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FX Update - Chinese devaluation rocks markets

Written by Ian Dobbs on August 18th, 2015.      0 comments

Market Overview:
The major news of the past week was the Yuan devaluation by the People’s Bank of China. It was a big surprise to markets and it’s still not completely clear as to their motivation. If you believe the PBOC it was an adjustment away from a fixed peg (against the USD) to more of a ‘managed float’ in which market forces play a bigger part. The other school of thought is that it was just another effort to stimulate growth from the central bank, and this raises serious concerns about the health of the Chinese economy and global growth in general. The fact the devaluation came only days after terrible Chinese trade data suggests the latter. An article out last night from the state-owned China Securities Journal suggested the PBOC may look to stimulate further by cutting the required reserve ratio. They last cut the RRR on June 28th when they also cut interest rates. This would back up the view that the Chinese authorities are still very concerned about the economy and that would suggest continued pressure on commodities, and by extension commodity currencies. It’s fair to say that global growth is struggling at the moment and this is keeping inflation very subdued. The IMF believe the world's economy will expand at the slowest pace since 2009 this year. In this environment it's going to be a very difficult decision for the Fed to hike interest rates, despite their desire to do so.

Data from Australia last week played second fiddle to the Chinese Yuan devaluations which dominated markets. For the time being it looks like the ‘one-off’ adjustment has been completed and the PBOC now seem more comfortable with the level of their currency. Attention now turns to the Reserve Bank of Australia’s (RBA) minutes out this afternoon. These should confirm that the bank is very much in the neutral camp at the moment, although they wouldn’t hesitate to act again if conditions warranted. The RBA’s Assistant Governor Kent delivered a speech recently on the labour market. In it he said they expect unemployment to remain steady through 2016, then begin falling in 2017. He added there is slightly less spare capacity in the labour market than earlier anticipated. On the currency he said further pass through of the Australian dollar’s fall is still to come, and the impact of the currency’s decline on prices is helping to offset slow wage growth. Although the RBA are sounding very ‘neutral’ in all their releases, the market is still pricing in a very good chance of another interest rate cut before the end of the year. If the market is wrong, the AUD may not have all that much further to fall. For the time being however, with concerns around Chinese, and global, growth prospects weighing on the outlook for commodity prices, the risks for the AUD remain to the downside.

New Zealand
The New Zealand dollar struggled throughout last week as the impact of the Chinese Yuan devaluations roiled markets. The general consensus, if here is one, is that it’s negative sign for Chinese growth and therefore commodity prices. The news didn’t get any better for the NZD with the release of Friday’s retails sales data. This was a big disappointment coming in at just 0.1%, the lowest level in nearly two years. The market was expecting a result of 0.5%, which in itself would have been a big decline from the prior 2.3%. This data only strengthens the case for another interest rate cut from the RBNZ next month. Tonight we have another dairy auction from Fonterra and there are some hopes that prices could stabilize, if not actually increase a touch. Fonterra’s recent announcement that it will reduce the amount of product put up for sale at the dairy auctions over the next 12 months is likely helping. Unfortunately for the dairy sector a broad based recovery in prices seems a fair way off at this stage. Producer prices and migration data will also draw attention this week.

United States
Some very mixed data from the United States over the past week is only serving to make the Fed’s September interest rate decision an even more difficult one. Retail sales were probably the highlight coming in on expectation at +0.6%. Friday’s release of consumer sentiment however, which printed at 92.9, was weaker than forecast and softer than the prior reading. Last night we saw the NAHB housing market index increase to its highest level since 2005, but countering this was the Empire State manufacturing index. Considered to be a leading indicator of the broader manufacturing sector, it declined to its lowest level since 2009. There is plenty data to digest over the coming week starting tonight with building permits and housing starts. Later in the week we get inflation, the Fed minutes, the Philly Fed manufacturing index, existing home sales and manufacturing PMI. The Fed have a dual mandate of employment and inflation and while the employment sectors suggests an interest rate hike is probably overdue, inflation remains stubbornly low. Tepid wage growth, the Yuan devaluation, declining commodity prices and a soft global growth environment all suggest a real lack of inflation pressure in the foreseeable future. As much as the Fed desperately want to move interest rates off the ‘zero bound’ where they have been for the past six years, they are going to struggle to justify it on the current inflation outlook.  

