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FX Update - It’s all about the Fed.

Written by Ian Dobbs on September 15th, 2015.      0 comments

Market Overview:
The market has one focus this week, the Federal Open Market Committee meeting on Wednesday 17th. The result will be released very early on Thursday morning (Australasian time) and it’s one of the more anticipated central bank announcements for a very long time. The Fed haven't moved interest rates in six years, and they haven’t hiked interest rates in nearly ten. To make this even more interesting the market is divisively split between those who feel the will hike and those who don’t. The broader implications for the global economy are also significant. There is a lot of concern about the impact on emerging markets who now hold much higher levels of US dollar denominated debt. Total debt ratios for emerging markets are also now much higher than they were at the peak of the last credit cycle in 2007. That story will play out over the long run, but in the meantime with no clear indication of just which way the Fed will go, we could see some real volatility in all markets. Since 2008 there is a long list of central banks who have hiked interest rates, only to be forced to turn around and cut them again within 12 months. The big question is will the US Fed be in the same boat?

The Australian dollar has been on a more solid footing this past week, helped by solid employment data and a broad improvement in iron ore prices. Even a change of Prime Minister after a late night coup yesterday failed to significantly dent the currency. In fact the AUD looks to have largely approved of Turnbull as the new PM due to the prospect of him providing more ‘economic leadership’. We have the RBA minutes set for release in the coming hours and these should provide some more insight into thinking with the central bank. The market isn’t expecting any surprises however, with the RBA firmly on hold for the time being.

New Zealand
The New Zealand dollar has remained largely subdued since last week’s RBNZ monetary policy statement. The New Zealand Institute of Economic Research (NZIER) released their consensus forecasts and they said economic activity indicators have softened over the past quarter with the deterioration particularly apparent across confidence indicators. They see weaker household spending and weaker business investment partially offset by continued residential construction activity. They expect economic growth to track below 3% out to 2019. We get GDP data for the second quarter on Thursday and the market is looking for growth of around 0.6% which would be something of a bounce back from the first quarter’s soft 0.2% outcome. The first quarter was affected by a number of one off factors that should have mostly reversed in Q2. Ahead of that data we have another dairy auction from Fonterra to digest. The results will be released later tonight and it will be interesting to see if dairy prices can continue to recover after the two previous solid auctions.

United States
Although the focus in the US this week is firmly on Wednesday’s Fed meeting, with the results out early Thursday morning Australasian time, we do have some key data to digest ahead of that release. Retail sales tonight and inflation figures tomorrow will add to the overall picture of the economy that the Fed take into consideration. At the end of last week we saw a slightly stronger than expected reading from producer prices, but a much weaker than forecast consumer sentiment outcome. The University of Michigan Consumer Sentiment Index plunged from 91.9 prior to 85.7 in the latest reading. That’s the lowest level since September last year. The Fed have a very tough decision on their hands. A good case can be made for holding fire at this meeting, but giving a strong signal that a hike will come in December. However, the Fed are desperate to lift interest rates from the zero bound, where they have been for six years now. Zero interest rates are an emergency measure and no one envisaged that they would have to be maintained for so long. There are also big unwelcome side effects of extremely low interest rates, such as asset price inflation and the mispricing of risk, that only get bigger the longer you leave them. Global markets also feel very fragile at the moment though and the repercussions of a rate hike could well be significant.

United Kingdom
The Bank of England (BOE) didn’t dramatically change their economic outlook at last week's meeting, although they did suggest risk are skewed moderately to the downside thanks to concerns around activity in China and Europe. This week we get some more key pieces of the economic puzzle with inflation, wage and retail sales data all set for release. Inflation is expected to remain very subdued with a year on year outcome of 0.0% forecast. Wage growth in the other hand is expected to outpace price rises by the biggest margin since before the financial crisis. Expectations are for average weekly earnings, excluding bonuses, to have grown by 2.9% in the three months to July compared with a year ago. With extremely low inflation this ‘real wage’ growth is very welcome after workers saw a number of years of falling real pay in the wake the financial crisis. It’s also the reason the BOE are not overly concerned about the current low rate of inflation which is only serving to boost household’s real incomes. The UK economy does seem to have cooled a touch recently and this will allow the BOE to keep interest rates lower for longer, but the improving picture of household income suggests it’s not something to worry about at this stage.

Europe has been strangely absent from the headlines recently and the raft of second tier data released from the region last week provided only passing interest. This week we have ZEW economic sentiment from Germany, and the Eurozone as a whole, to digest along with the final reading of inflation. A recent poll of traders showed 11 out of 19 expect the ECB to expand or extend their quantitative easing programme, potentially before year end, in an effort to boost inflation expectations. That expectation should limit any Euro appreciation over the medium term, although the potential fireworks around this week’s US Fed meeting means there is a greater amount of uncertainty over price action in the very near term.

Last week saw some mixed data from Japan that failed to impact the current economic outlook. Better than forecast readings from consumer confidence and the BSI manufacturing index, were countered by disappointing results from core machinery orders and producer prices. The Bank of Japan release their monetary policy statement later today and although many expect further easing’s from them over the coming months, there is little expectation of action at this particular meeting. Senior LDP lawmaker and advisor to PM Abe, Yamamoto, was quoted again in the press over the weekend calling for further policy action at the banks October meeting. He said the economy is stagnating and although further easing may increase the demerits of a weaker Yen, through an increase in the price of imports, these can be offset with additional fiscal stimulus. Later in the week Governor Kuroda is set to speak and we also have the BOJ monthly report and the trade balance to digest.

There has been nothing of note released from Canada since last week’s Bank of Canada (BOC) rate statement. The bank seems comfortable with its current policy setting while it watches the effects of previous easing’s work their way through the economy. They also expect the continued US economic recovery to help underpin exports. This week we have manufacturing sales and inflation data to digest, although the main focus will be on the US Federal Reserve’s rate statement and the potential for volatility that could create.

Major Announcements last week:
  • European Q2 GDP .4% vs .3% expected
  • RBNZ ease OCR to 2.75% as expected
  • Australian Unemployment 6.2% as expected
  • BOE leave monetary policy unchanged as expected
  • US Producer Prices -.8% vs -.9% expected
  • European Industrial production 1.9% vs .6% expected