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FX Update - NZD and AUD downtrends continue unabated

Written by Ian Dobbs on September 8th, 2015.      0 comments

Market Overview:
After two days of talks in Turkey the G20 released they communique over the weekend pledging to avoid depreciating their currencies to gain competitive advantage as the fallout from China’s slowing economy continues to be a drag on global growth. A potential ‘currency war’ has gained plenty of attention recently in the wake of China’s Yuan devaluation last month. The recent release of forex reserves data show China’s reserves declined by the most on record for any month in August as the country is forced to sell USD’s (and US treasury holdings) in order to prop up the Yuan. The pace of capital outflow from China is breath taking and the rate they are burning through reserves is unsustainable in the long run. This is a big reason many forecasters expect they will be forced to devalue further over the coming months. Emerging markets are also feeling the pressure from China and an eventual interest rate hike from the Fed will not help them either. An increasingly large amount of emerging market debt in recent years has been denominated in USD’s and the dollar's appreciation along with an impending interest rate hike is very bad news. Emerging market are going to be a real area of concern heading into next year.

Last week’s disappointing data, in the form of GDP and retail sales, pressured the Australian dollar and it has remained on the back foot ever since. The currency traded to fresh cycle lows against the USD last night around 0.6900 and is currently not far from that level. Over the coming days we have more data to digest in the form of business confidence, consumer sentiment, inflation expectations and employment change. The Australian economy is having a very tough time ‘transitioning’ away from mining and as such concerns around China will continue to weigh. Chinese stock market volatility seems to have abated, for now at least, helped by a public holiday there on Thursday and Friday. But the broader outlook for the Chinese economy is not improving at all. Although the Reserve Bank of Australia have sounded very much like they are comfortably ‘on hold’ recently many in the market expect they will be forced to cut interest rates again over the coming months. For these reasons the Australian dollar is likely to continue to remain broadly under pressure.

New Zealand
For New Zealand this week is all about the outcome of the Reserve Bank's (RBNZ) interest rate meeting on Thursday morning. The bank is universally expected to cut interest rates by 0.25% to 2.75% and this is well priced into the market. The real interest will be to what degree they signal further cuts. Most in the market believe another cut to 2.50% is likely, but after that things are a lot less certain. Close attention will be paid to the RBNZ forecasts on growth and inflation to give clues as to the potential forward path for interest rates. Their assessment on global growth and the outlook for China will also draw attention. The New Zealand dollar has seen across the board pressure in recent weeks and the extent of any further losses in the near term will be dependent on the RBNZ’s forecasts and overall tone. The RBNZ will likely maintain some sort of easing bias after this week’s meeting, but the big fall in the New Zealand dollar in recent months will eventually boost inflation and this suggests the case for cutting past 2.50% is not that strong.

United States
The release of key US employment data on Friday night hasn’t done much to influence either way the prospect of an interest rate increase by the Fed come September 17th. The headline number for non-farm payrolls change was at the lower end of expectation coming in at 173k. Aside from that the report painted a picture of a reasonably healthy employment market. There were positive revisions to prior numbers totalling +44k, the unemployment rate dropped to 5.1%, and wages growth came in stronger than expected with average hourly earnings +2.2%. Opinion is still massively divided around the prospect for the Fed's first interest rate hike in nearly 10 years. If you were looking at employment alone, they should have hike rates a long time ago, but the Fed has a dual mandate and the other component is inflation. Inflation remains extremely low and while the Fed don’t actually have to see inflation pick up before they hike, they have to be confident it will eventually pick up. The issue here is the global environment. The Chinese economy, problems in emerging markets, soft commodities and lower global growth in general all suggest inflation will remain subdued for some time yet. Add to this the fact the Chinese are now being forced to sell around 100bln a month in US treasuries in order to maintain the Yuan’s valuation. If this continues it will put upward pressure on longer term US interest rates and provide a kind of ‘quantitative tightening’ in itself. The Fed have a lot to think about some their September 17th meeting and it’s shaping up to be a very interesting decision. Still to come this week we have import prices, producer prices and University of Michigan consumer sentiment.

