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FX Update : Official Fed talk puts markets in a spin

Written by Ian Dobbs on September 13th, 2016.      0 comments

Financial markets got their largest fright since June’s UK Brexit vote on Friday after comments from US Fed Presidents Rosengren and Kaplan. The comments pointed to the increased chance of low interest rates overheating the US economy and the strengthening case (in past months) for a rate hike. The comments saw global equities and risk currencies fall heavily as the Fed fund futures jumped 6% to place a 24% chance on a Fed move next week. The 39% jump in the VIX volatility index on the day highlights the recent complacency that the financial markets have had given the prospect of continued low global interest rates and further central bank stimulus.  Comments from Fed officials yesterday have helped calm the markets in recent trade after they spoke of a lack in urgency in the need to raise US rates, this saw the markets eliminate all of Fridays September Fed funds move. Expect a quieter week this week until Thursday (noting the window for Fed member comments is now closed) when the key US data wrap starts. Expect no change from the BoE when they meet earlier in day given the recent run of stronger than expected key UK data.

Volatility in the markets has jumped since our report last week on the back of comments from US Fed officials. These initially drove the risk currencies and global equities lower on Friday before they underwent a rebound in trade overnight. This rebound came on the back of further comments which spoke of the need for caution and the lack of urgency in the need for moving US rates. Australian data last week included numbers on the June quarter GDP which showed solid growth of 3.3% year-on-year, although the quarterly number was well down on the previous period and was bolstered by heavy public spending in the defence sector. The RBA was seen remaining on hold at its latest cash rate review. This decision was as expected after departing Governor Stevens judged that present policy would help achieve the inflation target over time. However,  weak underlying global inflation pressures and record low wages growth domestically have combined with a high AUD to lend weight to the argument for a further cut. Other data included housing finance which fell in July and the AIG services and constructions PMIs which like the manufacturing PMI earlier fell in August. ANZ job ads were strong and the July trade deficit improved sharply from the month prior, although was helped by the volatile gold export component. Dominating focus for this week will be the latest read on employment on Thursday.

New Zealand
Official Fed commentary has dominated market sentiment since our last commentary. Friday’s comments from the Fed’s Rosengren and Kaplan drove a heavy sell-off in US equities and a 39% spike in the VIX index of volatility. This came after they spoke of the low interest rates increasing the chance of overheating the US economy and of the strengthening case for a US rate hike. The comments saw risk taken of the table and the NZD fall over 2.5% (against the greenback) from its recent highs at one stage overnight. However, comments from other Fed members reversed the direction of the markets after they spoke of the caution and little need for urgency around raising US rates. Last week was a quiet one locally for key data releases with the main contributor to market sentiment being the weaker US data and the further lift in the latest GDT dairy auction. Other releases included the June quarter manufacturing sales numbers which rose on the back of solid primary industry gains and ANZ commodity prices which reflected the recent strong rise in the price of dairy products. Local focus this week includes numbers on the June quarter current account (tomorrow) and GDP (Thursday).

United States
Trade in the greenback last week was dominated by two key events. The first was the weak ISM Non-manufacturing survey earlier in the week which saw the USD decline. The second was comments of Boston Fed President Rosengren and Dallas Fed President Kaplan on Friday whom both pointed to the case for a rate hike later this month. The comments saw the USD rally sharply and US equities undergo their strongest sell-off since the UK Brexit vote. However, much of the losses have been reversed in overnight trade on the back of further Fed official comments which pointed to no urgent need in raising the US benchmark rate. Other data last week included indicators on the labour market which remained strong as the rate of job offerings, hiring and people quitting remained at high levels, and jobless claims which remained very low. The Fed’s Beige book spoke of modest growth and a tight job market which showed little sign of overall wage pressure. This week is set to start quietly, although will heat up on Thursday when we get various indicators which include those from the manufacturing and retail sectors and numbers on inflation on Friday (amongst others).

