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FX Update - Increased volatility a sign of things to come?

Written by Ian Dobbs on January 20th, 2015.      0 comments

Note : Direct FX was not at all impacted by the wide reaching volatility seen following the Swiss National Bank action to remove its floor against the EURO. The fact that Direct FX does not offer margin based foreign exchange trading facilities, and our geographical bias towards Australasia, provided ample defence to the markets temporary, but significant stress. It is business as usual at Direct FX and we wish you all the best for 2015.
Market Overview:
The biggest development in the world of forex over the holiday period was the surprise announcement from the Swiss National Bank (SNB) last Thursday that it had abandoned the 1.20 floor it had set in EUR/CHF. The floor was put in place in 2011 to stop the CHF appreciating too much on the back of safe haven flows going into the currency during the Euro crises. The removal of the floor was a massive surprise and the volatility that followed flowed into all currency pairs. Only three days prior on Jan 12th, the vice president of the SNB was quoted in the press as saying the minimum exchange rate “must remain as the cornerstone of our monetary policy.” It seems they had a rapid change of heart and the 1.20 floor no longer became tenable. The CHF instantly appreciated trading up 30% against the EUR at one point, before settling closer to +20%. The SNB have lost in excess of 60 billion on the currency position they amassed while defending the floor, while some banks, hedge funds, traders and broking houses have also been caught by the move. All this comes just ahead of what could be a very big week for Europe. On Thursday night the European Central Bank are expected to finally announce a programme of quantitative easing to help ward off the threat of deflation. Then on the weekend Greek voters go the polls to elect a new government and all indications are pointing to the Syriza party as likely victors. The Syriza party are anti austerity and have said they will try to renegotiate the bailout conditions. The risks of a Greek exit from the Euro will increase dramatically should they win power.

The holiday period has seen a mixed bag of data from Australia with a weaker than expected retail sales figure on the 9th of January, countered by a much better than forecast result from employment change last Thursday. The gain in jobs of 37,400 was much stronger than the 5,000 rise expected and it has served to ease near term expectations of a rate cut by the RBA. The unemployment rate also came in better than expected at 6.1%, but the main takeaway from the data was that total Australian employment has hit a new all-time high at 11,679,376. The RBA meet on February 3rd and although some forecasters are still calling for a cut in interest rates, in light of the recent data it seems likely any potential move would come later in the year. Commodities in general have continued to see pressure over the holiday period and this has added to volatility in the Australian dollar exchange rate. Attention over the coming days will focus on consumer sentiment data tomorrow and inflation expectations on Thursday.

New Zealand
The only data of note released from New Zealand over the holiday period was the result of Fonterra’s dairy auction on January 7th. Prices gained 3.6% and there is now some hope that the recent declines have ended. We get the results of the next dairy auction tonight and another gain will make pleasant reading for farmers who are currently experiencing some very dry conditions in parts of the country. Earlier this morning we saw the latest NZIER business confidence survey and it showed an improvement to 23 from a prior reading of 19. Tomorrow we have inflation data to draw focus and it’s likely to be a soft result thanks to the decline in oil prices. The market is expecting a reading of 0.0% although its impact should be minimal with the central bank expected to look through any near term weakness in inflation and focus on the relative strength in the underlying economy.

United States
A mixed bag of data from the United States over the past few weeks hasn’t dramatically impacted expectations for a rate hike from the Fed in June or soon thereafter. The US employment situation remains strong with a further decline in the unemployment rate to 5.6% seen earlier this month. Solid domestic growth and declining unemployment are certainly positives for the US economy at the moment, but countering that is very soft wage growth, low inflation and concerns around global growth. Although on balance the Fed are still likely to hike around mid-year, the pace of any increases will be very gradual. A US bank holiday yesterday means it has been a quiet start to this week data wise. Over the coming days however, we do get building permits, housing starts, weekly unemployment claims and manufacturing PMI.

United Kingdom
The UK Pound saw a surprising amount of selling pressure in the first week of this year and it’s hard to point the finger at one particular reason. Certainly we had some softer than expected data with the trifecta of PMI’s from the manufacturing, construction and service sectors all printing below expectation, but the level of selling seemed out of proportion with this data. More than likely it was just the result of some natural business that needed to be done at a very illiquid time of the year. We have seen a slight recovery in the GBP since then, but overall the currency is still significantly lower than where it was trading before Christmas. The other release of note in the past couple of weeks was inflation data, which came in at the lowest annual rate since May 2000. This was obviously driven by weakness in oil prices and BOE Governor Carney has stated that he sees no need for more stimulus on the back of the drop in CPI. This week there are some key releases to digest. On Wednesday we have employment and wage data which will be followed by the Bank of England minutes. Then on Friday we get the latest reading from retail sales.

Developments in Europe have grabbed the markets attention recently with the dramatic removal of the Swiss National Bank’s (SNB) floor in the EUR/CHF at 1.20. The impact of this move is negative for the EUR, as the SNB had become the single largest buyer of Euro’s in the market while they were defending the floor. With them no longer active a large amount of EUR support has just disappeared. The volatility is far from over with attention now turning to Thursday’s ECB meeting and the widely expected announcement of quantitative easing. An asset buying programme of some sort has largely been priced into the market, but the devil will be in the detail. What structure will the programme take and how big will it be? These are key details that will dictate near term direction for the Euro. Having taken a long time to get to this point one would hope the size of the QE announced will be substantial i.e. EUR500 bln or greater. Once the market has digested the ECB announcement the focus will quickly shift to Greece and the election to be held there this weekend. With the anti-austerity Syriza party currently in the lead in the polls, Greece could again become a flashpoint Europe. Cash is already fleeing the country with two Greek banks having to ask for emergency lending facilities from the ECB to cover the liquidity squeeze ahead of the election. Greece remaining in the Euro is no longer a certainty and although a Greek exit would be manageable, the risk is it could pave the way for further defections in the future.

There has been little in the way of significant data released from Japan over the past couple of weeks. We did see a softer than expected result from core machinery orders last week, but it’s impact was limited. The Yen has seen plenty of action however, with periods of strength on the back of flight to safety flows during periods of heightened market volatility. Last night we heard from the LDP’s Yamamoto who is a senior figure in the party. He said there will be no further easing’s from the Bank of Japan this year, unless the economy is hit by a large external shock. He believes the bold steps the BOJ have already undertaken will start boosting the economy by mid this year and the there is a good chance the 2% inflation target will be achieved in the financial year 2016/17. We will hear from the BOJ themselves tomorrow after their regular policy meeting and later in the week we also have the BOJ monthly report.

The Canadian dollar has seen a fair amount of pressure over the past few weeks weighed on by soft oil prices and largely disappointing data releases. A poor employment change result on January 9th of -4.3K came on the back of a rash of other soft results and this left the CAD in a vulnerable position. There was little released from the country last week, but over the coming days there is plenty of data to draw focus. Manufacturing sales, wholesale sales, the Bank of Canada rate statement, inflation and retails sales are all set for release.

Major Announcements last week:
  • UK Inflation 0.5% vs 0.7% expected
  • US Retail Sales -0.9% vs 0.2% expected
  • Australian Employment Change +37.4k vs +5.3k expected
  • SNB removes 1.20 floor in the EUR/CHF
  • US Inflation -0.4% vs -0.3% expected
  • US consumer Sentiment 98.2 vs 94.2 expected
  • Chinese GDP 7.3% vs 7.2% expected