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FX Update - It's all about the Fed.

Written by Ian Dobbs on December 17th, 2013.      0 comments

Market Overview:

Please note : This will be the last Weekly FX Update for 2013. Commentary will resume the week starting 6 Jan. Have a very happy and safe festive season from all the team at Direct FX.

Activity within the wider market has been sporadic over the last week. In general, lower levels of liquidity can be expected in the run up to the festive season. Changing the dynamic this year is the prospect of one of the more anticipated US Federal Reserve monetary policy announcements in history. The impacts of the Fed’s quantitative easing (QE) program have had a truly global reach. The gradual removal of this unheralded stimulus will be the dominant driver in markets in the coming year. The impacts on the Australasian economies will be both direct and indirect in terms of immediate exchange impact, and the economic impacts of the policy on different trading partners over time. Until the situation becomes more clear, expect periods of increased volatility throughout 2014. Given the shambolic communication from the Fed throughout 2013, the markets will remain appropriately tentative around Fed announcements. Adding further to the mix is the transition of leadership from chairman Bernanke to the incoming leadership of Janet Yellen in early 2014.

Current sentiment is very negative on the Australian dollar. Even last week’s employment numbers printing at a seven month highs couldn’t halt the currency’s slide. To be fair, that was one of the few pieces of key data recently that has surprised on the strong side. The AUD also wasn’t helped by RBA Governor effectively stating that a rate of 0.8500 to the USD was a realistic level for the currency. Yesterday the Abbott government abandoned its target of returning the budget to surplus in for years. The PM indicated a 2016-17 surplus was unrealistic. It seems likely this year’s deficit will be up around $50 bln. We also had some slightly weaker than expected Chinese manufacturing data yesterday. Although the index is still in expansionary territory at 50.5, this was a three month low. On a brighter note a recent article the UK Telegraph, sighting a Morgan Stanley report, suggests Australia has the potential to become an ‘energy superpower’ by 2017. The article says Australia has a window of opportunity to become a major supplier of liquefied natural gas (LNG) to growing Asian demand. In the last couple of hours the RBA have released the minutes from the previous meeting. They show no major change from the previous meeting and the reaction has been limited.

New Zealand
The New Zealand dollar has been well supported since last week’s RBNZ monetary policy statement. Their slightly higher projected track for interest rates over the next two years highlights the strength in the economy and positive outlook going forward. This was further underlined by data out yesterday. Consumer sentiment came in at 120.1 which is up from 115.4 last month and a four year high for the index. We also had the NZ Performance of Services Index which printed at 56.3. This was a touchdown on the previous reading of 58.2, but is still strong nonetheless and well above the 50 level which denotes expansion in the industry. There was also good news for the film industry with the announcement that the next three Avatar films will be made here in New Zealand. That will translate to an extra $1 - 2 bln spent in the economy over the coming years. Over the next few days we have business confidence and GDP data to draw focus.
United States
The cold hard reality is that there is only one announcement that matters this week or next. That announcement will come from the Federal Reserve Bank early Thursday morning Australasian time. Are they going to taper or not? The Fed have had a debacle this year with their communication around the issue. In June chairman Ben Bernanke signalled they would start tapering in the coming months and the USD started a strong run. When they didn’t taper in September, the USD gave back all of its gains. The Fed have created all sorts of volatility with this so far and now the markets have no idea whether we will get a yes or no from them this week. So we are likely in for more interesting moves as markets react to the announcement. Quantitative easing (QE) has been a massive policy gamble by the Fed. Its ramifications have been far reaching and will be felt for a long time. How markets react to the eventual withdrawal of relentless cheap money remains to be seen, but there are some big risks ahead. The least of which is not the stock market. Without a shadow of doubt, the QE program has inflated stocks. For much of the past two years the stock market would rally on the back of bad economic data. This is because poor data meant the Fed would keep printing money. The stock market is now well overvalued on just about any measure. Will the Fed pull the trigger before Christmas? We will know the answer in less than 48 hours, and the decision could set the tone for market dynamic for 2014.

We got a lot of second tier data from Europe last week and most of it was on the soft side. It didn’t seem to impact the Euro much however, as the currency continues to perform better than expected. Last night we got manufacturing and service PMI data which highlighted a growing problem for the Eurozone. The German results we solid, with manufacturing expanding to 54.2 and services declining a touch to 54.0. But the French results showed both sectors declining further into contraction territory with manufacturing coming in at 47.1 and services at 47.4. France is at the core of the Eurozone, but its economic performance is leaving a lot to be desired. This could prove to be a big hurdle for the Euro in 2014. Still to come this week we get German economic sentiment, business climate, and Eurozone inflation. President Draghi was on the wires again last night saying the ECB is aware of the downside risks to inflation and the bank is ready to act. Further action by the ECB is a very likely possibility in the New Year.

United Kingdom
Last week’s data had little impact on the current positive outlook for the UK economy. A slightly weaker trade balance was countered by industrial production that came in a touch better than expected. There were a number of Bank of England (BOE) speakers throughout the week, but none of them added anything new. This week offers a little more for the market to digest. We start off with inflation data tonight. The last few months have seen inflation in the UK moderate and this will be a big relief for consumers and the BOE. There is very little in the way of inflation pressure globally at the moment and another tame result is expected here. Also this week we have the bank of England minutes, unemployment, retail sales, current account, and the final reading of GDP.

Last week wasn’t a good one for Japanese economic data. The downward revision to GDP was particularly disappointing and this was followed by softer than expected readings from the business activity index, consumer confidence, and core machinery orders.  However, the week did finish on a slightly brighter note. Industrial production release on Friday came in at 1% against and expectation of 0.5%. This marks the third consecutive month of output growth and it certainly looks like the weaker Yen is helping Japanese manufacturing. Yesterday we had the release of the Tankan indexes for manufacturing and non-manufacturing. These both beat expectation which bodes well for the near term outlook. The only other data this week is the trade balance, and this is followed by the Bank of Japan (BOJ) monetary policy statement on Friday.

Last week was a very quiet one for Canadian data. The only figures released were housing starts and the house price index. Both of which came in a touch under expectation. This week will provide a better insight into the health of the economy with manufacturing sales, wholesale sales, inflation, and retail sales all set for release.

Major Announcements last week:
  • Japanese Q3 GDP +1.1% vs +1.6% expected
  • Chinese Inflation 3.0% vs 3.2% expected
  • UK GDP 3 month estimate. .8%
  • RBNZ leaves monetary policy unchanged
  • Australian Unemployment rate 5.8% as expected
  • US Retail Sales +.7% vs +.6% expected
  • European Manufacturing PMI 52.7 vs 51.9 expected
  • US Manufacturing PMI 54.4 vs 55 expected