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FX Update - Central banks provide market direction

Written by Ian Dobbs on November 4th, 2014.      0 comments

Market Overview:
Central bank announcements last week provided market direction for a number of currency pairs with significant reactions to releases from the US Federal Reserve, the RBNZ and then the Bank of Japan. Although we have both the Bank of England and European Central bank meetings later this week, along with the Reserve Bank of Australia today, they shouldn’t provide anywhere near the same sort of volatility. The focus now turns to employment data set for release from New Zealand, Australia and the US over the coming days. The overriding theme from all the recent volatility has been continued US dollar strength. This is expected to continue to dominate heading into the years end. Declining oil prices and a lack of inflation pressure in many western countries means central banks are in no hurry to raise rates. Countries like the US and the UK however, should be looking to start normalizing interest rates if only so they have room to cut again should we see another significant economic downturn. With rates effectively at zero the only action the Fed or BOE could take now if needs be would be to turn the printing presses back on and undertake further QE. The diminishing returns of such policy suggest the downside of this action would outweigh any positives.

Last week was a quiet one for data from Australia with only import prices and the producer price index of any note. Neither had much of an impact on the market with import prices coming in softer than expected at -0.8% and the producer price index printing right on expectation at +0.2%. Yesterday saw the Australian dollar come under a little pressure after building consents data surprised with a very weak result of -11.0% month on month. The market was expecting a reading of around -0.9%. This marks the single worst monthly decline since July 2012. It didn’t help sentiment that had already been dented by softer than expected Chinese manufacturing PMI, which fell to a five month low. However, there is much more to come this week and that started with retail sales this afternoon. The market was looking for an increase of around 0.3%, and this came in at a strong 1.2% The trade deficit, also just released, came in wider than expected at 2.26 billion. The Reserve Bank of Australia (RBA) rate statement will be released later on today and no change is expected at all in the actual monetary policy or statement tone. Later in the week the focus will turn to employment change numbers, which have been volatile lately to say the least.

New Zealand
Last week’s RBNZ meeting saw the central bank largely confirm market expectations that they are on hold for the foreseeable future. With a lack of inflation pressure, declining commodity prices, and some heat coming out of the property market, there is no hurry for the bank to tighten again and it looks like they will remain on hold until late next year at least. Friday saw the release of building consents and these were very weak. The month on month decline of -12.2% was something of a surprise and well below expectations for +1.0%. The NZD saw some pressure on the back of this data. Countering this was news the China has lifted the temporary suspension of Fonterra base powder for infant formula and whey powder. This suspension had been in place since August 2013. The focus now turns to employment data on Wednesday and Fonterra’s latest dairy auction.

United States
The key economic releases from the United States over the past week have generally been very supportive. After the Federal Reserve (Fed) struck a more positive tone at last Thursday’s meeting, the USD saw solid gains and sentiment was improved further on the back of GDP data. Third quarter GDP came in at a very healthy 3.5%, which was significantly higher than the forecast of 3.1%. Weekly unemployment claims remain low and last night’s ISM manufacturing index was much stronger than forecast printing at 59.0. Some second tier data has been a little more mixed with personal spending and income figures missing expectation, while consumer sentiment and Chicago PMI were both stronger than forecast. Overall, the US economy seems to be performing very well at this stage and market expectations for a rate hike around the middle of next year seem well placed. The US dollar is reacting how you would expect making broad based gains, however the same cannot be said for long term interest rates. Yields on government bonds remain at very low levels considering the improving economic outlook. The US 10 year treasury is currently trading at 2.34%, only up a few points over the past week. Still to come this week we have the trade balance, ISM non-manufacturing PMI, non-farm payrolls data and a speech from Fed Chair Janet Yellen.

