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FX Update - A long weekend in the US sees low FX volatility

Written by Ian Dobbs on July 8th, 2014.      0 comments

Market Overview:
Financial market volatility has been at very low levels recently and this was magnified by the US holiday on Friday that saw a large part of the market take an extra-long weekend. We are in fact back to the sort of volatility levels seen in 2007 and some are questioning whether the markets have become complacent with regard to future risks. One of those risks is centred around China and the effect of its cooling property market on the economy. The Chinese are optimistic they can maintain growth above 7% and will fine tune policy to help small firms. But they have so far ruled out the further use of big stimulus preferring to use targeted measures instead. Improving data in the United States is seeing adjustments to interest rate forecasts with some now expecting a rate hike in late 2015. In the UK a rate hike is expected in early 2015 although that could be brought forward if economic data and the housing market continue to perform strongly. In Europe however any upward adjustment to interest rates is a very long way off.

Last week proved to be a tough one for economic data from Australia and for the Australian dollar. Poor trade balance and retail sales figures were compounded by negative comments from the RBA’s Stevens. We did see a big bounce bank in building approvals data, although this did little to help overall sentiment. So far this week we have seen a couple of second tier releases that have been mildly encouraging. The Performance of Construction index jumped from 46.7 to 51.8, and Job advertisements for June are up 4.3% from a prior reading of -5.6%. Job ads are now 6% higher than they were at the start of the year and this is consistent with a very gradual improvement in labour demand. In the last couple of hours we have seen business confidence which has improved to 8 from last month’s 7. The business conditions component showed a bigger jump and is now at its highest level since January. Still to come this week we have consumer sentiment and the more important employment change data. That data will likely set the tone for the AUD heading into the weekend.

New Zealand
It has been a very quiet period for data out of New Zealand. Last week was dominated by further declines in business confidence and dairy prices which helped to cap the NZD to a degree. We got another reading on business confidence this morning with the release of the Quarterly Survey of Business Opinion (QSBO) and it confirmed last week’s result with a decent pull back from the very high readings seen earlier in the year. Overall however the index is still high by historical standards and consistent with continued economic expansion. Yesterday’s release of QV house prices for June showed gains moderating to an 8% year on year increase, which is down a touch from May’s 8.2%. The slowing of house price gains should continue with interest rate rises combining with the LVR restrictions to take some heat out of the market. The only other data of note this week will be Thursday’s manufacturing index, although it’s unlikely to have much impact on the level of the NZD.

United States
A long weekend in the United States means there has been no data of significance released since last Thursday’s employment report. That result did surprise many coming in on the strong side at +288k. As a result we have started to see a few institutions bring forward their expectations for rate rises in the US. The adjustments are only mild however with expectations now for a hike in late 2015 as opposed to early 2016. A lot can happen between now and then and so far these changing expectations have had little impact on the value of the USD or longer term bond rates. But it is a trend to watch as it may gain momentum, especially if history repeats itself and we get a very strong bounce back in growth after the shocking weather affected first quarter. We have a number of Fed speakers of the coming days along with the release of the minutes from the latest Fed meeting set to hit the wires on Thursday morning.

United Kingdom
The United Kingdom economy continues to perform well and data last week was generally supportive of the outlook going forward. Manufacturing and construction PMI’s both came in better than expected and while the services PMI did undershoot forecasts it is still at very healthy levels overall. The housing market remains a focal point and is probably the biggest risk to future economic stability. The latest reading of house price gains showed +1.0% last month with the yearly gains running at 11.8%. The bank of England does not want to raise rates prematurely just to cool the housing market and as such they are open to using a range of macroprudential tools to rein it in. They have recently imposed lending restrictions on banks and further measures are a possibility. At the end of the day however, historically low interest rates are the driver of these gains and one has to question whether a 0.5% cash rate is still appropriate for an economy performing as strongly as the UK’s. At this point an interest rate hike in the first quarter of next year seems likely, but the risks are that it may have to come earlier. The Bank of England meets this week although with no change expected we will have to wait for the minutes to be released in two weeks’ time to get a feeling for the range of views with the Monetary Policy committee (MPC).

Data from Europe last week only served to confirm what we already know. The economic recovery there is very fragile and has very little momentum. Inflation is dangerously low at 0.5% and unemployment is hovering around 11.6%. The one thing that is certain is that interest rates are going to stay low for a very long time in Europe. After last week’s ECB meeting President Draghi suggested that the door was still open for quantitative easing (QE) should the economy warrant it. But comments from other officials since then suggest the bar for enacting that sort of policy is set very high. Draghi is more than likely hoping the threat of QE will help to weaken the Euro which has remained stubbornly strong despite recent central bank action. We will hear more from Draghi this week with a speech scheduled for Thursday morning. We also have the German trade balance, French industrial production and the ECB monthly bulletin to digest.

The highlight from Japan last week was the release of the quarterly Tankan report. It was a bit of a mixed bag with current sentiment taking a knock, thanks in large part to April’s sales tax increase. This was largely offset by firms ratcheting up plans for capital spending which will be pleasing for the government and the Bank of Japan. Governor Kuroda was on the wires yesterday saying Japan’s economy continues to recover moderately as a trend and this is likely to continue. He sees Japanese inflation hovering around 1 -1.5% for some time, and said the BOJ will continue with current policy for as long as needed to achieve the 2% price target. Later in the week we have core machinery orders and the tertiary industry activity index to digest.

A couple of data points from Canada last week had little impact on the Canadian dollar that continued to recover ground across the board. A slightly weaker reading on GDP was offset by the trade balance that printed a touch better than expected. Last night we saw building permits data that raised a few eyebrows. The 13.8% gain was much stronger than the expectations for just +3.1%, and a big jump from last month’s +2.2%. The Bank of Canada are hoping for a ‘soft landing’ in the housing market but gains like this suggest that might be hard to engineer. The positive impact on the currency from this data was short lived however after the Ivey PMI result disappointed the market coming in at 46.9 vs expectations of 51.3. This is the second reading in a row below the key 50 level that denotes expansion or contraction. The Ivey PMI index is considered a leading indicator of economic health and we have now seen a consistent fall in the index since March’s peak of 57.4. This was also reflected in the Bank of Canada’s business outlook survey released last night. The overriding theme from that is that business are hesitant to fully commit to investing with many firms yet to see signs of a notable and sustained strengthening in demand. Still to come this week we have housing starts data and the key release of employment change.

Major Announcements last week:
  • RBA leaves cash rate unchanged at 2.5%
  • UK manufacturing PMI  57.5 vs 56.7 expected
  • US ISM manufacturing PMI 55.3 vs 55.6 expected
  • Australian trade balance -1.91b vs -0.16b expected
  • UK construction PMI 62.6 vs 59.7 expected
  • Australian building approvals +9.9% vs +3.1% expected
  • Australian retail sales -0.5% vs 0.0% expected
  • UK services PMI 57.7 vs 58.1 expected
  • US non farm employment change +288k vs +214k expected
  • US ISM non manufacturing PMI 56.0 vs 56.2 expected
  • Canadian building permits 13.8% vs 3.1% expected
  • Canadian Ivey PMI 46.9 vs 51.3 expected