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FX Update - Global markets are on a knife edge.

Written by Ian Dobbs on August 25th, 2015.      0 comments

Market Overview:
Markets are starting to look very fragile and we are in for some real volatility over the coming weeks and months. The past week has been a shocker for stocks. In the US the Dow at has fallen over 10% from its highs and is now down on the year. Chinese stocks smashed through recent lows losing more than 8% yesterday. European stock markets are also feeling heat. Risk aversion is causing big moves in foreign exchange with the biggest gainers so far the Euro and the Yen. Further weakness in the Chinese economy, after Friday’s release of very soft manufacturing PMI data, has been fingered as the cause, but in all reality it’s really just the trigger. US stock market valuations had diverged from economic reality a long time ago and sooner or later something was going to cause a correction. Commodity prices continue to tumble, although gold seems to be benefiting from safe haven status. Bloomberg’s commodity index recently hit its lowest levels since 1999. Inflation expectations in the US are falling to levels last seen when the Fed launched the quantitative easing programmes one, two and three. Indicators of global trade don’t make for any better reading, with the risks to global growth all skewed to the downside. Somehow in amongst all this, the Fed are supposed to raise interest rates for the first time in nearly ten years when they meet next month. It looks like they will need to be very brave to do so. China on the other hand are widely expected to announce further easing measures in the coming days / weeks. This may provide some temporary respite, but the Chinese economy could yet see real trouble. The Chinese property market rolled over last year and has been losing ground ever since (although recently the pace of depreciation has slowed), their stock market has crashed and they’ve started to devalue their currency (many expect further devaluations of the Yuan). What China can’t afford to have happen next is a collapse of their shadow banking system. The ‘shadow banking system’ refers to the collection of non-bank financial institutions that provide lending and credit facilities to consumers and businesses. It has seen massive growth in recent years, but it’s far less regulated and has far less transparency in relation to the quality of lending going on. Safety margins are also lot smaller than in the traditional banking system and if the ‘shadow banking bubble’ bursts it could be potentially devastating. In New Zealand we saw the collapse of our own ‘shadow banking system’ with a huge percentage of finance companies going bankrupt in the years after 2007. China could be heading for a similar thing, but on a much much grander scale and with global implications.

There has been very little in the way of key economic data released from Australia over the past week. Over the coming days we do have private capital expenditure data and a speech by RBA Governor Stevens to digest, both of which will be closely watched. The Australian dollar has seen plenty of pressure however, with poor Chinese manufacturing data leading to broad weakness in commodities and a further plunge in Chinese stocks. Volatility in all market has been extreme in the past 24 hours. Risk aversion has also been a notable theme in trading in recent days and is likely to remain so in the near term.

New Zealand
Although there hasn’t been much in the way of economic data released from NZ since last week’s better than forecast dairy auction, there has certainly been plenty of volatility in the New Zealand dollar. In fact last night saw some of the more wild moves in recent memory as risk aversion and fragile stock markets had everyone on edge. Chinese stocks had a very big down day yesterday falling by some 8.5%. That’s the biggest fall since 2007. When the US equity markets opened up very weak last night (the Dow Jones was down 1,000 points at one stage) markets everywhere panicked. Volume evaporated in the FX market with literally no bids in some of the NZD crosses for as far as you could see. Markets quickly regained some composure and started to function normally again, but it was a wild ride. We can expect continued nervous trading over the coming days with liquidity much lighter than normal.

United States
Data from the US has very quickly taken a back seat to wider market concerns, and in particular action in the stock market. US stocks have been trading at unrealistic valuations for some time now and all they have needed was a trigger to start a correction. That trigger came from a further big fall in the Chinese stock market yesterday. To be fair, yesterday’s move was probably more like the straw that broke the camel's back. Concerns have been building recently on many fronts. The Chinese Yuan devaluation, global growth, commodity prices, Chinese stocks and inflation expectations have all been flashing red signals recently. The markets have been weighing these negative signals against a reasonably healthy domestic economy in the US. Solid growth and employment numbers suggest the US remains on the right track. But we now live in a much more global world and those wider concerns are now overpowering the domestic situation. It’s looking increasingly less likely that the Fed will hike interest rates next month, although some commentators still expect them to. We have seen some serious volatility this year in all markets and it seems likely this will continue through year end. Still to come this week we have durable goods orders and GDP data to digest and the market is likely to remain on a knife edge.

United Kingdom
UK retail sales released late last week were a little disappointing printing at just +0.1% for July against expectations of +0.4%. There were however, positive revisions to prior numbers that tempered the headline fall and helped to limited the GBP’s negative reaction to the release. Other recent releases of note recently include public sector net borrowing, which was much lower than forecast, suggesting the UK finances continue to improve. The Confederation of British Industry also announced they have upgraded their GDP forecasts for this year and next. They now expect GDP of 2.6% (up from 2.4) in 2015 and 2.8% (up from 2.5%) in 2016. The say a stronger productivity, robust household spending and solid business investment prospects have all lead to the improved outlook. The UK hasn’t escaped the recent market turmoil in stocks and a lower global growth profile will only provide more reason for the Bank of England to be very patient before considering to raise rates.

At the end of last week we saw manufacturing PMI for the Euro region as a whole remain steady 52.4, which was a touch better than forecast. Looking into the core nations showed manufacturing in Germany improved to 53.2, while French manufacturing declined further to 48.6. Service sector PMI’s were a little better with the overall Eurozone reading improving to 54.3 from 54.0 prior. Like most global stock markets the European bourses have seen pressure in recent days on the back of big falls in Chinese stocks. Amongst all the volatility the Euro currency has been big gainer. General risk aversion has seen positions unwound in recent days and with most speculators having been positioned for Euro weakness this year, it has resulted in a lot of buying back of Euros. The unwinding of ‘carry trades’ has also benefited the Euro and it’s impossible to say just how much further the currency may go. Tonight we get the German IFO business climate index, but to be honest, the majority of traders will once again be focused on developments in stock markets.

The Japanese Yen has seen some very big swings in recent days as wider market volatility impacted. In times of risk aversion the Yen traditionally appreciates and that was certainly the case this past 24 hours. The Japanese won’t be happy about the Yen strength as it makes their exports less affordable, but for the time being there is little they can do. They will wait to see if the market corrects over the coming days and barring a further sharp sell off in stocks it will likely do so, at least to a degree. All this uncertainty will only add to the expectation of further easing measures from the Bank of Japan over the coming months. Prime Minister Kuroda has said in recent days that he accepts the BOJ’s explanation that hitting the 2% price target with the self-imposed deadline has become difficult given the sharp fall in oil prices. Later this week we get data on household spending, inflation, retails sales and unemployment.

Canada produced better than forecast data for retail sales and wholesales sales at the end of last week, while inflation came in as expected at 1.3% year on year. The Canadian dollar failed to make gains on the data however, as the price of oil tumbled further side-lining the domestic data releases. Wider market volatility continues to be the main driver in FX at the moment with stock markets looking particularly vulnerable in the past 24 hours. We can expect more volatility over the coming days with markets remaining very nervous.
  • UK core Inflation 1.2% vs .8% expected
  • US core Inflation 1.8% as expected
  • UK Retail sales 4.2% vs 4.4% expected
  • US Philly Fed Index 8.3 vs 7.0 expected
  • China Manufacturing PMI 47.1 vs 47.7 expected
  • EUR prelim. Manufacturing PMI 52.4 vs 52.2 expected
  • Canadian core Inflation 2.4% as expected