United Kingdom
PMI readings from the UK last week were a little soft and this will only have added to the recent pressure the UK Pound has seen. Against the USD the GBP suffered a nine day losing streak which was only broken last night when it put in a solid bounce. There was no economic data or specific news to trigger the turnaround and it seems the market may have just gone a little too far too fast. We do have the Bank of England (BOE) interest rate meeting this week and these are now a lot more interesting. We get the result of the meeting, the voting pattern, a rate statement and the minutes all at the same time. The market has slowly been pushing out expectation of an eventual interest rate hike from the BOE well into next year and it will be interesting to see if this fits with the central bank's own view. Ahead of that meeting we get manufacturing production and trade balance data to digest.

The European Central Bank (ECB) did a good job of weakening the Euro after their meeting last week. Their downgraded growth and inflation forecasts have suggested the potential for further easing measures over the coming months and they certainly made it clear they would act again if needed. The biggest hurdle to increasing or extending their quantitative easing programme at some point in the future is the supply of applicable bonds they can buy. This issue was largely acknowledged at last week’s meeting when they increased the amount of any single issue they purchase from 25% to 33%. Over the weekend we heard from the ECB’s Noyer who repeated a theme often heard from President Draghi himself. He said that monetary policy alone cannot sustain activity and that other channels are needed to boost investment. The comments are aimed at Euro area governments who need to do more of the heavy lifting to stimulate economic growth. They have largely fallen on deaf ears however and this issue remain a big stumbling block toward a much broader economic recovery in the region. The mostly second tier data from Europe this week will only draw passing attention.

There has been a lot of speculation recently that the Bank of Japan (BOJ) will downgrade their economic forecasts. It seems recent weakness in industrial output and exports have raised the prospect that the second quarter downturn will extend into the third and fourth quarters. The IMF said over the weekend there is a good chance they will cut Japanese GDP forecasts for 2015 and 2016. They did add however they don’t see the need for the BOJ to ease further in October as long as inflation expectations are well anchored. The market is not quite so sure about that with many forecasters expecting further action from the central bank over the coming months. The Japanese Yen has seen heightened volatility in recent weeks lead by swings in risk sentiment. There is plenty of potential for this to continue in the coming weeks with the Yen seeing increased demand as a ‘safe haven’ currency in times of wider market volatility. Data this week to draw focus includes the final reading of GDP, consumer confidence and core machinery orders.

Data from Canada last week was mostly positive and supportive of the Canadian dollar. A better than forecast GDP result for June was a nice surprise, although it wasn’t enough to stop the economy falling into a technical recession in the first half of the year. Friday’s release of employment data was also a bit stronger than forecast. Employment change came in at +12.0k versus -4.5k expected and there was also a big swing toward full time work and away from part time employment. Tempering this was the unemployment rate however, that increased to 7.0% from 6.8% prior. Friday also saw the release of Ivey PMI which jumped sharply to 58.0 from 52.9 prior. This jump was much bigger than expected although it can be a volatile indicator so caution is warranted when reading too much into one outcome. A bank holiday on Monday has seen a quiet start to this week, although things liven up over the coming days with building permits data and the Bank of Canada rate statement to digest.

Major Announcements last week:
  • European Core Inflation 1.0% YoY as expected
  • Australian Private Sector Credit +.6% vs +.5% expected
  • Canadian Q2 Current Account -17.4B vs -16.9B expected
  • RBA leave monetary policy unchanged as expected
  • ECB leave monetary policy unchanged as expected
  • European Manufacturing PMI 52.3 vs 52.4 expected
  • UK Manufacturing PMI 51.5 vs 52.0 expected
  • Canadian GDP Jun +.5% vs +.2% expected
  • US ISM manufacturing 51.1 vs 52.6 expected
  • Australian Q2 GDP +.2% vs +.4% expected
  • Australian Retail Sales MoM -.1% vs +.4% expected
  • US Unemployment rate 5.1% vs 5.2% expected
  • Canadian Unemployment rate 7.0% vs 6.8% expected