How US Government Shutdown is Good for USD and Stocks
Posted on: 21 January 2019 , by: Boris & Kathy , category: Market Review
For the first time this year, we’re seeing renewed demand for U.S. dollars and it is not due to risk aversion. U.S. stocks ticked up every day last week, driving equities higher across the globe.
Britain’s all important Brexit vote did not have the catastrophic impact on the markets that everyone feared even though Prime Minister May lost by a wide margin. Investors are also looking forward to China Vice Premier’s visit to the US at the end of the month in the hopes that trade tensions will begin to thaw. Sterling was the best performing currency this past week followed by the U.S. dollar. The Swiss Franc and New Zealand dollars sold off the hardest. There are three things to watch in the week ahead – 1) Plan B for Brexit - due Monday, 2) US Government Shutdown, 3) Non-US data. The third category is a big one because it includes the European Central Bank rate decision but unless the US government shutdown ends, currencies such as EUR, AUD and CAD will be driven by domestic rather than global news.
- Empire State Manufacturing Index 3.9 vs. 10.0 Expected
- PPI Final Demand MoM -0.1% vs. -0.2% Expected
- PPI ex Food and Energy MoM -0.1% vs. 0.2% Expected
- NAHB Housing Market Index 58 vs. 56 Expected
- Fed Beige book reports economy growing in most of us as weak spots emerge
- Philadelphia Fed Index 17 vs. 9 Expected
- Industrial Production 0.3% vs. 0.2% Expected
- University of Michigan Consumer Sentiment Index 90.7 vs. 96.8 Expected
- Existing home sales – Potential for downside surprise as rising interest rates reduce housing demand
- Durable goods orders – Softer manufacturing activity should translate into weaker demand for durable goods
- New home sales - Potential for downside surprise as rising interest rates reduce housing demand
- Support 108.00
- Resistance 110.00
Why US Government Shutdown is Great for Stocks
The U.S. government shutdown has been great for stocks because it delays a number of economic reports that would have otherwise confirmed that the economy is losing momentum. No news is good news for U.S. assets such as the dollar and stocks. While the short list of data that was released was not entirely negative, there’s no doubt that the trend of growth is lower. Manufacturing activity improved in the Philadelphia region, but activity eased to its weakest level since May 2017 in the NY area. Producer prices dropped less than expected but it still declined for the first time in 4 months. Consumer confidence also hit a two year low according to the University of Michigan which is concerning because sentiment has a direct impact on spending. Major reports such as retail sales and the trade balance have been delayed due to the shutdown and while government shutdowns don’t tend to inflict lasting damage on the economy, its never gone on for this long so the pain will certainly be greater. Now in its fourth week, the shutdown could take more than 0.5% off growth as 800,000 government workers who are not getting paid cut their spending and investment.
The stalemate could end soon, as the Trump Administration grows anxious. Tens of thousands of workers are being called back to work and are promised at least one pay period. Unfortunately, the White House has shown no signs of relenting with Trump hitting back at Pelosi’s call to delay or cancel his state of the Union address by cancelling her trip to visit troops in Afghanistan. It's not clear how long much longer President Trump will put the economy and the country in limbo through his attempt to strong-arm the Democrats in providing funds to build a border wall.
- German CPI revisions 0.1% vs. 0.1% Expected
- EZ Industrial Production -1.7% vs. -1.5% Expected
- EZ Trade Balance 15.1B vs. 12.6B Expected
- EZ CPI 0% vs. 0% Expected
- ECB Rate Decision – No changes expected but they could be cautious given recent ECB comments and data disappointments
- German and EZ ZEW survey – Potential for downside surprise given recent weakness in EZ data
- EZ and German PMI Manufacturing & Composite - Potential for downside surprise given recent weakness in EZ data
- German IFO report – Will have to see how ZEW and PMIs fare but potential for downside surprise given recent weakness in EZ data
- Support 1.1300
- Resistance 1.1500
Will the ECB Send EUR/USD Below 1.13?
Euro did not see one day of gains this past week, and further losses are likely ahead of the European Central Bank’s monetary policy meeting. Many ECB officials have described Euro-area growth as slowing and expressed concerns that the risks are to the downside. We expect ECB President Mario Draghi to do the same because not only has the economy lost momentum but a disorderly Brexit remains a serious threat to euro-area growth. Last week he said recent economic developments were weaker than they expected and with uncertainties, especially global risks still prominent, significant stimulus is needed because the slowdown could be longer than expected. Taking a look at the table below, although there have been upticks in German labour market activity and spending, inflation is falling with manufacturing and business activity weakening. This week, we’ll get updated investor sentiment and PMI reports before the rate decision, but even if there are improvements (and we don’t think there will be), the central bank has made their concerns very clear. The tone of Draghi’s press conference will be dovish as he expresses concerns about uncertainty, stresses the need for continued stimulus and squashes expectations for a rate hike. If data surprises to the downside and Draghi is dovish enough, we could see EUR/USD fall to 1.12 easily.
