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FX Update - Emerging market concerns impact currency markets

Written by Ian Dobbs on January 28th, 2014.      0 comments

Market Overview:
Last week saw the year’s first wave of risk aversion wash across the wider markets. The emerging market economies are seen as vulnerable as the Fed’s tapering programme progresses, and an excellent example of this is the Argentinean Peso that is almost twenty percent lower since October 2013. The increased risk aversion towards the end of last week saw bond and equity markets lower, and the likes of the Yen and the US dollar outperform. The Australasian currencies were not immune to the change in sentiment, with both currencies seeing times of pressure, albeit the NZD performed the better of the two. Central banks are squarely back in focus this week. The US Federal Reserve are poised to lower levels of stimulation for a second time, and the RBNZ have a line call on whether or not to initiate their hiking cycle at their announcement of Thursday.

There has been no data of note from Australia since last Wednesday’s stronger than expected inflation numbers. The impact on the market from that release was very short lived however, as it was countered the very next day by softer than expected Chinese manufacturing data. Concerns about a hard landing in China have been around for a while now, but the issue has again been a topic of discussion for experts gathered at the World Economic Forum in Davos. We get separate survey on the Chinese manufacturing sector at the end of the week and it will be closely watched to see if it confirms the poor result from last Thursday. An Australian holiday yesterday means it has been slow start to the week in terms of economic news. However in the last couple of hours we have seen business confidence data that has showed some improvement and given the currency a small boost. Later in the week we get readings on new home sales and producer prices.

New Zealand
Last Tuesday’s inflation data has been the only release of note ahead of this week’s key event. The RBNZ’s rate meeting and statement set for release on Thursday at 9am will be very interesting indeed. The central bank has signalled that a tightening cycle will start early this year and it will be a very close call as to whether they pull the trigger this week, or at their next meeting in March. The majority of the market is expecting March for the first hike, but recent data from NZ has all been supportive of a rate increase and this raises the risk of a move on Thursday. Following the rate decision we get building consents data, and then the trade balance. On Friday at midday Governor Wheeler is giving an on the record speech, and as usual this will be closely followed by the market.
United States
There is a raft of data out from the US this week, but the big focus will be on the Fed meeting and accompanying statement set for release on Thursday morning. The Fed are likely to continue tapering, with another reduction of asset purchases to the tune of $10bln. There has been some talk that recent emerging market turmoil could see them pause, but this seems unlikely. Unwinding this policy was never going to be smooth or easy and if the central bank pauses every time it creates some waves then QE will never end. Recent data has been generally supportive of a continued recovery, with last week slightly softer than expected manufacturing PMI offset by a better than forecast reading on services PMI that was released last night. Existing home sales and new home sales have both been a little weaker than expected, although neither are at levels that should raise concerns. Ahead of the Fed meeting on Thursday we get data on durable goods orders and consumer confidence tonight, then later in the week we get fourth quarter GDP.

Surveys on both the manufacturing and services sectors were almost uniformly better than expected last week which will make pleasant reading for the ECB. We did get softer than forecast German economic sentiment data last Tuesday, however this was offset by a stronger result from the German IFO business climate index released last night. According to an IFO official, that result points to German GDP of around 0.5% in 2014. One of the biggest threats to the region remains deflation, with current inflation dropping to well below target. ECB President Draghi believes they won’t fall into the deflationary trap even though he admits inflation will stay low for a protracted period. One thing is for sure, interest rates are going to stay low in Europe for a very long time, and the next move could well be a cut. This week sees a lot of second tier German data set for release, along with the more important Eurozone inflation and unemployment rate.  

United Kingdom
With little in the way of market moving data out since last Wednesdays much better than expected employment data, the focus has been on how this affects the Bank of England's forward guidance policy. Mark Carney and other officials have been stressing the point that rates will likely stay low even if the unemployment rate falls below the 7% threshold. The bank wasn’t expecting that to happen until well into 2015 but with the current unemployment running at 7.1% it is likely to happen a lot sooner than that. This does bring into question the validity of forward guidance as a policy, and how the BOE react to the current situation will have an impact on its credibility. The bank could lower the specified unemployment threshold although this defeats the aim of the policy which is to create greater certainty. Currently the market is struggling to decide just when is a likely time for a BOE rate hike. Governor Carney says exceptional policy stimulus remains relevant for the British economy and even when the central bank raises interest rates it will do so gradually. There will be more to come on this and a speech by governor Carney on Wednesday could well give us further insight. Ahead of that we get GDP data tonight which should confirm the economy is on a firm footing.

The only release of note over the past week has been the BOJ monetary policy statement in which the central bank left rates unchanged. Governor Kuroda believes inflation should hit the bank’s target of 2% within two years and that it is currently way too early to normalize monetary policy. The IMF have said recently that they see no need for the BOJ to ease policy further and that doing so could have adverse effects and help to create asset bubbles. The IMF also believes the Yen is slightly undervalued vs Japan’s medium term economic fundamentals. This however is likely to remain the case in the near term while the central banks QE policy remains in place. The focus this week turns to retail sales, inflation, unemployment, and industrial production data.

Although last week held some pleasant surprises for economic data out of Canada with manufacturing and retail sales both beating expectation, they had little positive impact on the value of the currency. Although the central bank maintained its current neutral stance at its rate meeting on Thursday, they are certainly starting to lean towards and easing bias. They highlighted the downside risks to inflation which they now see reaching the 2% target in about two years’ time. This is longer than previously forecast. We got the latest reading for inflation on Friday which reinforced that view. The Consumer Price Index rose 1.2% on an annual basis against an expected result of 1.4%. This is however an increase over the previous months reading of 0.9%. The only data out this week is GDP set for release on Friday evening.

Major Announcements last week:
  • German Economic Sentiment 61.7 vs 63.4 expected
  • Canadian Manufacturing Sales 1.0% vs 0.3% expected
  • Australian CPI 0.8% vs 0.5% expected
  • Bank of Japan rate announcement - unchanged as expected
  • UK unemployment 7.1% vs 7.3% expected
  • Bank of Canada rate announcement - unchanged as expected
  • Chinese Manufacturing PMI 49.6 vs 50.6 expected
  • French Manufacturing PMI 48.8 vs 47.6 expected
  • German Manufacturing PMI 56.3 vs 54.7 expected
  • Canadian Core Retail Sales 0.4% vs 0.3% expected
  • Canadian Core CPI -0.4% vs 0.4% expected