The U.S. dollar traded higher against most of the major currencies this past week. Unfortunately the strength was driven by risk aversion and not healthier data.
This can be confirmed by the fact that the Australian dollar was the worst performer and the Japanese yen the best performer. High beta currencies tend to perform poorly when investors are nervous whereas the yen is generally bid up under these same conditions.
Geopolitical risks are front and center for forex traders this month with terrorist attacks in Russia and Sweden and the U.S.’ airstrikes in Syria putting investors on edge. U.S. data took a backseat to these developments, resulting in a messy to end to a busy trading week. The Chinese – U.S. Summit ended the best way possible – with no shots fired from either side. Instead, President Trump said “tremendous progress” was been made and declaredthe U.S.’ relationship with China as “outstanding.” Without going into details he also said “I believe lots of very potentially bad problems will be going away.” In a statement released by China, President Xi told Trump, "We have a thousand reasons to get China-US relations right, and not one reason to spoil the China-US relationship." While Chinese President Xi won’t be happy with the U.S.’ attacks on Syria (as their views are more closely aligned with Russia), this was the best ending that the markets could have hoped for from one of this week’s most dangerous event risks.
Meanwhile we believe that the weakness in March non-farm payrolls will come back to haunt the dollar as the market looks forward to the latest U.S. consumer spending and inflation reports. Geopolitical risks and softer U.S. data could keep investors risk averse, leading to weakness in USD/JPY and other high beta currencies like the euro. The U.S.’ decision to take direct military action in Syria is shifting U.S.-Russian relations and that could be bad news for the markets. Fox News reported that a Russian warship has entered the eastern Mediterranean heading toward 2 US Navy destroyers that launched airstrikes last night. Yet many investors may be confused by the quick recovery in the U.S. dollar post payrolls but the move was driven by a combination of short covering, positive outcome to the U.S. / Chinese Summit and a flight to safety into U.S. dollars.
Finally sterling ended the week lower against most of the major currencies. Data has been mostly weaker and likely to worsen as the U.K. moves towards leaving the European Union. Although service sector activity accelerated, manufacturing and construction activity slowed in the month of March. Friday’s Halifax house price report, industrial production and the trade balance also missed expectations. Next week, we’ll get more insight into whether the hawkish dissent from BoE member Forbes at the last monetary policy meeting is justified. This past week’s data and the cautious comments from BoE member Vlieghe certainly puts her views into question. Vlieghe believes the BoE should be cautious as the U.K. consumer slowdown could intensify. The U.K.’s inflation and employment reports are scheduled for release next week. Inflation is an exceptionally important input into the central bank’s policy.
After trading in an exceptionally tight range for most of the week, the euro finally broke down on Friday, falling to its lowest level versus the U.S. dollar in 3 weeks. The move had nothing to do with data as German industrial production and trade activity improved in the month of February. Instead, ongoing terrorist attacks in Europe are making investors nervous about Marine Le Pen’s chances of becoming the next President of France. She is running on a campaign of anti-immigration, anti-terrorism and the latest polls show her virtually neck to neck with Emmanuel Macron going into the first round of voting on April 23rd. The latest terror attacks probably won’t make it into this week’s ZEW survey but we continue to expect the euro to trade with a heavy bias despite improving domestic conditions. At the same time, ECB officials are still worried about inflation – central bank President Draghi said this past week that it is clearly too soon to declare success on inflation and they need more inflation confidence to change their stance. As such, he sees no need to deviate from the wording of forward guidance even as the balance of growth risks seem to be shifting upwards. ECB member Constancio agrees that it is too soon to declare success on inflation and Praet believes rates should stay at present or lower level well past QE.