United Kingdom
Last week’s employment numbers from the UK raised the prospect the jobs market is levelling off somewhat after consistent growth in recent years. We will need to see more data before making that conclusion, but these recent numbers won’t be putting any pressure on the Bank of England (BOE) to raise interest rates sooner than expected. The unemployment rate remained steady at 5.6%, but somewhat disappointedly wage growth slowed from 3.2% to 2.4%. Tonight we get the latest reading of inflation and it’s expected to once again come in at 0%. That would mean five out of the last six months inflation has been flat or negative. The BOE’s Forbes said recently that the bank will need to hike interest rates well before inflation hits the 2% target, and that waiting too long to raise rates would risk undermining the economic recovery. He makes a valid point, but inflation at least needs to be heading in the right direction. There is no inflation pressure currently and recent developments with the Chinese Yuan and commodity prices suggest further downside pressure over the coming months. A Bank of England (BOE) interest rate hike at this stage is likely only going to come sometime well into the first half of next year. Other data to watch out for this week includes retails sales and public sector net borrowing.

The Euro had a good week last week helped by positive developments on the Greeks third bailout package along with buying interest created by the Chinese Yuan devaluation. However, data from Europe wasn’t so supportive. While the final reading of inflation came in as expected at 0.2%, the GDP result for the second quarter was softer than forecast at 0.3%. The market was looking for a reading of 0.4%. Growth in both the core nations of Germany and France disappointed which only serves to highlight the long slow road to recovery the region has to look forward to. This week we have manufacturing and service sector PMI’s to digest, although they’re not set to hit the wires until Friday. The economic calendar looks pretty light until then.

Mixed data from Japan last week was completely side-lined by action in the wake of the Chinese Yuan devaluation. With the PBOC (People’s Bank of China) seemingly now comfortable with their ‘one-off’ devaluation attention is turning back to domestic data. Yesterday we saw Japanese GDP data for the second quarter and although it printed a touch stronger than expected at -0.4%, it really didn’t make good reading at all. Exports and consumer spending were both very weak and unless they see a turnaround in both those components the government may be forced to look at further stimulus measures. The Bank of Japan will probably now be forced to cut its growth expectations and if the third quarter also comes in weak, there is a very good chance we will see further monetary policy easing’s. We have the BOJ meeting and monetary policy statement this week on Thursday and the market will be paying very close attention to their projections.

Last week was a quiet one for economic data out of Canada. On the housing market we saw housing starts come in a touch softer than forecast, but countering this was the new house price index which increase by more than expected at +0.3% in June. On Friday evening we saw the latest reading of manufacturing sales and this was much weaker than forecast at 1.2%. The market was expecting a gain of around 2.3%. Despite the gain, manufacturing sales are still currently some 5% below the post-recession peak setback July 2014. Weak oil, and commodity prices in general, have played a big part in the disappointing manufacturing performance of late, but looking ahead the non-commodity export sector should see benefits from the declining Canadian dollar and strengthening US economy.  

Major Announcements last week:
  • The Chinese Yuan is devalued by just over 4%.
  • UK Claimant Count -4.9k vs +1.4k expected
  • UK Average Earnings 2.4% vs 2.8% expected
  • US Retail Sales 0.6% as expected
  • NZ Retail Sales 0.1% vs 0.5% expected
  • Eurozone GDP 0.3% vs 0.4% expected
  • US Consumer Sentiment 92.9 vs 93.5 expected
  • Japanese GDP -0.4% vs -0.5% expected