USD/CAD - Dollar Steady But Nervous on Eve of Federal Budget

There’s been lots to consider in the last few weeks for the Canadian dollar, not least because the world’s second and fourth largest countries by area are facing huge uncertainty over the future of the Free Trade Agreement which has been in place for almost 30 years. With the U.S. dollar on a weaker trajectory and a huge increase in stock market volatility, the loonie has not been unscathed. Over the past week it ended on net firmer against the U.S. dollar around $1.2550 but weaker against all the other FX majors. This morning in Europe, USD/CAD is up nudging $1.26.

Finance Minister Bill Morneau met at the end of last week with private-sector economists in Toronto ahead of next Tuesday's budget. According to Bloomberg, they discussed the impact of U.S. tax changes, as well as ongoing talks to revamp the North American Free Trade Agreement. Nothing concrete came out of the discussions though Scotiabank is quoted in the press saying, "You’ve got stuff like tax reform in the U.S., increases in carbon tax and minimum wages and you’ve got NAFTA uncertainty. There are a range of things that are weighing on business sentiment… one of the things that the business community (in Canada) would be looking to is a sense from the government that they are mindful of all the pressures that are on the business side.”

The Bank of Canada has raised rates three times since July 2017 and its next monetary policy meeting is on March 8, two days after the Reserve Bank of Australia and the same day as the European Central Bank. Money markets are indicating around a 70% probability of another hike by May, but it is not expected to come before then. This week brings official data on retail sales on Thursday then on Friday it’s earnings, hours worked and the Consumer Price Index numbers. Before then, wholesale trade numbers are released today. The Canadian dollar opened in North America at USD/CAD $1.2590, AUD/CAD $0.9940 and GBP/CAD $1.7605.

USD/CAD: Expected Range $1.2530 -- $1.2635

We welcome back our U.S. readers from their Presidents' Day holiday. While they were away, the U.S. dollar had another good day, albeit closing below its best levels seen during the European afternoon. Its index against a basket of major currencies had risen on Friday from a low of 87.95 to close around 88.75. Yesterday, it extended these gains up to 89.10 before slipping back to 88.85 as stock index futures lost 100 points then rallied back to flat at the end of the European day. It’s not clear what is the direction of causality here: whether the currency is driving stocks or vice-versa. If the causality isn’t clear, though, the correlation most definitely is and will be something to watch closely today, especially as the yield on 10-year U.S. Treasuries is at a cycle high of 2.91%.

Though U.S. stocks and the currency seem well-correlated (negatively) the U.S. dollar still isn’t getting any support from higher bond yields or the expectation of much higher short-term interest rates over the course of this year. Fed funds futures are fully pricing three 25-basis-point rate hikes and put the probability of the Federal Reserve raising rates four times this year at 25%versus just 17% immediately before last week’s U.S. CPI release. The overwhelming narrative among bank strategists is that the U.S. dollar is headed lower, if for no better reason than that is the prevailing trend. Morgan Stanley was the latest global investment bank to slash its medium-term U.S. dollar forecasts this morning citing "twin deficits" as its biggest concern.

The highlight of this shortened week ahead will probably be Wednesday’s release of the Minutes of the January 31 Federal Open Market Committee; just two days before the 666-point drop for the Dow Jones Industrial Average and the subsequent surge in volatility. Of course, the further 2,000-point drop and similar-scale rally seen over the last two weeks should make any conclusions from the minutes even more conditional and unreliable as policy signals than they usually are. But, as we’ve said before, there’s a whole army of Fed watchers who have to earn their living trying to sort the wheat from the chaff on every sackful of words from the Eccles Building. The U.S. dollar index opened this morning around 89.30; more than a full point above its recent three-year low of 87.95.

