The Week Ahead: Some Like It Hot

Foreign Exchange: The Week Ahead
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Back in January, the Fed took a decisively dovish turn in its monetary policy stance.  Subsequently, Fed speakers have maintained this consistent dovish narrative despite the US economy running "hot" as illustrated by an unemployment rate of 3.8% among other economic data points. 

Certainly concerns over a global slowdown, combined with muted inflation expectations in the U.S., have played a role in the Fed's desire to be patient. To this point, central banks in other developed markets have seen the Fed's dovish turn and raised theirs another level.  As a result, the USD finds itself strong on the year despite the Fed's decisively dovish turn. 

But there is potentially another reason for the Fed's shift.  In a testimony to Congress, Fed Chair Powell noted that "we're trying to think of ways of making that inflation target highly credible, so that inflation averages around 2 percent, rather than only averaging 2 percent in good times and then averaging way less than that it bad times."

The key takeaway from this quote is that the Fed is potentially looking for inflation to average 2%, which means that during "good" times such as now, inflation needs to run hotter than 2% to compensate for undershoots during "bad" times.  Combining this quote with the steady stream of research coming out of the Fed evaluating possible changes to the Fed's approach to inflation indicates that we could be in line for a change in the Fed's inflation reaction function sooner rather than later. 

Inflation expectations are often informed by realized inflation.  Given that inflation has averaged around 1.6% since the Great Recession, there are signs that the Fed is starting to be concerned about unanchored inflation expectations to the downside.  With credibility of the Fed's target dependent on what the Fed does today, any change to the Fed's inflation reaction function—i.e. a willingness to deliberately overshoot 2% inflation--would most likely be implemented this business cycle. 

While the Fed still remains in the brainstorming stage, an adoption of the view that overshooting 2% is "good" rather than dangerous raises the threshold for restarting the hiking cycle higher as well as helps explain the dovish pivot during a period of strong economic data. 


3/14 Japan Expectations for rates to remain unchanged at -0.10%


United States and Canada

3/11 Retail Sales Expectations for a print of 0.0% after a 1.2% decline
3/12 CPI Expectations for a gain of 0.2% after a 0.0% print
3/13 PPI Expectations for an increase of 0.2% following a -0.1% print
3/13 Durable Goods Orders Expectations for a decline of 0.6% 
3/14 New Home Sales Expectations for a small increase to 625k
3/15 Industrial Production Expectations for an increase of 0.4% after a -0.9% print


3/13 Industrial Production Expectations for a gain of 1.0% after a decline of 0.9%
3/15 EZ CPI YoY Expectations for a decline from 45.3 to 43.3
3/11 German Indust. Prod. Expectations for a gain of 0.4% following a -0.4%
3/12 U.K. Trade Balance Expectations for another large trade deficit
3/12 U.K. Industrial Prod. Expectations for a decline of 1.3% after a -0.9% print

Asia/Japan, and New Zealand 

3/12 Japan PPI YoY Expectations for a gain to 0.7% after a 0.6% print



The EUR finally broke down last week through the recent range that had lasted back to November on continued weak data from the dovish ECB report. There was a lot of chatter about longer term stop loss orders being executed on Thursday as the price fell through key technical levels. However, the euro recovered on Friday’s disappointing U.S. jobs report and corrected its way back into the same previous range. Expect more consolidation this week with much attention focused on the U.K. Parliament that could have spillover effects for the euro and EUR/GBP.


For those who have been following the GBP over the past few months, it has been a roller coaster ride of expectations. Most recently, the GBP has fallen seven consecutive days against the U.S. dollar as almost all of the positive expectations about either a soft Brexit or a delay to the March 29 deadline are baked in. This week will be critical as on 3 consecutive days, Parliament will be voting on various Brexit options that will help clarify the path the U.K. has chosen to further the negotiations with the EU. Expect the GBP to remain volatile.


While the correlation with the JPY and "risk-on" or "risk-off" strategies is not as strong as earlier in the year, the correlation remains workable. The JPY rose sharply during December as equities and interest rates cratered; as stocks have rebounded in January and February along with interest rates, the JPY has weakened. Global equities cratered again last week and the JPY has strengthened again. Continue to expect a similar trading pattern. 


RBC, our mothership, had forecast a range for the CAD for Q1 of 1.3600/$ to 1.3100$...we congratulate them on picking a top and bottom given the volatile times we are witnessing.  Despite two great job reports to start the New Year, other weak data, combined with a somewhat dovish Bank of Canada, is keeping the currency vulnerable in the short term as the market weighs continuing weaker global growth. Expect further consolidation this week.


The CNY has been benefiting from a number of fronts since the beginning of the year. The Chinese government and central bank have been using all monetary and fiscal means possible to keep the economy liquid and afloat. Continued positive expectations surrounding a successful conclusion to the U.S.-China trade deal also spurred demand for CNY but it appears, in the short term, that most of the good news has been baked into the price. Expect further consolidation this week.


The AUD reflects the recent bipolar nature of global equities and interest rates. December was a "risk-off" month and the Aussie weakened sharply reflecting all that pessimism and negativity. January and February got off to a great start with more optimism for equities and interest rates, and the AUD rebounded slightly. Markets continue to remain concerned about the Chinese economy; the potential downstream effects for Australia's economy remain strong keeping the currency under pressure as Aussie interest rates continue to fall. 
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