By Michael O’Neill
The value of a currency used to be measured by a stated quantity of gold. Between 1893 and 1933, American’s could give the US government $20.67 and receive an ounce of gold.
Currency valuations are a tad more complicated in 2017. The “gold standard” is long gone. The world’s major currency values aren’t “pegged” to a benchmark but instead are “floating” with exchange rates determined by the market.
Central bank monetary policies are the building block for a host of economic factors that impact FX rates. These include, but are not limited to, interest rates, trade data, inflation, employment, consumer confidence, commodity prices, and geopolitical issues. The importance of a single data point changes with whatever is the current focus.
That brings us to today. FX markets have been volatile and erratic but ultimately, directionless. Uncertainty is the Gold Standard.
FX traders are not starved for information or data. Far from it. There have been central bank meetings, policy statements and press conferences. Key economic reports have been released. There have been major geopolitical issues, commodity price volatility and threats to Trade pacts. And still, the US dollar cannot find any direction.
Since the beginning of October, the “big-three” currency pairs, have been stuck in narrow ranges. EURUSD in a 1.1550-1.1875 range, USDJPY in a 111.50-114.75 band and GBPUSD in 1.3030-1.3340 range.
The Bank of Canada may have the answer.
Deputy Governor Carolyn Wilkins said that “Uncertainty can affect monetary policy actions” in a speech in New York on November 15. Sure, that’s like announcing “water is wet.” But she does have a point.
There is a lot of uncertainty in the world. Will North Korea launch nuclear missiles? Will Saudi Arabia/Iran tensions escalate? Will China continue to annex the South China Sea? Will Russia continue to absorb former USSR states? Will ISIS strike New York?
Geopolitical risks aside, there are major US monetary policy concerns, particularly the composition of the Federal Reserve. Jerome Powell is replacing Janet Yellen as Fed Chair. President Trump is supposedly considering nominating perceived hawkish candidates, John Taylor, and Kevin Warsh to fill vacant seats. A hawkish slant to the FOMC risks higher US interest rates sooner rather than later.
The ongoing US tax report debate has been a source of volatility for the greenback. President Trump’s plan to slash corporate and personal tax rates have supported the US dollar. Failure to pass the legislation would be detrimental to the currency.
Trade deals are another source of uncertainty. Brexit negotiations do not seem to be going very well for the UK. Prime Minister Theresa May’s government majority is slim and shaky and may hurt Britain’s bargaining position. The European Union is reportedly demanding €50 billion as part of the Brexit divorce bill. The UK is considering €22 billion. The EU has said that the divorce bill must be settled before the discussion of future trade talks can begin. If Brexit negotiations fail, Euro and Sterling currency disruption could spread to other currencies.
The NAFTA renegotiation is messy and a major source of uncertainty. The going fifth round of negotiations kicked off in Mexico on November 15. US Commerce Secretary Wilbur Ross said he is willing to play “hardball” because Canada and Mexico have the most to lose if the deal is scrapped. Canada is challenging US Softwood Lumber Tariffs, imposed earlier, under Article 19, the existing dispute resolution mechanism. (The Americans want Article 19 scrapped, if there is a new agreement) If Mr Ross is playing hardball, Canada just beaned him.
The Bank of Canada says that they haven’t included NAFTA scenarios in their forecasts.
Oil price volatility triggered sharp moves in G10 currencies this week. Saudi Arabia Crown Prince Mohammed bin Salman has gone to great lengths to protect and solidify his power in the Kingdom. He said he was willing to extend oil production cuts beyond the March 2018 date. Opec has forecast rising oil demand out-pacing supply in 2018 which helped to drive West Texas Intermediate (WTI) prices to $57.83 last week. This week, the International Energy Association seemed to contradict that claim. They predicted slower growth and rising production in the year ahead.
BoC Deputy Governor Wilkins said in her November 15 speech that one of the reasons that the Bank of Canada left interest rates unchanged was because inflation stayed at the lower end of its targeted 1-3% band. The BoC is unsure of the reasons for the low level, and that uncertainty led to inaction.
The lack of direction in the majors, and the Bank of Canada’s shift to “uncertain” from “neutral” has affected Canadian dollar trading as well. USDCAD has bounced within a 1.2440-1.2912 band and is in a short-term uptrend while prices are above 1.2690
The week ahead will be busy and illiquid. There will be month end portfolio rebalancing flows, FOMC minutes release and a barrage of US economic data. It is also American Thanksgiving week. The US dollar reaction is certainly to be uncertain.