in the foreseeable future; ominous clouds over risk trends necessitate a safe haven; and faltering commodity trend will indirectly bolster the primary pricing instrument. Yet, these are overreaching for convenience. Congestion is a more universal condition, and the Dollar’s performance is far from uniform.

When taking measurements, it is important to understand your tools and their calibrations. For those referencing the DXY, its performance does look impressive. Yet, there is a distinct concentration to this barometer that provides a skew to the signal. The ICE index is trade-weighted, which given heavy weighting to EUR/USD (the most liquid exchange rate in the FX market by a wide margin). This benchmark pair dropped 2.8 percent over the past two weeks – the biggest Dollar move amongst the majors – to a 7-month low. The other ‘majors’ were bound to their ranges. That would suggest the Dollar could take limited credit for this progress.

Technically speaking, the Greenback could capably rally forever should its major counterparts consistently lose ground. However, that is unlikely in a market defined by congestion and uneasy complacency. From the Euro, lost ground after the ECB’s decision to defer its taper announcement doesn’t write the script for a full topple for the currency. Pound has shown greater resilience to Brexit headlines this past week. Yen and commodity-based crosses meanwhile are waiting for their cues from risk benchmarks. This is not a cast of characters that seem likely to put the Dollar in the spotlight.

Looking out over the coming week’s docket, however, there is reason to believe the Greenback may be able to rest back control of its own bearings. Monetary policy is generally the most productive theme for the FX market these past years, so it is reasonable to presume that it would offer the most ready traction should it look for grip. Speculation is not focused on the November 2nd meeting (due in part to its proximity to the US Presidential Election and the uncertainty that event presents) but rather the December 14th ‘anniversary’ to the first the first hike. Fed Fund futures price approximately a 66 percent probability that the central bank moves at that meeting.

To bolster the conviction of a 12-month follow up to ‘liftoff’, the most capable event to move the needle is the US 3Q GDP update. This is the kind of systemic assessment of the economic picture that can be considered black-and-white in defining the conditions for monetary policy. A significant rebound from the second quarter’s moderate 1.4 percent pace could solidify hike motivation. Indeed, the consensus forecast is for a pickup to a 2.5 percent pace of expansion. Yet, it should be said that such a forecast sets the bar high. Further, this key event is due at the very end of the week.

Other fundamental fodder to move the rate view and/or the Dollar include a host of Fed speeches penciled in. The terms of this policy group’s tone is changing with remarks like those made by San Francisco Fed President John Williams who said they should have hiked in September and low rates can lead to a recession. Another indicator to keep tabs on is the Conference Board’s consumer sentiment survey. Both the headline and components are valuable forecasting for economic activity moving forward.

The 3Q Gross Domestic Product (GDP) reports coming out of the U.K. and U.S. along with a fresh wave of central bank rhetoric may spur increased volatility in GBP/USD, but the pair may continue to consolidate within a narrow range as British Prime Minister Theresa May increases her efforts to avoid a ‘hard Brexit.’

Bank of England (BoE) Governor Mark Carney is scheduled to appear before the House of Lords Economic Affairs Committee next week as U.K. lawmakers continue to assess the economic implications of leaving the European Union (EU), but the central bank head may largely endorse a waitand-see approach for monetary policy as a growing number of officials sees a greater threat of overshooting the 2% target for inflation amid the sharp depreciation in the British Pound. With the U.K. economy expected to grow an annualized 2.1% during the threemonths through September, the Monetary Policy Committee (MPC) may sound increasingly hawkish and stick to the sidelines throughout the remainder of the year as central bank officials warn the next quarterly inflation due out on November 3 will reflect the sharp decline in the exchange rate. In turn, the bearish sentiment surrounding the sterling may abate ahead of the BoE’s November meeting, but efforts by the new government to prevent a ‘hard Brexit’ may fail to bear fruit as the EU remains reluctant to starting negotiations until Article 50 of the Lisbon Treaty is enacted.

At the same time, economic activity in the U.S. is anticipated to pick up in the third-quarter, with the growth rate projected to increase an annualized 2.5% following the 1.4% expansion during the three-months through June, but a marked slowdown in the core Personal Consumption Expenditure (PCE), the Federal Reserve’s preferred gauge for inflation, may drag on interest-rate expectations as central bank officials continue to warn ‘surveybased measures of longer-run inflation expectations were little changed, on balance, while market-based measures of inflation compensation remained low.’ Even though the Federal Open Market Committee (FOMC) appears to be following a similar path to 2015 and talks up expectations for a December rate-hike, New York Fed President William Dudley, St. Louis Fed President James Bullard, Chicago Fed President Charles Evans, Governor Jerome Powell and Atlanta Fed President Dennis Lockhart may continue to endorse a ‘gradual’ path in normalize monetary policy as the central bank remains cautious in removing the accommodative policy stance. With that said, dovish remarks from the slew of Fed officials may undermine the near-term strength in the greenback especially as the central bank continues to reduce its longrun interest rate forecast in 2016.

