Marshall Gittler's Market Outlook: EUR soars, AUD plunges; UK employment data, US CPI & retail sales

Market Recap

A soaring EUR and collapsing AUD were the big features of the day overnight. EUR started rallying after German Q3 GDP beat expectations (+0.8% qoq vs +0.6% expected, +0.6% previous). This despite the fact that the second estimate of overall EU growth for Q3, announced three hours later, was unchanged from the first estimate. It demonstrates that once again, German economic statistics are more important for EUR than EU-wide statistics.

AUD’s move was in response to weaker-than-expected data on wages, which rose +0.5% qoq in Q3 vs +0.7% expected (+0.5% previous). The move surprised me because this indicator usually doesn’t affect the FX market that strongly and indications are that most market participants don’t follow it that closely. Last time it missed expectations (16 Nov 2016) the currency was virtually unchanged an hour later. This time though the currency collapsed immediately after the announcement and just kept falling.

Note that there was a larger-than-usual increase in the minimum wage on 1 July, which suggests that wage increases for other employees were much lower than expected.

As in most other countries, the Reserve Bank of Australia (RBA) has said it is looking for wages to increase as unemployment falls and for inflation to rise as a result. The figures were yet another data point showing that the historical relationship between unemployment, wages and inflation is no longer what it used to be in another developed country. That called into question the pace of RBA tightening. With commodity prices also falling – iron ore plunged 4%, oil was down 2.8% and copper off 2.3% — AUD is likely to continue under pressure for some time, in my view. Tonight’s Australian labor data may cause a temporary rebound though if it comes in as expected or better (see below).

USD was generally weaker as the global rout in stock prices deepened and US Treasury yields fell further despite a much higher-than-expected US PPI. 10-year yields decline 3 bps Tuesday and were off another 2 bps this morning. Reports that Senate Republicans will include a repeal of a key part of Obamacare in the tax bill has caused some concern, because that may make it even more difficult to pass the bill. Watch today’s US CPI for direction (see below).

GBP was lower on a TWI basis probably because of the surge in EUR, but it gained against the weakening dollar – that says something about just how weak USD was, considering that the UK inflation data came out below expectations while the US PPI came out above expectations.

Oil plunged on a confluence of negative factors:  1) the International Energy Agency (IEA) said that the recent rise in prices plus milder-than-expected weather was slowing demand growth; 2) the American Petroleum Institute (API) reported that US inventories of crude oil jumped 6.51mn barrels in the latest week, as opposed to market expectations for a 2mn barrel decline; and 3) the recent indications of a slowdown in China. Combined with today’s restart of NAFTA negotiations (see below), I think this spells trouble for CAD.

Today’s market

The fifth round of NAFTA negotiations and discussions will begin today. The round is formally scheduled to take place from Friday to next Tuesday in Mexico City, but it’s been reported that some of the negotiating groups will begin meeting from today to start the talks. For CAD, one of the most contentious points is a US proposal to set minimum levels of US content for autos. That’s dangerous for Canada, because autos are Canada’s second-largest export (14% of total exports, vs 26% for #1, energy products,  and 12% for #3, minerals.)  After listening to Trump’s anti-free-trade tirades in Asia recently, I don’t see anything good coming out of this round for CAD or MXN.

Chicago Fed President Charles Evans and ECB Governing Council Member Ardo Hansson will both participate in a panel discussion on European monetary policy at a UBS European Conference in London.

The first indicator of the day is the UK labor market data. The market expects the unemployment rate to stay at 4.3% for the third month in a row, a level last seen in 1975, while the number of new jobs is forecast to remain positive but slowing to well below the recent trend. 

Wage growth is forecast to be little changed from the previous month. Note that wages are rising less rapidly than consumer prices, which were up 3.0% yoy according to yesterday’s CPI data. The UK experience is one of the more extreme examples of the global conundrum about the relationship between the labor market and wages – here we have the unemployment rate at the lowest level in 42 years, yet wages are actually falling in real terms. 

Putting politics and Brexit aside – something that can’t be done of course, but just imagine it could be – then the labor market is probably the key to Bank of England policy. A lower unemployment rate and faster pay growth would probably convince the Monetary Policy Committee (MPC) that inflation was well established back at normal rates due to domestic reasons and they should proceed to normalize interest rates. On the other hand, a higher unemployment rate and continued flat or below-inflation pay growth would mean little risk of inflation accelerating and probably result in them staying on hold. Personally, I expect the unemployment rate to rise and pay growth to remain sluggish as Brexit approaches and uncertainty rises. That suggests to me that the Bank of England is likely to remain on hold for the time being and GBP is likely to weaken.

ECB Executive Board member Peter Praet chairs the closing policy panel at the ECB conference on central bank communication, which began yesterday. Bank of England Chief Economist Andy Haldane will be on the panel as well.

Later in the day, BoE Deputy Governor Ben Broadbent speaks on “Brexit and Interest Rates” at the London School of Economics. Broadbent “will discuss some aspects of the impact of EU withdrawal on UK interest rates.” This should be an important event for the markets and I would recommend anyone with a position in GBP to pay close attention. Following the BoE’s recent rate hike on 2 November, Broadbent reiterated the MPC’s position in a radio interview when he said that “we anticipate we’ll need maybe a couple of more rate rises to get inflation back on track,” although he stressed that this was “not a promise.”

The US CPI is probably the key indicator out this week, even though it’s technically not the Fed’s preferred inflation gauge. The headline rate of year-on-year change is expected to decelerate, while the core inflation rate is expected to stay the same. This is not the kind of result that calls for an urgent Fed response and so it could be negative for the dollar. Furthermore, the core inflation figure has missed expectations six out of the last seven months, so there’s also the possibility of a disappointment. 

After a surge in September caused by people replacing the cars that got ruined in the floods, the headline US retail sales figure is forecast to be unchanged from the previous month – still a pretty good result after such a jump. Excluding autos and gasoline, retail sales are forecast to continue at last month’s monthly pace, which would still be good. This figure ought to be positive for the dollar, in my view. 

At the same time, the Empire State manufacturing index is expected to fall somewhat. Seeing as the previous month’s level was quite high for this series – it hasn’t been higher than that for a sustained period since 2004 – I don’t think this should be considered particularly worrisome.   

These three major US indicators don’t normally come out at the same time. Which one is likely to be the most important? That’s hard to say. In fact, all three seem to have a similar impact on EUR/USD, judging from the relationship between the “surprise” on the indicator and the subsequent movement of the currency. (In technical terms, they all have a similar r2, a measure of correlation.) In the case of both the CPI and the retail sales, the headline figure seems to exert a stronger influence on the market than the core (in the case of the CPI) or any of the adjusted figures (in the case of the retail sales).

I would suggest you watch those two – the headline CPI and the advance retail sales figure — plus the Empire State index, and see which way the surprises lean – that is, how do they differ from the consensus forecast? If the surprises are contradictory, then I would probably go with the bigger of the CPI or retail sales surprise. That is, for example, if the CPI surprises on the downside but the retail sales surprises on the upside, I expect EUR/USD would probably trade in the direction suggested by whichever surprise was bigger.

Finally, overnight Australia releases its employment data. The market expects the unemployment rate to stay at 5.5%, the lowest it’s been since 2013, and for employment to rise further. Although the forecast rise in employment shows some deceleration from the recent trend, it would still be the 13th consecutive increase in employment, the longest streak on record. The relatively healthy labor market should be a positive for the AUD. 

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