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FX Update - Bond market volatility increases dramatically

Written by Ian Dobbs on June 9th, 2015.      0 comments

Market Overview:
Long term interest rate markets had a wild ride last week with yields moving significantly higher in many countries. Germany led the way with 10 year yields approaching 1.0% after being as low as 0.05% in mid-April. This move comes in the face of the ECB quantitative easing programme, which should put downward pressure on yields. The implications of the bond market rout are open for debate. It’s not uncommon for the bond market to lead broader moves in the wider economy, and maybe the move higher in yield is signalling a pickup in inflation is just around the corner. More likely however, is that what we have seen recently is exactly what a number of officials have warned about over recent months. Liquidity in many key interest rate markets is not what it used to be with central banks owning huge amounts of the debt on issue. In an environment where the US, and even the UK, are moving closer to the point where they try to ‘normalise’ monetary policy, the result will be increased volatility and markets may have to get used to moves of this magnitude.

Data from Australia last week proved to be something of a mixed bag. Although GDP for the first quarter was stronger than forecast at +0.9%, it was followed by a couple of disappointing results from retail sales and the trade balance. It seems the first quarters surprisingly strong growth is unlikely to carry over into the second quarter. A bank holiday in Australia yesterday has meant a very quiet start to the week, although over the coming days we do get business confidence, consumer sentiment, inflation expectations and employment change data to digest. Reserve Bank of Australia (RBA) Governor Stevens is also due to speak tomorrow afternoon.

New Zealand
There is only one focus in New Zealand this week and that is on Thursday’s Reserve Bank of NZ’s (RBNZ) interest rate decision and monetary policy statement. The market is split right down the middle with half calling for a 0.25% rate cut, and the other half suggesting the bank will remain on hold. Those calling for a rate cut this week sight persistently low inflation, further declines in dairy prices, very tame wage gains, and the implementation of macroprudential tools to curb housing investors. On the other side of the coin we have those who believe that although an interest rate cut may well eventually come, either late this year or sometime in 2016, we are unlikely to see one on Thursday. The RBNZ’s new investor restrictions don’t come into effect for a couple of months yet, low inflation is mostly driven by the tradable sector, and demand across the economy is still strong. The RBNZ would seem to be jumping the gun just a touch with a cut now, considering they increased interest rates less than a year ago. Either way we should be in for an interesting morning on Thursday.

United States
Last week finished on a high note for the United States with some very solid employment data. Up until that point we had seen some very mixed results which had failed to give a clear picture of how the economic recovery was tracking. However, Friday’s non-farm payrolls data was unquestionably strong. The US economy added 280k jobs, which was well above the forecast of 225k. Wages also increased more than expected jumping 0.3% month on month, up from 0.1% last. The unemployment rate did tick up to 5.5% from 5.4%, but this was due to an increase in the participation rate as more people enter the labour force. Without a shadow of a doubt data like this screams out for a rate rise in September. The Fed will find it hard to justify keeping interest rates at near zero percent with employment growth of this magnitude. The missing element of the US recovery so far has been consumer spending which has been very sedate considering the improving jobs picture. That is why the Fed will be especially happy to see the better than forecast wage growth, and that in itself may be enough to convince the ‘doves’ within the Fed that consumer spending will eventually improve. The USD jumped higher across the board on the back of the data. Releases to watch out for this week include retail sales, producer prices and consumer sentiment.

United Kingdom
The Bank of England (BOE) left interest rates unchanged at 0.5% when they met last week and chances of a rate hike this year took a big hit with the release of much weaker than forecast services PMI data. Service sector PMI dropped to 56.5 from 59.5 prior and it’s especially important as it accounts for nearly three quarters of the UK economy. BOE Governor Carney is set to deliver a speech this week on Thursday and the market will be keen to get a feel for his take on the current state of the economic recovery. Ahead of that release we have data on manufacturing production, industrial production and the NIESR’s estimate of GDP. The UK’s Confederation of British Industries (CBI) recently revised their growth forecasts for the UK economy. They now expect GDP in 2015 of 2.4%, down from 2.6% prior, with inflation beginning to accelerate from late 2015. They cite the major risks to their outlook as being a sluggish Eurozone, Greece, and the UK’s EU referendum.

Data out of Europe over the past week has been supportive of the economic outlook going forward. There is certainly still a lot of room for improvement, but indications are that a gradual and sustained recovery may well be taking hold in the Eurozone. Last week saw improved inflation readings, better than forecast services PMI, solid retail sales data and small drop in unemployment. Crucially we have also seen very recently, better than expected outcomes from German factory orders, and German industrial production. Germany really is the engine room of Eurozone growth and it will continue to be key in driving a broad based recovery in the region. I wish I could say we were closer to some sort of finality in the never ending Greek debacle, but the truth is the situation is no clearer. Greece’s recent move to ‘bundle’ payments to the IMF at the end of the month has just bought more time for posturing and talk. The two sides have been in negotiations ever since the Syriza party came to power in late January and a deal is still far from certain. Greek banks are bleeding money as funds flee the country in fear of a Greek exit from the currency union. Whether or not the Greek government actually had the funds to pay the IMF payment that was due last week is open for discussion. Without a shadow of a doubt, they do not have the ability to make the now ‘bundled’ payment due later this month. So another deadline looms, although we have seen a number of those come and go over the past few months. Greece poses the biggest risk to Eurozone growth in the near term and they need to get some finality to the situation so region, and Greece itself, can move forward. Data from Europe over the rest of this week is mostly a second tier affair so unfortunately, headlines regarding Greece will continue to draw the most attention.

Last week saw generally positive data from Japan with the highlight being a sizable jump in average cash earnings figures. Yesterday we got the final reading of first quarter GDP and this was significantly higher than forecast. GDP came in at +1.0% quarter on quarter, versus +0.7% expected. There was also solid growth in capital expenditure which increased 2.7% from the prior quarter. The preliminary reading had capital spending at just +0.4%. These were very positive numbers and will make pleasant reading for the Government and the Bank of Japan (BOJ). Still to come this week we have the economy watchers sentiment, consumer confidence, core machinery orders and tertiary industry activity data.

The United States wasn’t the only country to produce impressive employment data at the end of last week. Canada also released employment change numbers that came in well above forecast. The market was looking for a gain in employment of +10.2k but the actually number printed at +58.9k. That’s the strongest gain in seven months. Full time employment was up 30.9k while part time jobs gained 27.9k. The unemployment rate remained steady at 6.8%, thanks largely to an increase in the participation rate. This result comes on top of last week strong Ivey PMI data and it certainly adds weight to Governor Poloz’s optimistic view for the remainder of 2015. The Canadian dollar made good gains on the back of the data and it should remain broadly supported over the coming week. Tonight we get building permits data and then later in the week we have the new house price index and a speech from Poloz to digest.

Major Announcements last week:
  • Global Dairy Trade Price Index -4.3%
  • Australian GDP 0.9% vs 0.7% expected
  • UK Services PMI 56.5 vs 59.2 expected
  • ECB leaves interest rates unchanged at 0.05%.
  • Canadian Trade Balance -3.0b vs -2.1 b expected
  • US ISM Manufacturing PMI 55.7 vs 57.1 expected
  • Australian Retail Sales 0.0% vs 0.7% expected
  • Australian Trade Balance -3.89b vs -2.17b expected
  • BOE leaves rate unchanged at 0.5%
  • Canadian Ivey PMI 62.3 vs 55.1 expected
  • Canadian Employment Chance +58.9k vs +10.2k expected
  • US Non-farm Payrolls Change +280k vs +225k expected