Building trade war risk remains key focus for FX market

FX Daily Commentary by Lee Hardman, Currency Analyst at Bank of Tokyo-Mitsubishi UFJ (A member of MUFG).

AUD: building trade war risk & RBA remains comfortably on hold

“The foreign exchange market has remained very stable during the Asian trading session. The key focus in the foreign exchange remains the ongoing shift to more protectionist US trade policies which is keeping the US dollar on the back foot against the other major currencies. The traditional safe haven currencies of the yen and the Swiss franc have been the main beneficiaries amongst G10 currencies so far this year, while the Canadian dollar and the Australian dollar have underperformed. The Canadian economy would be hit hardest by the imposition of steel and aluminium import tariffs. The outlook for other commodity currencies such as the Aussie would turn more negative if trade tensions continued to escalate, and thereby materially increasing downside risks to global growth. Bloomberg has reported overnight that White House economic adviser Gary Cohn is summoning executives from US companies that depend on aluminium and steel to meet with President Trump this week in a last ditch effort to halt the imposition of import tariffs. Top Republicans such as House speaker Paul Ryan have also expressed concern. Yet President Trump has stated clearly that “we’re not backing down”.

Source: Macrobond

It is not just the more risk averse trading conditions which have been weighing on the Aussie at the start of this year. The Aussie has also been undermined by the modest paring back of RBA rate hike expectations. Market participants have become less confident that the RBA will begin to raise interest rates later this year. The RBA left is key policy rate unchanged overnight for the nineteenth consecutive month, and they continued to signal that it remains comfortable to keep their current policy stance for the foreseeable future. The statement contained only marginal tweaks. The RBA now judges that “the rate of wage growth appears to have troughed” although wage growth and inflation is still described as “low”. The RBA would like to see evidence that the tightening labour market is feeding through to stronger wage growth before signalling a shift to tighter policy. As a result it leaves the Aussie without a positive catalyst in the near-term.

EUR: risk of anti-establishment alliance has eased

The euro and European financial markets have largely shrugged off the results from the Italian election almost as if it had not even happened. Financial market participants have been encouraged by comments yesterday from Northern League leader Matteo Salvini who stated that “the centre-right is the coalition that won, it’s the coalition that can govern”. He also stated that he won’t consider “bizarre” coalitions with other groups. The comments have helped to ease some initial concerns that the Northern League could consider forming an alliance with other anti-establishment parties such as the Five Star Movement and even the Band of Brothers which would have a majority. In contrast, the centre-right parties lack a majority to govern and would require support from other partiers. It still leaves the make-up of the new government uncertain. The new government when formed is expected to prove unstable. Nevertheless, we remain of the view that political developments in Italy are unlikely to justify a weaker euro in the near-term as economic growth and financial stability in the euro-zone will not be seriously challenged at the current juncture

GBP: upside potential for the pound remains in place

The pound continues to remain on a softer footing in the run up to the upcoming EU Leaders Summit on the 22nd and 23rd March. Recent comments from EU officials have dampened expectations that a Brexit transition deal can be reached as soon as this month. In contrast, UK Prime Minister May has struck a more optimistic tone. She stated in her keynote speech on Friday that “we are close to agreement on the terms of an implementation period which was a key element of December’s deal”. She added yesterday that further progress is expected in the coming days. The comments support our optimism that a transition deal can still be achieved quickly. We expect the UK government to make strong efforts, similar to at the end of last year, to secure a transition deal which is a key part of their strategy for a “smooth & orderly” Brexit. We have also been encouraged by the domestic reaction to Prime Minister May’s speech last week on future relations with the EU, which was welcomed by hard Brexit supporters and more pro-EU members of the government. It has helped at least temporarily to ease concerns over political stability in the UK.

If a transition deal is secured in the coming months, it would leave the door open for the BoE to raise rates again in May. The release yesterday of the latest services PMI survey surprised to the upside as it increased by 1.5 point to 54.5 in February. Markit noted that it was consistent with GDP growth of 0.4% in Q1 which should prove sufficient for the BoE to hike again in May. The bad weather this month could have some dampening impact on growth in Q1, although it will be only temporary. Overall, we continue to see scope for the pound to strengthen in the coming months.”

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