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FX Update - Markets tread water as economic and geopolitical risks couple

Written by Ian Dobbs on September 2nd, 2014.      0 comments

Market Overview:
The coupling up of geopolitical and real economy risks have seen mostly sideways trade emerge over the last week. The Ukrainian situation has intensified with sanctions, troop mobility and the exportation of necessary gas supplies making for a complex cauldron of motivations. The timing of these issues could not be worse for Europe as the economy continues to suffer. In the increasingly connected sphere of global markets, the European economic softness has far reaching ramifications. The prospect of increasing policy accommodation in Europe has seen pressure on global interest rates. It makes for an interesting situation in the US were the divergent economy appears to be forging ahead after a solid recovery in the second quarter. The prospect of close to record low longer end interest rates as the QE program is halted in October, will be welcomed at the Federal Reserve. Much of the increased demand for US interest rates is a flow over from Europe. The aid of low longer end interest rates will probably see the prospect of a hike in short term rates brought forward overtime. Under this scenario the prospects for the US dollar look good.

Data last week from Australia provided something of a mixed bag. Softer than expected construction work done data was countered by a much better than forecast result for private capital expenditure. Yesterday saw a couple of second tier releases in the form of company operating profits and the AIG manufacturing index, both of which came in somewhat softer than expected. These results had little impact on the currency that has been a solid performer over the past week. In the last couple of hours we have seen building approvals data and this came in a little stronger than forecast. But the main focus today will be on the RBA rate statement, which is set for release later this afternoon. No action is expected from the central bank and it seems likely they will remain on hold well into next year at least. However, we could see some stronger language on the value of the currency which could see it under some pressure. Tomorrow we get GDP data and on Thursday we have retail sales and trade balance to digest.

New Zealand
There hasn’t been much in the way of key data released from New Zealand over the past week. Yesterday did see the terms of trade come in much better than expected at +0.3%. The forecast was for -3.5%, but it seems falling dairy prices have been offset to a degree by declining import prices. The terms of trade have now reached the record high set back in 1973. This is unlikely to continue however, as a weaker NZD should eventually flow through into higher import prices. The impact of this data on the currency was negligible. Of more interest this week has been the political situation with continued revelations of dirty politics and the eventual resignation of government minister Judith Collins. The election that was looking like a one horse race could well end up being a lot closer than many expected. This hasn’t had much of an impact on the currency to date, but as the election draws closer the potential risks could start to weigh. We also have another dairy auction tonight and the market will be keen to see further stabilisation, or even a small bounce, in prices. Another decline in prices will translate directly into a weaker New Zealand dollar.

United States
A public holiday yesterday means it have been a very quiet start to the week in the US. Last week saw overwhelmingly positive data out of the States that points to a continued strong recovery in the months ahead. Durable goods data was healthy, second quarter GDP was stronger than forecast, consumer confidence is improving and on Friday evening the Chicago PMI (a leading indicator of economic health) printed at its best level since May. The 64.3 result was also much higher than expectations for a reading of 56.8, and a big jump from last month’s 52.6. It seems momentum in the US economy is building and this should see the Fed eventually signal rate hikes are coming in the foreseeable future. We do have some key releases set for this week which should continue to support the positive outlook. Manufacturing PMI hits the wires tonight, then later in the week we have the trade balance, factory orders, non-manufacturing PMI and non-farm payrolls to digest.

United Kingdom
The UK economy continues to perform well although some data series have moderated from the highs see a few months ago. Manufacturing PMI is one of those with the latest reading coming in weaker than expected at 52.5. That is down on last month's reading of 54.8 and a significant decline from July’s result of 57.5. However, late last week we did get a better than forecast readings from CBI realized sales and the Nationwide house price index. The focus now turns to construction and service PMI data out tonight and tomorrow night respectively. The Bank of England (BOE) then hold their regular rate meeting on Thursday, the minutes of which will only be released a couple of weeks later.

The outlook for Europe remains far from positive. It seems ECB President Draghi’s recent call for fiscal policy changes to help boost demand has fallen on deaf ears. On the data front the highlight last week was inflation which came in on expectation at just +0.3%. This is a fall from last month’s +0.4% but at least the core number, which strips out volatile food and energy, rose a tick to +0.9% from +0.8% previously. Unemployment remains unacceptably high at 11.5% and manufacturing activity throughout the region moderate in August with the overall PMI declining to 50.7 from 50.8 previously. The Ukrainian situation could not come at a worse time for Europe with sanctions on Russia also likely to have a negative effect on many European nations including Germany. With winter fast approaching gas supplies from Russia that run through the Ukraine to the rest of Europe could well get turned off. Contingency plans for this might have to involve limiting industrial use which would see activity contract further. The focus this week is firmly on the ECB with their regular policy meeting and press conference on Thursday evening. It is unlikely we will get any action from them at this meeting, but we should get a further step toward a quantitative easing programme in the coming months. This programme will likely see the purchase of asset backed securities, as opposed to outright government debt.

Concerns are growing about the ability of Japan’s economy to recover quickly from April's sales tax hike, and rightly so. Friday saw the country release a raft of data and the majority of it was disappointing. Household spending fell for the fourth straight month declining by 5.9%. The unemployment rate ticked up to 3.8% and industrial production was softer than forecast at just +0.2%. The only bright spot was retail sales that printed at +0.5% against expectations for -0.1%. Inflation gains also seem to have stalled and recent capital spending data also disappointed. Prime Minister Abe is set to make a decision on the next sales tax increase (a jump from 8% to 10%) over the coming months, but some advisers are now suggesting it should be delayed until 2017. The Bank of Japan (BOJ) meets on Thursday and although many expect the bank to maintain its current optimistic economic outlook, it’s looking increasingly like the economy is going to undershoot those expectations.

Canada released GDP data at the end of last week and the headline made encouraging reading. June’s monthly result was +0.3% which was better than the forecast for +0.2%. This means that the economy grew at 3.1% (annualized) in the second quarter against expectations for 2.7%. There were however significant downward revisions to data from the first quarter and this tempered the markets enthusiasm to a degree. We have plenty to digest this week with the Bank of Canada (BOC) rate statement, trade balance, employment change and Ivey PMI all set for release.

Major Announcements last week:
  • German Ifo Business Sentiment 106.3 vs 107.1 expected
  • US Durable Goods Sales 22.6% vs 7.8% expected
  • US CB Consumer Confidence 82.4 vs 89.1 expected
  • Australian Private Capital Exp. 1.1% vs -.6% expected
  • US prelim. Q2 GDP 4.2% vs 3.9% expected
  • Japan Prelim. Industrial Production +.2% vs +1.2% expected
  • NZ ANZ Business Confidence 24.4 vs 39.7 previous
  • European Inflation +.3% as expected
  • Canadian GDP +.3% vs +.2% expected
  • US Chicago PMI 64.3 vs 56.8 expected
  • Chinese HSBC Manufacturing PMI 50.2 vs 50.3 expected
  • UK Manufacturing PMI 52.5 vs 55.1 expected