United Kingdom
Data from the UK last week was a mostly second tier affair with results printing close enough to expectation to have little market impact. This week should prove a lot more interesting, with a number of key indicators set for release. The first of which was manufacturing PMI out last night. It came in significantly better than forecast at 53.2 and helped to support the UK Pound. Over the coming days we get constructing and service sector PMI’s along with manufacturing production data and the Bank of England (BOE) rate meeting. There has been a lot in press recently around the UK’s continued membership in the European Union. The European Commission set out revised contributions for all EU member states recently, which took into account their economic growth in recent years. This resulted in the UK been handed a surcharge of GBP 1.7bln which David Cameron called a “growth tax” and has so far refused to pay. While negotiations continue on that Cameron has also said he wants to cap the amount of migrants the UK accepts from other parts of Europe. He was quickly shot down by Germany’s Angela Merkel however, who said the free flow of labour was key to the EU and she would accept a UK exit from the EU in order to protect the migration rules.

There has been little to get excited about in terms of economic data from Europe over the past week. Key inflation data came in bang on expectation at +0.4% year on year, which was at least an improvement over the previous 0.3% reading. It is still dangerously low and this was acknowledged by the ECB’s Visco who said they cannot ignore the concrete risk of Eurozone deflation. We did see German unemployment fall by more than forecast, however the European wide unemployment rate remains constant at 11.5%. German retail sales and French consumer spending both disappointed, as did the Eurozone manufacturing PMI released last night. It printed at 50.6 which was just below the expectation of 50.7. Declines in German and Italian manufacturing were largely offset by gains in the French and Spanish readings. We get service sector PMI’s over the coming days along with EU economic forecasts, German factory orders, French industrial production and the ECB rate meeting.

It has been a long time since a central bank completely surprised the market, but that is just what the Bank of Japan (BOJ) did on Friday afternoon. In this day and age changes in central bank policy stance are usually signalled and/or predicted well ahead of time, but almost no one was expecting the BOJ to make any adjustments at Friday meeting. Completely out of left field the BOJ announced further easing measures and sent markets into a spin. The BOJ have increased the rate at which they expand the monetary base by around 20 trillion Yen annually. They are going to increase purchases of government bonds, exchange traded funds, and real estate investment trusts. The Yen got slaughtered immediately and has remained under heavy pressure ever since, while the stock market surged nearly 5%. The BOJ’s Kuroda said the easing was aimed at ending the deflationary mindset and that the BOJ will continue easing as long as needed to reach their 2% target. Recent falls in oil prices had put downward pressure on inflation and this risked undoing all the work the bank had achieved in erasing the deflationary mindset. This action was obviously hotly debated within the BOJ and it only passed by a 5:4 vote. The BOJ are now creating money to cover the fiscal deficit and the majority share of Japan’s annual budget. They are effectively monetizing the national debt, which is something more often seen in developing nations. Any data releases have taken a back seat to this news and the Yen is likely to remain under pressure for the foreseeable future. We get the BOJ minutes on Thursday and these should make very interesting reading.

Last week saw only a couple of releases of note from Canada. The raw material price index came in below forecast at -1.8%, as did GDP for August when it printed at -0.1% vs expectations of 0.0%. This was the first contraction in eight months and was driven by declines in oil and gas production and manufacturing. Last night we saw manufacturing PMI data which increased to 55.3 from 53.5 prior, and we also heard from BOC Governor Poloz who said that continued monetary policy stimulus may be needed even after excess capacity is absorbed. He added the effects of deleveraging, fiscal normalization and uncertainty will restrain global growth, and that it should take around two years to use up the excess slack in the Canadian economy. We have some key economic releases still to come this week with the trade balance, building permits, Ivey PMI and employment change all set for release.

Major Announcements last week:
  • US Durable Goods Sales -.2% vs +.5% expected
  • US CB Consumer Confidence 94.5 vs 87.4 expected
  • FED statement buoys outlook
  • RBNZ confirms more neutral policy stance
  • BOJ surprises with further policy stimulation
  • US advanced GDP 3.5% vs 3.1% expected
  • European Inflation +.4% as expected
  • Canadian GDP -.1% vs 0.0 expected
  • Australian Building Approvals -11.0% vs -.9% expected
  • UK Manufacturing PMI 53.2 vs 51.5 expected
  • US ISM Manufacturing 59.0 vs 56.5 expected
  • Australian Retail Sales +1.2% vs +.3% expected