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FX Update : China and oil continue to dominate

Written by Ian Dobbs on January 19th, 2016.      0 comments

Market Overview:
Chinese economic concerns and weak oil prices are the two overriding themes of 2016 so far. The past week has provided little respite from either of these major influences and global financial markets are exceptionally nervous about the weeks and months ahead. Oil prices have seen fresh weakness thanks largely to the lifting of sanctions on Iran. This news couldn’t have come at a worse time for oil, and we now have the prospect of new supply coming onto an already saturated market. Talk of $20 a barrel, which only months ago seemed a little far-fetched, now seems incredibly realistic. The Chinese authorities’ attempts to avoid a ‘hard landing’ for their economy are starting to look very reactionary and confidence that they have control over the situation is rapidly declining. All this is weighing on global equity markets and threatening the prospects of global growth for the year ahead. The one thing the Chinese authorities seem to have too much control over is economic data releases. There have long been concerns about the validity of economic numbers coming out of China, and today’s fourth quarter GDP numbers will draw a lot of attention and be closely scrutinized.

There hasn’t been much, in terms of market moving data, released from Australia since last Thursday’s better than forecast employment numbers. The market has remained volatile however, with continued concerns around China and commodity prices weighing on the Australian dollar. Over the coming days we have Westpac consumer sentiment and inflation expectations data to digest, along with some key releases from China. Although the global market volatility seen so far this year raises concerns on a number of levels, it won’t have impact the Reserve Bank of Australia’s (RBA’s) current stance, which is firmly ‘on hold’ for the foreseeable future. The bank will in fact be very comfortable with the decline of the Australian dollar from the elevated levels seen late last year.

New Zealand
The New Zealand dollar has continued to see pressure this past week as risk aversion remains the theme of 2016. Concerns about China and weak global equities have resulted in a very nervous start to the year for the financial markets and the road ahead continues to look bumpy. Domestic data was sadly lacking last week, but tonight we have another Global Dairy Trade auction to digest and tomorrow we get the latest reading of inflation. It’s very hard to see any positive surprises to dairy prices in the current environment, and with every passing auction that fails to impress, the forecasted payout for the season becomes harder to achieve. Inflation for the fourth quarter of 2015 hits the wires tomorrow morning and is expected to print at -0.2% q/q and 0.3% y/y, well below the central bank's mid-point of 2.0%.  While the latest fall in the price of oil won’t be included in this data it certainly suggests there is limited upside potential for inflation over the coming months.

United States
Data from the United States last week was for the most part disappointing. The only positive surprise was consumer sentiment which improved a touch from 92.7 to 93.3. Countering this were weaker than expected readings from industrial production, the Empire State manufacturing index and retail sales. The soft data has caused a number of forecasters to revised down their GDP estimates for the fourth quarter. Throw into the mix the global market turmoil, declining equity markets and continued weakness in the price of oil, and you could easily conclude that the Fed tightening cycle, which kicked off in December, is starting to look like it will be even more gradual than forecast. Recent speeches from Fed officials have downplayed the impact of market turmoil on the US economy, but investors are starting to cut their bets that we will see a further four rate hikes this year. A US bank holiday yesterday has meant it’s been a slightly quieter start to this week, but data over the coming days will draw plenty of attention. Inflation numbers will be the main focus but we also have building permits, housing starts, oil inventories, the Philly Fed manufacturing index and unemployment claims to digest.

United Kingdom
The UK Pound has suffered a terrible start to 2016 as expectations of any potential Bank of England (BOE) interest rate hike get pushed out until early 2017. Data released last week was largely disappointing with softer than forecast outcomes from manufacturing production, industrial production and construction output. The BOE voted 8 to 1 to keep rates on hold at Thursday’s meeting, which was no surprise. It’s going to a tough year for the Pound which also has to deal with the uncertainty of a referendum on Britain's membership of the EU. No date has yet been set for the vote, but it’s likely to be around mid-year sometime. The implications are huge for the UK economy and current polls suggest it’s far from a certain outcome. This week we have some key data to draw focus starting with inflation numbers tonight. That will be followed by employment and earnings data on Wednesday night, and the week is rounded out with retails sales figures on Friday.

A number of second tier data releases from Europe last week were of little consequence with attention firmly on global market volatility and declining equities. The Euro has been one of the big winners throughout the turmoil so far in 2016, which would suggest it has become one of the funding currencies of choice for the carry trade. The ECB are unlikely to be happy with the Euro’s recent strength and President Draghi may well try to jawbone the currency lower when the central bank meet on Thursday. The ECB meeting will provide the main focus for the week, although there is little expectation for any action so soon after the bank announced further easing measures back on December 3rd. Other releases to watch out for this week includes inflation data, manufacturing PMI and services PMI.

Japanese Yen gains on the back of safe haven demand has been the story of 2016 so far, and the past week was no different. Recent data has for the most part been disappointing, but it’s had little impact on the currency as wider market concerns have dominated. Further declines in oil prices and concerns about Chinese growth are only going to make the Bank of Japan’s (BOJ) 2% inflation target even harder to achieve. Governor Kuroda was speaking in parliament yesterday and he said they will continue to ease until inflation is stable. There is little in the way of domestic data to get excited about this week. China will remain firmly in focus, particularly the GDP result set for release later this afternoon.

The Canadian dollar has had a volatile week losing ground across the board. Continued declines in oil prices have done the damage, and with Iranian oil about to hit an already oversupplied market, the near term prospects don’t look encouraging. Domestic data releases were of no consequence last week, although this week should be a different story. Manufacturing sales, inflation and retails sales will all draw attention but the real focus will be on the Bank of Canada’s (BOC) rate meeting early on Thursday morning. It’s a very close call whether they cut interest rates at this meeting in response to renewed oil price weakness with markets pricing in around a 50% chance. An interest rate easing has been fully priced in by March however.
Major Announcements last week: (Tuesday only)
  • UK Manufacturing Production -0.4% vs 0.1% expected
  • Australian Employment Change -1.0k vs -11.0k expected
  • Bank of England leave interest rates unchanged at 0.5%
  • US Core Retail Sales -0.1% vs 0.2% expected
  • US Producer Prices Index -0.2% as expected
  • US UoM Consumer Sentiment 93.3 vs 92.7 expected