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FX Update - Risks associated with central banks remain prevalent

Written by Ian Dobbs on November 18th, 2014.      0 comments

Market Overview:
Declining oil prices are helping to drag down inflation rates in most developed nations and this is seeing expectations for rate hikes from many central banks get pushed further into the future. The question has to be asked whether this is a good enough reason to keep interest rates at, or close to, zero in countries like the US and the UK. Zero percent interest rates are an emergency measure that have their place, but over the long term there is little evidence of a benefit to the economy. Japan has had zero interest rates for nearly 20 years now and they are no closer to achieving sustainable growth or inflation rates. At some point the financial risks and imbalances that this policy setting promotes start to outweigh the potential benefits and this should be in the forefront of central banker’s minds. The scary fact is that out of the G7 nations, Bank of England Governor Carney is the only one to have ever raised interest rates. He did so when he was leading the Bank of Canada.

Encouraging signs last week from business confidence, consumer sentiment and inflation expectations all helped to support the Australian dollar to a degree. RBA deputy Governor Kent tried to talk the AUD down a touch late last week when he suggested the central bank hadn’t ruled out intervening in the currency markets, but the impact was short lived. There was no market impact from the G20 meetings held in Australia over the weekend, with the most notable point that tensions between Russia and the West are as frosty as ever. In the past few hours we have seen the minutes from the last RBA meeting although these held no surprises. Although the central bank believes the AUD is still above fundamental value, they also suggest the Bank of Japan stimulus and Japanese pension fund flows could keep the AUD there for some time. The see the housing market supported by very low interest rates and population growth, and they also note that lending to home investors is rising faster than to owner occupiers. Governor Steven’s is set to speak tonight and that pretty much wraps up the scheduled releases for the week.
New Zealand
The focus last week in New Zealand was on the RBNZ’s Financial Stability Report. The main point to come out of that was that with still very positive migration flows the central bank does not feel comfortable adjusting the LVR restrictions at this stage. Yesterday we got the latest reading from retail sales and it showed the consumer is good spirits. Sales jumped +1.5% from the previous reading against an expectation of just +0.8%. There were solid increases in supermarket and grocery store sales, possibly helped by the strong population growth from positive migration, but also good increases in discretionary spending areas like cafes and restaurants. This is a positive sign for the economy going forward and is certainly boosted the value of the NZD in the hours after the release. The focus now turns to Fonterra’s dairy auction tonight which will be followed by producer prices data on Thursday.

United States
We saw some decent data from the United States last week, although the USD remained on the back foot heading into the weekend. Pressure on the currency came as a survey of US inflation expectations declined to its lowest level since early 2009. That release seemed to outweigh the better than forecast readings that were seen on Friday night from retail sales and consumer sentiment. The market may be getting hung up on the weaker inflation outlook, but comments from some Fed governor are starting to suggest low inflation may not be a hindrance for rate hikes. The Fed’s Bullard said low inflation doesn’t justify keeping interest rates near zero, and the Fed’s George suggested financial stability risks warrant hiking rates to curb excesses in lending and financial markets. She said although financial stability doesn’t appear to be an issue today, it didn’t appear to be an issue in 2007 or 2008, and it turned out to be a terrible problem. She’s right about that and there are once again signs of excesses in the financial sector. Subprime auto loans (auto loans to people with tarnished credit) have risen more than 130 percent in the last five years. This explosive growth is been driven by some of the same dynamics that were at work in subprime mortgages, i.e. the demand for securitized debt with good rates of return. History is destined to repeat itself, but are people’s memories really this short?! Tonight we get producer prices data then later in the week the focus turns to building permits, the FOMC minutes, inflation data and the Philadelphia Fed manufacturing index.

