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FX Update - China remains in focus

Written by Ian Dobbs on September 1st, 2015.      0 comments

Market Overview:
While the UK and US economies continue to grow at decent rates, the rest of the world isn’t look quite so healthy. The old saying that “when America sneezes the rest of the world catches a cold” is now more accurately applied to China. It certainly seems that growth in America isn’t flowing as before to other parts of the world. This is in large part because the US economy has shifted away from the consumption of goods, toward the consumption of services. China on the other hand has been the dominant consumer of raw materials and their slowing economy is reaping havoc on those who supply them. Confidence in the Chinese authorities’ ability to effectively manage the downturn has also taken a hit. Their failed efforts to stabilize the stock market with direct intervention suggests they are bumbling through this crisis just like many other countries would. This means the chance of a ‘hard landing’ in China is a very real outcome. The Chinese are also burning through their foreign exchange reserves, which were some of the biggest in the world. They are having to use them to support the Yuan which has seen a dramatic increase in capital outflows since the recent devaluation. Estimates are that the Chinese were forced to sell just over $100bln of US treasuries in the first two weeks after the devaluation. They may well be forced to devalue again over the coming months if that pace of capital outflow is maintained.

This week is a big one for economic releases from Australia. It starts with the Reserve Bank of Australia’s (RBA) rate statement later this afternoon and although no one is expecting a change in policy at this meeting, there are many who suggest another 0.25% cut could come in November. The market will be paying close attention to the central bank's rhetoric on China, global growth and commodity prices. The outlook for all three of those factors is less than encouraging and a confirmation of such from the RBA will be viewed as a critical step toward further easing. As you would expect the Australian dollar is trading pretty heavily in this current environment. Tomorrow sees the release of GDP data with the market expecting a gain of 0.4% in the second quarter, down from 0.9% in Q1. On Thursday we then get the latest readings on retail sales and the trade balance.

New Zealand
The New Zealand dollar has had another tough start to the week thanks in large part to data released yesterday. ANZ Business Confidence for August plummeted again to -29.1 (from -15.3 prior) which is the lowest level in six years. If businesses aren’t confident about the economy they won’t invest to increase production and they’ll hold off taking on new staff. ANZ added their “composite indicator of economic activity has fallen to a three year low, with the economy approaching stall speed”. The New Zealand dollar reacted very negatively to the news and has spent the past 24 hours under all sorts of pressure. Prime Minister Key was on the wires saying the NZ economy is well placed to handle global ups and downs. He added that while NZ faces headwinds from dairy and China it should still expand at about a 2% pace. Tonight we have another dairy auction from Fonterra to digest and dairy futures prices suggest we could see another healthy gain.

United States
Economic data from the US in the later stages of last week was something of a mixed bag. While durable goods orders and GDP were both significantly stronger than expected, we saw softer than forecast readings from pending home sales, personal consumption and consumer sentiment. Core PCE, which is the Fed’s preferred measure of inflation, also declined at touch to 1.2% year on year from 1.3% prior. There is still plenty to come this week with Friday’s non-farm payrolls data standing out as a key release in shaping expectations for a potential September interest rate hike by the Fed. Over the weekend we had the Jackson Hole Central Bankers Symposium and although there was a lot of talk, there was little in the way of ground-breaking revelations. The main takeaway was that the Fed remain keen to hike interest rate at the first viable opportunity. Whether market and economic conditions will provide that opportunity later this month remains open to debate. Strong data over the rest of this week will certainly bolster the case for a September hike, but this will have to be weighed against wider market volatility and concerns around global growth. If we get a collection of disappointing data releases this week it should close the door on September for rates lift off.

United Kingdom
GDP for the second quarter in the United Kingdom was confirmed on Friday at +0.7%. Exports and business investment help underwrite the expansion after a more sluggish start to the year. Whether or not that economic momentum can be maintained is open for debate. Continued strength in the UK Pound will be a head wind for exporters as it the global growth outlook with real concerns around China. The Bank of England (BOE) will welcome the rebound in investment as a signal that businesses are feeling confident about the economy going forward. The data hasn’t impacted interest rate hike expectations from the BOE which are slowly getting pushed back further into 2016 on the back of wider market concerns. A UK bank holiday yesterday has meant it has been  a quiet start to this week, but over the coming days we have PMI’s from the manufacturing, construction and service sectors to digest.

Inflation in the Eurozone remained unchanged in August at 0.2% year on year. That will probably be something of a relief to the ECB as the risks were skewed to a weaker result. Core inflation has also remained stable at 1.0% year on year. The August Eurozone economic sentiment index improved to 104.2, which was stronger than expectation. Unfortunately looking into the data further showed inflation expectations have fallen to 3.1% from 4.2% prior. This won’t make pleasant reading from the ECB and it continues to suggest the risks to inflation going forward remain to the downside. Aside from a raft of second tier data out this week, we have the ECB’s rate meeting on Thursday to digest and this will provide the main focus.

Recent data from Japan has been mixed at best. Slight improvements in inflation, unemployment and retail sales, have been countered by softer outcomes for household spending, housing starts and industrial production. Production has been sluggish because private consumption and exports remain weak and concerns around China and emerging economies pose further risks to output. Attention will now turn to average cash earnings data set for release on Friday.

The only release of note from Canada recently has been the raw materials price index which came in much softer than forecast. This had little impact on the currency which has been driven lately by movements in the price of oil. And the price of oil has definitely been moving! After hitting recent lows last week oil has rebounded some 25% taking the Canadian dollar higher with it. The announcement from OPEC that they are willing to talk to other producers to achieve “fair and reasonable prices” suggests we could see more coordination to cut production. OPEC produces 40% of the world's oil but they are not prepared to carry the burden alone of propping up oil prices by cutting supply. Still to come this week from Canada we have GDP data, the trade balance, employment change and Ivey PMI.

Major Announcements last week:
  • NZ Trade Balance -649m vs -665m expected
  • US Core Durable Goods Orders 0.6% vs 0.3% expected
  • Australian Private Capital Expenditure -4.0% vs -2.5% expected
  • US Q2 GDP 3.7% vs 3.2% expected
  • UK Q2 GDP 0.7% as expected
  • NZ ANZ Business Confidence -29.1 from -15.3 last
  • Australian Building Approvals 4.2% vs 2.9% expected