Dollar Extends Gains, GBP in Hot Seat with BoE

The mighty dollar's persistent strength is the biggest story of the day.  The greenback's broad based gains can be attributed entirely to the upward drift in Treasury yields and President Trump's promise of lower corporate taxes. Paul Ryan got the market excited this morning when he said their goal is for tax reform to become law by the end of the year. The Trump Administration had many setbacks but this is one area where the President should receive widespread Republican support because it is the party's best hope for a major legislative accomplishment before next year's midterm elections.  According to the House Ways & Means Chairman Brady, more details on their tax reform plans will be released on September 25th. So far, the market has been skeptical because the plan has been vague and while its still unclear how much progress has been made, setting a specific date to share more information gives investors hope which can go a long way. It helped investors shrug off the softer than expected producer price report that showed inflation growth rising less than expected in the month of August.  Tomorrow'sconsumer price report should be stronger with Hurricane Harvey driving up gas prices last month.  However today's move has taken the dollar to important resistance levels versus euro and yen that would be a perfect place for a profit taking or corrections. 

The U.S. CPI report is important but the big show tomorrow will be the Bank of England's monetary policy announcement. The BoE is widely expected to leave interest rates unchanged but with other central banks in the process or preparing to reduce stimulus, investors are looking to see if the BoE will do the same.  A lot has changed since their last monetary policy meeting in August. Six weeks ago, they voted 6-2 to leave rates unchanged, cut their forecasts for GDP and wage growth and expressed concerns about the economic implications of Brexit.  Since then we've seen consumer prices jump towards 3% and average weekly earnings growth accelerate from 1.8% to 2.1%.  These positive developments are encouraging but as shown in the table below the U.K. economy is not out of the woods.  While manufacturing activity accelerated, service sector activity slowed last month and most importantly, consumer spending took a hit from the prior slowdown in wage growth.  Yet the BoE is an inflation focused central bank which means it will be difficult for policymakers to ignore the rapid acceleration in price growth. They may try to downplay the increase but they could also suggest that the yield curve is too flat, implying that the market is underpricing the chance of tightening.  For this reason we expect a more hawkish BoE statement that will lead to an increase in interest rate expectations and the GBP/USD.  If the BoE votes 7-2 to leave interest rates unchanged and send a hawkish signal to the market, GBP will rise.  If Haldane who previously suggested tightening could be necessary dissents, leaving the vote at 6-3, GBP/USD will break 1.33 quickly and aggressively. However if they say they will look past the temporary rise in inflation and emphasize the uncertainties ahead along with the risks to growth, GBP/USD will slip below 1.3100.

Tonight's Australian labor market numbers will also have a significant impact on the Australian dollar.  AUD/USD peaked at the start of the week but a soft labor market report is necessary for continued weakness. According to the PMIs, both the manufacturing and service sectors experienced weaker job growth last month, which would be consistent with yesterday's softer business confidence report. We believe that the Australian economy is beginning to feel the strain of a stronger currency and data should start to reflect that.  The Canadian dollar ended the day unchanged against the greenback but with yields rising strongly and oil prices jumping 2.3%, we expect USD/CAD to reverse course and head back towards 1.21.  The New Zealand dollar on the other hand fell in lockstep with AUD and actually experienced steep losses comparable to the moves in EUR and GBP.  New Zealand consumer confidence numbers are due for release this evening but Australian data and China's retail sales + industrial production reports should have a more significant impact on the currency.

Last but certainly not least, EUR/USD broke below 1.19 today.  With no major Eurozone economic reports scheduled for release this week, the currency took its cue from the market's voracious appetite for U.S. dollars. Eurozone fundamentals have not changed. The ECB is still planning to reduce asset purchases next month but it will be difficult for EUR/USD to rise until the dollar stops falling.  We still like buying EUR/USD on dips so if you've got tolerance for a stop near 1.17, today's move down to the 20-day SMA would be the a good place to start scaling into a long position.  The Swiss National Bank also has a monetary policy announcement tomorrow and their meeting will be far less eventful than the BoE's.  The SNB is widely expected to leave interest rates unchanged and they will continue to call for a weaker currency, showing no signs of moving towards tighter policy.