United Kingdom
The UK Pound has remained under pressure in the wake of last week’s Bank of England’s (BOE) inflation report. With the central bank having slashed its inflation outlook there are now no forecasters predicting a rate hike from the BOE before the second half of next year. Some have even pushed their forecasts for the first hike out until quarter one of 2016. But is low inflation such a bad thing? Not if it’s driven by declining oil prices, which a good portion of this is. Cheaper petrol prices act like a tax cut on the economy, allowing more funds to be spent on other goods and services. Central banks will also ‘look through’ inflation moves that are temporary or driven by one off factors. The Bank of England did exactly that throughout 2010, 2011 and 2012 when inflation got as high as 5 percent. Another positive for the UK economy came in the form of last week’s average earning data. Wage gains increased by 1% and we may well be close to a time once again where wage gains outstrip inflation. That is a key metric for long term sustainable growth in the economy. Tonight we get the latest reading of inflation and the market is expecting a reading of 1.2%. The BOE minutes are out on Wednesday and these are followed by retail sales on Thursday.

ECB President Draghi, along with many other Eurozone officials, will have breathed a sigh of relief on Friday after GDP data didn’t print negative and actually came in a touch above the expectation at +0.2%. However, this was only a small piece of good news and there is no room for complacency on boosting the recovery. Draghi himself said last night that the economic outlook in the Eurozone is ‘increasingly sobering’.  He said early indications are that their credit easing package is delivering tangible benefits, although they need to remain alert for possible downside risks to their inflation projections. He added that growth momentum had weakened over summer and risks to their outlook continue to be on the downside. For the first time he also mentioned that the expanded asset purchase programme could include government bonds, although he added the ECB want’s more time to assess the effects of the measures already announced. Tonight we get German ZEW economic sentiment numbers then later in the week the focus will turn to manufacturing and service sector PMI data.

Japanese Prime Minister Abe’s plan to re-inflate the economy, commonly referred to as Abenomics, is in real trouble. It was dealt a serious blow by yesterday’s GDP data that showed the economy has fallen back into recession in the third quarter. GDP fell by -0.4% against expectations for a rise of +0.5%. This comes on the back of the second quarters -1.9% decline after the sales tax increase in April. A big chunk of the recent GDP decline came on the back of inventory adjustment which does have some positive aspects. A glut of inventories was holding back production, but those inventories have now been cut back and this should have a positive effect on production down the line. That is however, as good as it gets. Newspaper reports suggest PM Abe will hold a press conference today where he will announce a delay of second sales tax increase planned for October 2015. That seems like a no brainer, but the problem for Japan is they are facing a demographic time bomb. An rapidly aging population is going to put a real strain on public finances and Japan already has the world highest debt to GDP ratio at 227%. If confidence is lost in the government’s ability to get that under control, then a catastrophe is around the corner. The rumours are that at today’s press conference PM Abe will also dissolve parliament and call fresh elections for December. As if all this wasn’t enough we have the Bank of Japan (BOJ) rate meeting to digest on Wednesday and the trade balance on Thursday.

Last week was a reasonably light one in terms of economic released from Canada. The most notable outcome came from manufacturing sales data on Friday which printed at +2.1% versus expectations of +1.3%. This helped to support the Canadian dollar to a degree, as did an improvement in existing home sales and a investment flow data that came in better than expected. There is little else to digest until the end of this week when we get wholesale sales and inflation data. The market is looking for core inflation to remain stable at +0.2% on the month, whole wholesale sales are expected to increase 0.7%.

Major Announcements last week:
  • Chinese Inflation 1.6% as expected
  • UK Ave. Weekly Earnings 1.0% vs .9% expected
  • UK Unemployment rate 6.0% vs 5.9% expected
  • BOE lower Inflation expectations
  • European GDP +.2% vs +.1% expected
  • Canadian Manufacturing Sales 2.1% vs 1.3%
  • US (UoM) Consumer Sentiment 89.4 vs 87.3% expected
  • NZ Retail Sales 1.5% vs .8% expected
  • Japanese GDP -.4% vs +.5% expected