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FX Update - FX volatility remains subdued

Written by Ian Dobbs on May 27th, 2014.      0 comments

Market Overview:
Policy makers in both the United States and the United Kingdom have made it very clear recently that when rates do finally start rising, it will be very gradual and the peak of the cycle will be well below historical norms. This is likely to be the case in most developed countries over the coming years. The foreign exchange markets have been very quiet over the past week thanks in part to the US and UK holidays yesterday, but it’s more than just that. Current FX volatility is now at the lowest level since just before the Global Financial Crisis (GFC) in 2007. This does not imply we are heading for another meltdown, but it does seem likely the current subdued environment is only temporary. There are a number of risks on the horizon that could see markets start to trend again. Improving US data could see the US dollar finally start to appreciate, and outright quantitative easing from the European Central bank could see a significant fall in the Euro. The Chinese property market could continue to unravel which would pressure both the NZD and AUD. These are just some of the risks to the current low volatility environment. With materially lower levels of volume being traded currently in the global foreign exchange markets, any shock will see the price action impacted more than would normally be the case

The Australian dollar has been largely range bound since mid-last week with only a couple of economic releases having minimal impact. A survey of inflation expectations rose to 4.4% from 4.2% previously, and this was followed by manufacturing data from China that printed at 49.7, a five month high. However, it is still below the 50 level which denotes contraction or expansion in the industry. We have had a very quiet start to this week with public holidays in both the UK and the US yesterday. We have to wait until Wednesday to get local construction data which will be followed on Thursday with new home sales and private capital expenditure figures.
New Zealand
The New Zealand dollar traded heavily for much of last week weighed on by a further decline in dairy prices. Other data on the week had little impact with inflation expectations increasing to 2.4% from 2.3% previously. We have had a very quiet start to this week with large parts of the offshore market on holiday. Yesterday however, we did get NZ trade balance data which showed a smaller surplus than expected. The balance for April was +534m vs expectations of +634m. The decline was driven by exports which declined 11%, while imports fell 4%. These declines are largely seasonal however, and as such the impact on the currency was limited. Tomorrow we get business confidence data while Friday sees building consents figures set for release.

United States
Last week was relatively light data wise in the US although we did have plenty of comments from Fed officials. We also saw the minutes from the latest Fed meeting which showed the central bank is starting to discuss an exit strategy from their extraordinarily easy monetary policy. They were however quick to stress this does not mean a rate it is coming any time soon. It has also been made very clear that when rates do finally go up, it will be a very gradual pace of increase and the peak will be much lower than historical averages. The few data points that were released came late in the week. Manufacturing PMI improved to 56.2 from 55.4 previously, while existing home sales increased to 4.65m from 4.59m prior. However, this was below expectation for a jump to 4.71m. New home sales on the other hand came in better than forecast at 433k. This was a big jump from 407k previously and adding to the positive tone of the report were decent revisions to previous results. The housing sector has been a real concern recently with signs of waning momentum, so this is very welcome data. There has been nothing released in the early stages of this week with the US out on holiday Monday. The rest of the week should prove interesting with durable goods orders, consumer confidence, GDP, and pending home sales data.

Data from Europe last week has only helped to cement expectations of further easing from the ECB at next month’s meeting. Services PMI was the only bright spot coming in above expectation and improving over the previous reading. But countering this were disappointing readings on the current account, manufacturing PMI, German business climate and German producer prices. The only debate is around what measures the central bank will undertake, and recent comments from ECB leader Draghi suggest outright quantitative easing isn’t as much of a long shot as many have thought. He is quoted as saying “we are not resigned to allowing inflation to remain low for too long. Unwarranted tightening of monetary conditions from FX would require adjustment of our conventional instruments. At the other end of the spectrum a downshift in inflation expectations would be context for a broad based asset buying plan.” That sort of talk should keep the Euro under pressure in the lead up to the meeting on June 5th. The data calendar is a little lighter this week with the highlights being French consumer spending, German unemployment change, the money supply, and German retail sales.

United Kingdom
This week is a very quiet one for UK economic data. We only have mortgage approvals tonight, CBI realized sales tomorrow, and consumer confidence on Friday. Last week’s data held no major surprises. The second reading of GDP came in as expected at +0.8%, although public sector net borrowing data was worse than forecast at GBP 9.631 bln (expected 3.5 bln) and this saw the Pound come under a little pressure. The most interesting release was the minutes from the last BOE meeting. These suggested there could be real range of views developing within the monetary policy committee (MPC) on the timing of rate hikes. To date the entire MPC has voted unanimously behind Governor Carney to hold rates steady, but it seems we are likely to see some dissenters vote for hikes later this year. In a theme echoed in many developed countries, outgoing deputy governor Charles Bean suggested rates are likely to increase in “baby steps” and the peak will be below historical norms. He said it could take three to five years for rates to get to about 3%. He did however say there is a case for starting tightening’s earlier than currently forecast.

Last week’s Bank of Japan (BOJ) monetary policy meeting delivered no surprises and yesterday we got the minutes from the April 30th meeting. These showed that although exports have been somewhat weak, the bank believes the economy is likely to grow above potential from summer. The bank also expects to meet its target of 2% inflation by the end of the next fiscal year, although one member is sceptical and suggests the risk to inflation may well still be tilted to the downside. In other potentially more positive news, the Nikkei reported results of a survey showing average summer bonuses for workers will be up nearly 6% on last year. Manufactures in particular have been helped by the weaker Yen and as a result workers will be getting higher earnings. Governor Kuroda is set to speak tomorrow, and then on Thursday we get retail sales data. This will be followed on Friday by household spending, inflation, and industrial production data.

Late last week from Canada we got retail sales data that initially looked disappointing. The headline number of -0.1% was a big miss from the expected result of +0.3%. However, once you dug into the detail of the report there were positive revisions to previous numbers that helped to balance this out. It certainly wasn’t a strong report, but it wasn't as bad as it first looked either. We also got inflation data on Friday that came in bang on expectation at +0.2% for the month. There is little to draw focus this week until Friday’s GDP data hits the wires.

Major Announcements last week:
  • UK Inflation 1.8% vs 1.7% expected
  • BOJ leave monetary policy unchanged
  • BOE minutes show unanimous unchanged policy vote
  • UK Retail Sales 1.3% vs +.5% expected
  • FED minutes show discussions on stimulus exit started
  • China HSBC manufacturing 49.7 vs 48.1 expected
  • UK GDP .8% as expected
  • Canadian Inflation .3% as expected
  • NZ Fonterra GDT auction prices decline 1.8% on month