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FX Update - Risk aversion and weak stocks drive rates

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

Market Overview:
Throughout the last week there has been a continuation of the recent patchy market conditions. Risk aversion has seen elevated periods, with eyes firmly on the emerging markets and the efforts from various central banks to stabilize respective currencies. Of course all of this stems from the US Federal Reserve’s tapering of their quantitative easing (QE) programme. The increased risk aversion has seen equity markets lower and the US dollar and Japanese Yen in demand for the most part. The central bank focus continues this week with the Reserve Bank of Australia, European Central Bank and Bank of England all making monetary policy announcements. We can expect increased volatility within broad ranges in the coming months. Globally, employment markets are seeing growth for the most part. Crucially there has been a lack of apparent wage growth accompanying the jobs growth. Growth in wages is a key ingredient to enable economies and central banks to return to more balanced outlooks.

The big focus for this week is the Reserve Bank of Australia’s rate statement set for release later this afternoon. It is likely the RBA will convey a neutral tone as they are left with very little room to act in the wake of last month’s surprisingly strong inflation data. This should help to support the Australian dollar to a degree. On Friday we got the latest reading on producer prices, and this came in at 0.2% which was way below expectation of 0.7%. The previous reading was 1.3%. This soft figure suggests there is little in the way of pipeline inflation pressures in the economy and it may well be that the previously strong inflation data is the result of a number of temporary factors. Only time will tell if that is the case and until then the RBA are unlikely to signal any further potential easing’s. This outlook was supported by private sector credit data, also released on Friday that showed the biggest monthly rise since March 2012 coming in at 0.5%. This follows a 0.3% increase the previous month. Later in the week we get data on retail sales and the trade balance which are followed by the RBA monetary policy statement on Friday.

New Zealand
The New Zealand dollar has come under a fair bit of pressure since last week’s RBNZ rate statement. Although it is now almost a certainty that the central bank will begin it’s tightening cycle in March, the chance of a hike last week was priced into the market. With the non-eventuality of that, the currency has moved to reflect the no change decision. On Friday we got trade balance data that saw another strong surplus of $523mln. This was a little below expectation, but is still the highest level since March and it marks the second consecutive month of surplus. Yesterday we saw another strong business confidence survey with nearly three quarters of business expecting the economy to be in better shape in a years’ time. The focus now turns to employment data out tomorrow. The unemployment rate is expected to fall to 6.0% from 6.2% previously.

United States
We saw solid GDP numbers from the US late last week and these were backed up by personal spending and consumer sentiment figures that both came in a touch above expectation. However, the stock market has been losing ground recently and long term interest rates have also been falling and these moves have been reinforced by surprisingly weak manufacturing data released last night. The ISM Manufacturing Index fell from 56.2 in December to 51.3 in January. This is a big fall in the index and it marks a seven month low. Looking into the detail of the report didn’t make any better reading with the new orders component having the biggest fall since December 1980. The figures were definitely affected by the extremely cold weather seen in parts of the US in January, but it would be hard to attribute all the weakness to that alone. One ISM official called this data a ‘blip on the screen’ and only time will tell if he is correct. We have further key data out this week in the form of Non-Manufacturing PMI, released tonight, and the monthly employment report, released on Friday. Markets will be extra sensitive to any soft readings from these indicators.

This week should prove very interesting for Europe and the Euro. On Thursday night we get the result of the latest ECB rate meeting followed by the usual press conference. There are a number of commentators now expecting the central bank to announce another rate cut, or extra measures of some kind. These calls have grown louder in the wake of a further weakening in Euro area inflation data released on Friday. The fall to 0.7% from last month’s 0.8% certainly increases pressure on the ECB to act, although they may just use this meeting to signal likely action next month. The inflation data comes on top of worryingly weak German retail sales data which declined -2.5% against and expectation of a 0.2% increase. Euro-area unemployment also released on Friday held steady at 12.0%. With the current ECB rate at 0.25% conventional measures have largely been used up by the central bank and they may now have to dip into the toolbox of unconventional measures to fight the threat of deflation. Recent comments from President Draghi suggest he believes inflation will gradually return to the 2% target after a prolonged subdued period. Even if this proves to be the case there seems little risk in acting again now to support growth. Ahead of the ECB decision we have manufacturing and service PMI’s, retails sales, and German factory orders data to digest.

United Kingdom
The UK economy continues to recover at a decent pace. Last week’s GDP was a solid 0.7% for the quarter and bang on expectation. House prices remain firm and net lending to individuals is increasing. Last night we saw the latest reading from the manufacturing sector and although it declined a touch (to 56.7 in January from 57.2 in December) it is still at healthy levels overall. We get readings on the construction and services sectors tonight and tomorrow ahead of the Bank of England's monetary policy announcement on Thursday. The central bank is not expected to act and Governor Carney will likely reinforce the point that rates will stay low even if unemployment falls below the 7% threshold of his previously announced forward guidance policy. The Governor knows that although recent UK economic performance has been better than expected, the economy is coming from a low base and continued gains will get harder to come by unless salaries start increasing. A recent report released from the Office for National Statistics (ONS) shows UK real wages have dropped for the longest period in 50 years. They have been falling consistently by 2.2% annually since the beginning of 2010. Aside from further turmoil in Europe, this is the biggest hurdle to continued strong UK growth.

Aside from some slightly disappointing retails sales numbers, data out of Japan last week was very supportive of the economy going forward. Inflation data came in a touch above expectation at 1.3% year on year, in a sign that the Government and central bank are making good progress on ending years of deflation. This brings it one step closer to the 2% target set by Prime Minister Abe. On Friday unemployment data for December was released that dropped to a six year low at 3.7%, down from 4.0% in November. The next big hurdle, and one the PM Abe is trying to approach, is to get wages to increase. This is the final step that he hopes will start a self-reinforcing cycle of economic growth. There is limited data out this week with only average cash earnings of any note.

Last week was a quiet one for economic data from Canada with only GDP released on Friday evening. The 0.2% monthly result was exactly what the market had been expecting and as a result it had little impact. This week will provide better insight into the performance of the economy with building permits, the trade balance, Ivey PMI, and employment data all set for release.

Major Announcements last week:
  • Turkey, South Africa and india all raise interest rates to stabilize markets. Russia sells FC reserves (buys Roubles) and pledges to do whatever is required to stabilize the Rouble.
  • UK preliminary Q4 GDP 2.8% as expected
  • US Durable Goods sales -4.3% vs +1.8% expected
  • US Fed tapers QE by 10 billion as expected
  • RBNZ leaves cash rate unchanged at 2.50% (some picked rate hike)
  • German Inflation 1.3% vs 1.5% expected
  • US preliminary Q4 GDP 3.2% as expected
  • US Personal Inflation (PCE) 1.1% as expected
  • Japanese Inflation 1.3% vs 1.2% expected
  • European Inflation .7% vs .9% expected
  • Canadian GDP .2% as expected