CAD/EUR: Expected Range $0.641 -- $0.6455

The euro had a pretty quiet Monday. Although EUR/USD fell more than half a point either side of lunchtime in Europe, moving from $1.2425 to $1.2370, it then rebounded back on to a $1.24 'big figure as U.S. stock index futures recovered their losses. Overnight in Asia and this morning in Europe, it has again fallen on renewed concerns about what may be happening in German politics.

Two German developments are unsettling currency investors. The first is that the 463,723 Social Democratic party members still have to decide whether to enter another grand coalition under Chancellor Angela Merkel. They have until March 2 to submit their votes, and the result is expected to be announced the following day. At a special SPD conference in January, only 60% of delegates voted to authorize their leaders to hold coalition talks with the conservatives.

"I am convinced we will get a majority,” Andrea Nahles, who senior SPD officials this week endorsed as the party’s future leader, told Der Spiegel magazine at the weekend. "I don’t have a Plan B." The second concern is that even if a coalition is approved, a poll published yesterday by the newspaper Bild put the Alternative for Germany (AfD) at 16%, showing that they are currently more popular than the Social Democrats (SPD). They entered the Bundestag for the first time in September after winning 12.6% of the vote. The party was set up in 2013 and fought the election of that year on an anti-euro platform. They are now the second most popular party in the country so don’t be surprised to hear much more from AfD over the coming months.

The ZEW survey of the current economic situation in the euro-zone’s largest economy slipped more than expected this month to 92.3, although the latest assessment of Germany’s performance is still the second-highest reading on record. The ZEW indicator is compiled from a survey of banks, insurance companies and in-house finance teams who are asked about their assessments and forecasts for interest rates, stock markets and exchange rates across a clutch of major global economies. It is obviously more prone to influence from short-term market developments and the fall in stock prices during the survey period may well explain much of this month’s decline. The euro opened in North America this morning at U.S. $1.2340 and EUR/CAD $1.5540.

CAD/GBP: Expected Range $0.5665 -- $0.57

The pound had a bit of a wobble on Monday and ended up sharing bottom spot in our one-day performance table with the New Zealand dollar, having at one point been on its own way below the rest of the pack, before a rally during the North American morning. GBP/USD stood around $1.4030 at lunchtime in Europe but then took a dive to the low $1.3960’s as the initial 100-point gain for DJIA futures turned into a near 100-point loss. As stocks recovered, so too did the 'cable' rate, even though it struggled to hold on to a U.S. $1.40 handle. Overnight and during the European morning it was lower once more, before rallying on unsubstantiated reports that the European parliament is in favour of a softer Brexit deal.

The U.K. Minister for Exiting the European Union, David Davis, is set to deliver a speech today to Austrian business leaders in Vienna. According to reports, he will say, "We will continue our track record of meeting high standards after we leave the European Union. Now, I know that for one reason or another there are some people who have sought to question that our intentions. They fear that Brexit could lead to an Anglo-Saxon race to the bottom, with Britain plunged into a Mad Max-style world borrowed from dystopian fiction. … these fears about a race to the bottom are based on nothing – not history, not intention nor interest." For all his soothing words, Davis retains the image of someone who would cross the street to start a fight about Brexit and traders are wary that any unscripted remarks could once again raise tensions between him and negotiators in Brussels.

According to an 'exclusive’ report in today’s Business Insider magazine, the European Parliament is putting together a 60-paragraph document outlining its desire for an "association agreement" with post-Brexit Britain, in a break from the position of chief EU negotiator Michel Barnier. The European Parliament is pushing for a future relationship with the United Kingdom which could allow for Britain to retain "privileged" access to the single market. This marks a break from the direction previously taken by the EU's negotiating team, which has instead suggested that Theresa May's negotiating red lines mean Britain may only have access to a Canada-style free trade deal. It is claimed the EU Parliament currently plans to put the resolution to its Brexit Steering Group around March 8, before it is adopted at a meeting of all MEPs, also known as a plenary, in mid-March. This report lifted the sterling half a cent from its earlier low, though we might not have to wait long until it is completely disowned or contradicted by official EU sources. The British pound opened in North America at USD $1.3975, GBP/EUR $1.1325 and GBP/CAD $1.7600.