Last week we discussed the changing of the guard at the top of the Reserve Bank of Australia. After ten years at the head of the bank, ex-Governor Glenn Stevens handed over the reins to Dr. Phillip Lowe last month. And while the Australian economy has now went 25 years without an actual recession, a lack of inflation as global growth has cooled has raised some very serious questions about sustainability of Australian growth.

Global markets are still very much in the ‘getting to know you’ stage with Dr. Lowe. This week marked his first speech as the head of the RBA, and while markets had little expectation for any near-term moves on rates; Dr. Lowe struck a balanced tone towards future cuts that helped to drive the Australian Dollar higher in the first three days of the week, with AUD/ USD setting a fresh two-month high. In this speech, Dr. Lowe highlighted the fact that current low levels of inflation are not unprecedented in the Australian economy. He went on to note that since June of 1993, inflation has been below the bank’s 2% target approximately 24% of the time. But on the other hand, inflation has been above the bank’s 3% target roughly 23% of the time. Dr. Lowe continued by saying ‘what is important is that we deliver an average rate of inflation consistent with the medium-term target.’

While this does add a bit of opacity to future rate moves out of the bank, it does show that Dr. Lowe is taking a ‘big picture’ look at the situation with a great deal of historical context regarding near-term rate moves. It appears that he’s diverging from many of his contemporaries at other major Central Banks that are expressing grave concerns around lagging inflation and slower growth. This could be a positive for an Australian currency that’s dropped by -31.4% from the highs set in 2011.

While rate cuts might seem like a quick way to restore a bit of growth with some inflationary pressure, the simple fact of the matter is that this transmission mechanism appears to have seen diminishing marginal returns in many developed economies; namely Japan and Europe - each of whom went to negative rates in the recent past, but have yet to see any signs of promise or benefit in growth or inflationary numbers. While Australian rates might get nudged down in the near-future (after Q1, 2017 most likely, if at all), the RBA also has to contend with elevated asset levels in key markets, particularly real estate. This creates an uncomfortable scenario for Australian investors, and will likely need to be addressed by macro-prudential measures from the RBA should growth and inflation numbers continue to slow while asset prices remain high. This just further adds to the opaque nature of current economic projections for the Australian economy, in which slowing growth and elevated asset prices create divergent forces for the RBA to simultaneously contend with.

One benefit of this opacity is the fact that it may actually offer traders an amount of near-term clarity regarding Australian data prints. While many currencies are being driven by some extraneous driver produced from the representative Central Bank, like the prospect of more QE, this doesn’t appear to be a concern at the moment in Australia. More likely, we’re going to see markets paying more attention to Australian data as somewhat of a direct driver in the Aussie, with special focus being centered on inflationary data.

Next week brings us such a data point: On Tuesday evening in the United States (Wednesday morning in Australia), 3rd quarter GDP will be released. Current expectations are looking for .5% Quarterly growth to go along with 1.1% annualized growth. Should this number come out above expectations, we’ll likely see some element of strength in the Aussie with a miss bringing weakness into the currency.

However, due to the still opaque nature of the fundamental backdrop for the Australian Dollar, as highlighted by the dual forces of slowing growth with elevated asset prices whilst a new Central Banker takes over the top job at the bank, the forecast for the week ahead will be retained as neutral.

Gold prices were on a firmer footing this week with the precious metal up 1.15% to trade at 1265 ahead of the New York close on Friday. The gains come despite continued strength in the greenback with the USD Index (DXY) rallying back into the 2016 open at 98.69 (highest levels since February). The rebound in bullion is likely to be short-lived however as the technical outlook continues to suggest that further losses are likely before registering a more significant low in price.

Highlighting the economic docket next week is the advanced read on U.S. 3Q GDP with consensus estimates calling for an annualized print of 2.5% q/q. The Core Personal Consumption Expenditure (PCE) will be of particular interest with market expectations calling for a slowdown to 1.6% q/q from 1.8% q/q. Keep in mind that this is the Fed’s preferred gauge of inflation and a softer than expected print could weigh on expectations for a 2016 rate hike. As is stands, Fed Fund Futures are pricing in a 68% likelihood the central bank will hike in December. Look for advances in gold to remain limited as the prospect of higher interest rates weigh on demand for the yellow metal as a store of wealth.

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