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FX Update - The beginning of the end for QE

Written by Ian Dobbs on June 25th, 2013.      0 comments

3:15pm (NZT)
Market Overview:
As the markets digest the changing landscape after the US Fed’s announcement on tapering last week, the Bank of International Settlements has released its annual report, which includes a timely piece on stimulus. They warned of adding further monetary stimulus to a global economy that was past the height of the crisis. They also believe adding more extraordinary stimulus was becoming increasingly perilous and that central banks cannot do more without compounding the risks they’ve already created. Timely indeed. We’ve seen how the markets react to the threat of a mere reduction in stimulus from the US Fed. The repricing of risk assets across the board (in currency terms both the AUD and NZD are classed as risk assets), as stimulus is withdrawn, and eventually stopped,  will continue to reverberate in markets for the foreseeable future. The moves we have seen over the past couple of weeks in the form of a stronger USD, higher long term interest rates, and volatile stock markets, could all be the start of much broader trends.

There has been little out over the last few days to materially change the outlook for the Australian economy. The AUD made a fresh cycle low over night, but only by a handful of points, before staging a decent bounce. A liquidity squeeze in the Chinese banking system is getting a lot of coverage at the moment. Mostly because the Peoples Bank of China is so far refusing to step in and alleviate the pressure. It seems they are sending a signal to their banks to tighten up lending standards. This is however a dangerous game they are playing. Short term credit markets in China are starting to look like they did in the US before the Lehman’s collapse in 2008. The rest of the week offers very little in the way of fundamental data for Australia, with only private sector credit figures set for release on Thursday.

New Zealand
There has been little of importance released in New Zealand since last week’s softer than expected GDP data. We will have to wait for this Thursday to get readings on the trade balance and business confidence. In the meantime the New Zealand dollar will continue to be influenced by offshore factors. The currency has seen mostly sideways action bouncing around its cycle lows since the US Fed announcement last week. Longer term interest rates have also increased in line with offshore markets over the last few days.

United States
Last week’s announcement by Ben Bernanke that a scaling back of asset purchases is just around the corner has continued to reverberate through the markets. Bond yields have backed up a long way and equities are volatile. The sharp move higher in the USD has taken a pause the last couple of days, but it seems likely this move is just that start of a broader trend. There have however been a number of Fed officials releasing comments in the last two days stating that the markets have over-reacted to the news. They have stressed that the Fed is not exiting stimulus but merely dialing back liquidity. The Fed have created this monster and caused a mispricing of risk assets across the board. If they thought the road to an exit was going to be smooth, they are sadly mistaken. If this truly is the beginning of the end for quantitative easing, then the next 12 month will see much more volatility and some of it I suspect will be very painful with unforeseen ramifications.

Two pieces of data out in the last few days have been somewhat supportive of the Euro-zone outlook. Firstly we saw current account data on Friday that showed a continued healthy surplus. Then last night we got a reading on German business sentiment that has improved from last month.  The EUR itself has been quite volatile on the back of flows and position adjustments after the Fed announcement last Thursday. There was however an interesting article published (here) early this morning focusing on Italy. It states that Italy could be in need of an EU rescue in the next six months. The Euro-zone crisis has gone off the boil lately thanks in large part to the ECB. But the structural issues are yet to be fixed, and an Italian rescue would take things to a new level. The rest of the week sees lots of German data hitting the wires. Unemployment, retails sales and inflation data for Germany will all be released along with French consumer spending. We can also expect lots of talk from officials at the Euro economic summit later in the week.

United Kingdom
There has been little to change the slightly brighter outlook for the UK and the Pound Sterling over the last few days. Late on Friday there was the release of public sector borrowing data which showed an improving trend. The UK’s Osborne says austerity is still needed to avoid an economic relapse. He delivers his spending review this Wednesday and says spending is still too high. He is committed to finding another GBP11.5 billion in savings over the coming fiscal year. We will hear plenty from outgoing Bank of England governor King over the next couple of days. He’s reporting to a parliamentary committee tonight on the inflation outlook, then is scheduled to release an on the record speech tomorrow. Later in the week we see figures on the current account and a final reading on GDP.

This week we will get readings on the Japanese consumer with household spending and retail sales both set for release on Friday. Until then we will no doubt continue to get comments from BOJ officials. Over the weekend Governor Koroda was on the wires with a very upbeat assessment of the economic outlook. He sees a pickup in exports helped by the recent weakness in the currency and expects Japan’s economy to return to moderate growth. He said the BOJ will continue easing to achieve stable price growth, and sees no problems in Japan’s financial system. He also believes the markets will settle down as they reflect Japan’s recovery. Let’s hope he is right because recent volatility in stocks and bonds is not something you would want to see continuing in the long run.

The Canadian dollar out-performed many currencies last week in the face of the US Fed’s announcement on tapering. This was especially noticeable against the NZD and AUD as both cross rates to the CAD sank in the hours after the Fed meeting. However on Friday night Canada had economic data in the form of retail sales and inflation figures released. Both releases came in under expectation and disappointed the market. Core retail sales actually contracted on the month against an expectation of being flat. Inflation was also weak and both pieces of data weigh on the Canadian dollar. It has now started to play a little bit of catch up to weakness in the NZD and AUD. The only data of note this week is GDP, which won’t hit the wires until early Saturday morning, so current sentiment could keep the CAD heavy over the coming days.

Major Announcements last week:
Ben Bernanke signals ‘tapering’ in coming months
New Zealand GDP 0.3% vs 0.5% expected
Chinese manufacturing PMI 48.3 vs 49.4 expected
UK retail sales +2.1% vs 0.8% expected
Canadian CPI 0.2% vs 0.3% expected
Canadian retail sales -0.3% vs 0.00 expected