CAD/AUD: Expected Range $1.00 -- $1.011

In a holiday-thinned session, it was noticeable on Monday how sensitive the Australian dollar was to moves in U.S. stock index futures – which were open for trading even as cash equities were closed. The high for the day for AUD/USD around $0.7935 came with the DJIA up around 100 points and when the market turned negative in the European afternoon, so too the Aussie fell back to just a few pips above $0.7900. Holding on to that psychological level was a positive, and technically it was good to hold above Friday’s $0.7895 low, but as U.S. index futures are indicating around 100 points off for the DJIA so it is being tested as we go to print.

After leaving interest rates unchanged for 16 consecutive months, the Minutes of the February RBA Board signaled more of the same ahead. Business conditions remained at a relatively high level and prospects for non-mining investment "were more positive than they had been for some time" but strong retail competition has exerted downward pressure on consumer goods and food for some time and was expected to persist "in the next few years". Indeed, "members noted that food prices, excluding fruit and vegetables, had been little changed for nearly a decade". After all the warnings from the Governor and Deputy Governor in recent speeches, the Minutes reiterated that, "There was still a risk that growth in consumption might turn out to be weaker than forecast if household income growth were to increase by less than expected. In an environment of high household indebtedness, consumption might be particularly sensitive to adverse developments in household income or wealth"

One thing is still clear after the minutes: on current published forecasts, both CBA and NAB cannot be simultaneously correct. CBA has erased the two rate hikes it had penciled-in for 2018 while the NAB still has them in its forecast profile. The standout call on Australian interest rates is still the one from Westpac which notes, "Given our long-held view that rates would remain on hold in 2018, we were encouraged to note that the minutes point out financial market pricing suggested that market participants expected the cash rate to remain unchanged during 2018 but had priced in a 25bps increase by early 2019. Neither the Bank nor the markets are onside with our call for steady policy in 2019 as well, but a continuation of this benign inflation environment, weak consumer and softening housing markets could easily convince the Bank of our case." Two years of unchanged Australian interest would surely weigh down on the currency which opened in North America this morning at USD $0.7895, with AUD/NZD at $1.0720 and AUD/CAD $0.9940.

CAD/NZD: Expected Range $1.072 -- $1.0835

The New Zealand dollar last week touched a fresh 2018 high of U.S. $0.7434 before slipping back to close more than a cent higher at $0.7390, which is where it spent most on Monday before then losing almost half a cent against a generally well-bid U.S. dollar. Against its Aussie cousin, the AUD/NZD cross couldn’t break Friday’s six-month low of $1.0705 and moved around a quarter of a cent higher as the day progressed.

Statistics NZ reported this morning that producer output prices rose 1.0% q/q in the fourth quarter of 2017, in line with expectations and unchanged from the previous three months. Higher output prices were up mainly due to dairy product manufacturing and higher oil prices. Producer input prices were up 0.9% q/q, shy of expectations for 1.0%, which would have been the same rate as Q3. The statisticians noted "Higher crude oil prices led to increased costs for many industries, including petroleum, forestry and logging, transport, construction, and farming." In the year to December 2017, producer output prices increased 4.7% and producer input prices 4.4%. The farm expenses price index increased 2.5%, while the capital goods price index increased 2.6%.

A separate survey from ASB bank today shows expectations that house prices will rise are at a six-and-a-half year low. Nationally, expectations that house prices would rise were a net 16% for the three months to December, down from 17% in the three months to October. Details showed expectations that house prices would rise in the South Island had lifted to a net 30% from 29%, led by Canterbury at net 11% up from 8% previously. Price expectations continued to ease in the North Island to net 20%, down from 23% in the previous survey. The New Zealand dollar opened this morning in North America at U.S. $0.7360 and NZD/CAD $0.9270.

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