- CPI 0.2% vs. 0.2% Expected
- Core CPI 1.9% vs. 1.8% Expected
- CPI YoY 2.1% vs. 2.1% Expected
- PPI Input -1% vs. -1.4% Expected
- PPI Output 0.2% vs. 0.1% Expected
- Retail Sales –0.9% vs. -0.8% expected
- Retail Sales ex Auto fuel -1.3% vs. -0.8% Expected
- UK Employment Report – Potential for downward surprise because job growth slowed in services and construction with significant drop in services. No update on manufacturing
- Support 1.2700
- Resistance 1.3000
What is Plan B – 3 Main Scenarios?
Prime Minister May suffered a staggering defeat last week as her Brexit withdrawal agreement was rejected by a vote of 432 to 202. She survived a no-confidence vote, but now she must present a backup plan to Parliament by Monday. Before we get to the possible scenarios, sterling’s reaction to further Brexit uncertainty has been remarkable. Instead of falling, it hit a two month high of 1.30. As the market had ruled out a victory days before the Brexit vote, the recovery in GBP reflects expectations for an extension of Article 50 and the diminished possibility of a no deal Brexit.
We think May has no choice but to ask the EU for more time, which is why on Monday, they will look to extend Article 50. After that, it goes to vote by other EU member states who are widely expected to approve the request. However, don’t expect an open-ended extension. The European Parliament’s Brexit coordinator Verhofstadt suggested that he’s open to pushing the deadline to May and not beyond that because he doesn’t want Brexit opinions to spill over to European parliamentary elections. But an extension can’t be the only element of Plan B. May will need to decide what course to take in the coming months – either a Norway style model or a permanent customs union or relent to a second referendum – all of which should be positive for GBP. However, after winning her no-confidence vote, May made it clear that leaving with no deal cannot be ruled out. Although unlikely, if she does not request for an extension, paving the way for a no deal Brexit GBP will crash even if Parliament responds by taking control of Brexit negotiations.
Here are the 3 possible scenarios for Plan B
- 1)Delayed Exit Request > Leading to Norway style deal or permanent customs union
- 2) Delayed Exit Request > Leading to second referendum
- 3) No Delay Exit Request > No deal Brexit
The Parliament is scheduled to debate and vote on Plan B on January 29th.
AUD, NZD, CAD
- Westpac Consumer Confidence 99.6 vs. 104.4 Previous
- Consumer Inflation Expectations 3.5% vs. 4% Previous
- Home Loans -0.9% vs. -1.5% Expected
- Card Spending Retail -2.3% vs. -0.4% Expected
- REINZ House Sales -12.9% vs. 2.6% Previous
- Business PMI Manufacturing Index 55.1 vs. 53.7 Previous
- Existing Home Sales -2.5% vs. -1% Expected
- CPI MoM -0.1% vs. -0.4% Expected
- CPI YoY 2% vs. 1.7% Expected
- Employment Report – Potential for downside surprise as employment weakened significantly in services and manufacturing sectors
- PMI Services – Potential for upside surprise given strength in manufacturing
- Q4 CPI – Potential for downside surprise give drop in food prices
- Retail Sales – Potential for upside surprise given the robustness of the labor market
- Support AUD .7100 NZD .6700 CAD 1.3200
- Resistance AUD .7200 NZD .6800 CAD 1.3400
AUD and NZD – Potential for Further Weakness
The primary reason why the New Zealand dollar sold off more than its peers last week is because it surged at the beginning of the year. NZD and AUD benefitted significantly from the improvement in risk appetite early January but failed to rise despite the ongoing recovery in US stocks last week. Part of that had to do with data as New Zealand reported weaker card spending and house sales, but manufacturing activity also improved and dairy prices are finally moving higher. For the past three months, NZD had bigger moves than AUD and this is largely due to position adjustments. We saw more of that this week as AUD/USD traded in a narrow range while NZD/USD broke down even as data from Australia was worse than New Zealand – the latest reports show consumer confidence, inflation expectations and home loans falling from the previous period. In the week ahead, data should play a bigger role in the performance of AUD and NZD with Australian employment and New Zealand CPI scheduled for release. The risk is to the downside for both reports so further weakness is likely.
CAD – Supported by Oil and CPI
Like AUD, the Canadian dollar ended the week virtually unchanged against the greenback thanks to the recovery in oil prices and a stronger than expected inflation report. Although prices continued to fall in the month of December, economists had been looking for a steeper decline. Investors were also relieved to see year over year retail sales growth rise back to 2% from 1.7%. Retail sales are scheduled due this week and despite strong job growth, economists are looking for a steep decline.
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