United Kingdom
Last week was a mixed one for the GBP which saw the early week gains relinquished by the week’s end. The weakness came after the BoE inflation report and comments from US Fed officials on Friday. The comments which upped the ante on a US Fed rate hike later this month incited a rally in the greenback and a sharp sell-off in global equities. Data released in the UK last week included the latest services PMI indicator which jumped sharply from the month prior, and numbers from the manufacturing sector which disappointed after they fell by the largest amount in a year. Industrial production data was better than expected, although reflected strength from the relatively (Brexit) immune oil and gas sector. Halifax house prices fell 0.2% in August, only half the decline expected, although the three monthly rise was the slowest quarterly growth rate since Dec 2014. Trade data for July showed an improving UK deficit which was helped by a weaker GBP and improving level of exports. This week is set to be busy starting with inflation and producer price numbers today and employment tomorrow. Thursday’s key central bank decision should see the BoE remain on hold in light of the recent tone of better than expected key data.

Last week in Europe was dominated by Thursday’s ECB interest rate decision which saw the ECB leave monetary policy unchanged and economic forecasts which lacked any significant change. President Draghi’s comments that an extension to the current quantitative (QE) easing program was not discussed was interpreted as hawkish and saw the Euro rally during the announcement. An extension to the program (beyond the current March 2017 expiry) at the December meeting looks likely however. This is because of the lack of inflationary pressures and inflation rate which remains well below target, especially given that the ECB’s own economic forecasts assume a continuation of the current QE program. Data released during the week included EU services and composite PMI numbers which fell short of expectations and German industrial production and factory order data which were both weaker than expected. Retail sales across the EU lifted by more than expected in July and were up 2.9% year-on-year. Interest this week comes in the form of German inflation numbers today (EU inflation on Thursday) and the ZEW survey of economic sentiment. EU industrial production will provide limited interest tomorrow.

Volatility in the financial markets and safe haven flow has dominated trade in the Yen since our last report. The jump in volatility came on Friday after hawkish comments from Fed members spooked the market over the likelihood of a Fed rate rise later this month. The comments saw US equities fall heavily on the day and the Yen rise on the back of increased ‘safe haven’ demand. This theme has been lacking in the market in recent weeks as global equities continued to ride the wave of central bank stimulus and cheap credit. Comments from other Fed members overnight have helped the markets regain a stronger footing after they suggested there was no urgency to raise the benchmark US rate. Local data released last week included upwards revisions to the June quarter GDP growth numbers and stronger than expected wages growth. Current account data was slightly weaker than expected, although the leading index of the economy rose from the period prior. Machinery orders for July released yesterday was much better than expected and the BSI index of large manufacturing sentiment conditions released this morning showed a solid bounce in Q3.

Interest in Canada last week was dominated by the BoC interest rate decision and August employment data. The former pressured the CAD on the back of comments over the risk of weak inflation, lower than expected growth and concern over the household exposure to the overheated property market. Rates were left on hold at 0.5% as expected. Employment data released on Friday was better than expected with the creation of 52k full time jobs during the month helping offset July’s particularly weak report. More people entering the workforce saw the unemployment rate inch higher to 7%. Other data of interest included the Ivey PMI which was weaker than expectations, and building permits/housing starts numbers which both also failed to meet their consensus. New house prices which rose 0.4% m/m in July was double that expected. This week is particularly quiet in Canada so look to the USD and oil pricing for direction, particularly in light of the recent Fed member comments which has put additional focus on US rates, the USD and USD linked commodity pricing.

Economic Events.
  • Australian Q2 Company Profits, 6.9% q/q vs -4.4% prior.
  • UK Markit Services PMI, 52.9 vs. 50.0 exp. (Aug.)
  • EU Markit Services PMI, 52.8 vs. 53.1 exp. (Aug.)
  • Australian Cash Rate, on hold at 1.5% as exp.
  • NZ GDT Dairy Price Index, +7.7% vs. +12.7% prior.
  • US ISM Non-Manufacturing PMI, 51.4 vs. 55.0 exp. (Aug.)
  • Australian Q2 GDP, 0.5% q/q vs. 0.6% exp.
  • UK Manufacturing Production, 0.8% y/y vs. 1.7% exp. (Jul.)
  • Canadian Cash Rate, on hold at 0.5% as exp.
  • Japanese Q2 GDP, 0.2% q/q vs. 0.0% exp.
  • Australian Trade Balance, -2,410M vs. -2,750M exp. (Jul.)
  • Canadian Net Change in Employment, 26.2k vs. 15.0k exp. (Aug.)