Welcome to World First’s Monthly Currency Update, which will take a look back at the key trends of July and also look ahead at important events shaping currency markets in August.
AUD: Interest rates cut to record lows
Month in Review
July has been a terrific month in terms of data and events for the Australian dollar. However, our local currency has not really responded and outside of the occasional northern and southern spike. Over July we did not break out of a two cent range. On a positive note, non-farm payrolls smacked their expectations for six, a couple of Fed meetings aired on the side of caution and the inflation figures came in at expectation. The RBA, has now cut the official rates to 1.50% in attempts to boost inflation and hold the Australian Dollar below a level of 75 cents.
The Key Trends
Australia’s own inflation figure came out at the forecasted level of 0.4%. This was enough to slightly reduce the odds of a rate cut but not enough to stop it. The figures over July were not unkind to the Australian economy. Inflation came in at the expected levels, non-mining GDP is strong and business surveys showed the Australian economy transitioning at a solid pace. Another key trend which will move the Aussie in the near future is the FOMC. It was reasonably quiet over July but it did announce no change to their rates, yet did say that “near-term risk to the economic outlook has diminished.” This heightened the expectation of a rate hike in September by the FED.
The RBA have cut rates by 25 basis points to record lows of 1.50%. The reasons behind the cut are strongly focused on Australia’s inflation figures and how it’s the RBA’s job to stabilise inflation at the target 2-3% band. Since CPI inflation has been below 2.5% for each of the past eight quarters, the RBA has cut rates in order to theoretically, boost inflation back into its target range. Moreover, AUD resilience also provided sufficient cause to cut rates so as to ensure the AUD does not continue to spike higher.
An interesting take on the rate cut is the risk it now poses to the Australian housing market. Namely by adding to the Australian housing supply. The housing market is already growing at the fastest pace on record due to a surge in high density apartment construction. The rate cut could now place additional downside pressure on housing rents, already falling at the fastest pace on record. A significant increase in apartment supply is likely to weigh on rental growth further, which is a large component of the CPI basket, and means that the RBA will find it difficult to return inflation to its target band in the near term.
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USD: Yellen for some direction
Month in Review
The US dollar has remained under pressure for the month of July as surging Iron Ore prices and an increasingly hesitant FOMC continue to weigh on the ungainly U.S. economy. Investor and business confidence has suffered state-side due to the disconnection between solid economic data, coupled with relative calm in global markets post-Brexit, and a lack of movement from policy makers who are waiting for irrefutable clarity before setting the new course of economic direction.
The Key Trends
The USD Index, which measures the dollar’s strength against a trade-weighted basket of six of the most traded currencies, was rising post-Brexit since the Greenback was valued as a safe-haven asset, though the end of July has seen a sharp reversal given the above predicament.
August kicks off with a spate of key economic releases out of the States covering labour, trade and manufacturing data. Markets will closely track these releases given the related importance to future interest rate movements.
We maintain our thoughts that the eagerly anticipated Fed interest rate hike will take place in December. November is out due to its proximity to the Presidential election. The risk to our December call is that if near-term data surprises, September will become more favoured by the market – probability of a hike on September 21st currently sit at 26.4% compared to a 45.2% chance for December 14th.
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GBP: Brexit recession still on the cards
Month in Review
Q2 GDP data has a lot of people confused, so it is worth spelling out exactly what happened: The preliminary estimate of UK growth in Q2 rose by 0.6% against estimates of 0.5%.
Preliminary GDP figures are always heavily caveated; less than 50% of the survey data is in and will likely over-represent the beginning of the quarter compared to the end i.e. the majority of this data comes from April and not May or June. A complete picture of Q2 will be unavailable until September, far too late for policymakers at the Bank of England who announce their latest policy decision a week today.
It did not show however, as one UK news outlet even told its viewers, that growth in itself was a surprise with analysts expecting a recession. Recessions are measured after 2 quarters of negative growth, and we saw no analyst expectations that Q2 data would be negative.
The Key Trends
We are maintaining our call for a Bank of England interest rate cut by 25bps and an increase in QE by somewhere between £50bn and £75bn. Within the announcement we are also looking for something similar to the ECB’s TLTRO – Targeted Longer-Term Refinancing Operation – that allows banks to borrow at negative rates i.e. get paid for borrowing. This would be a subsidy to British banks that should insulate the financial system from the unwanted effects of negative deposit rates should the Bank see the need.
Unfortunately, we believe the overall UK economic picture is one of recession at the moment and while it is still too early to forecast, we are looking for Q3 GDP to fall by anywhere 0.1-0.4%. This month’s data will limit calls that the UK was slowing into the vote however.
The market almost completely disregarded the Q2 number instantaneously with pre-Brexit data losing a slight hint of importance given the Bank of England’s thirst for more present indicators.
A recent survey from the Centre for Economics and Business Research and YouGov has shown that UK consumer confidence has declined to its lowest level since July 2013. The CBI also reported yesterday that retail sales in the UK had fallen the most in 4 years.
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EUR: A month to forget
Month in Review
This month’s ECB announcement was almost a non-event. As expected the ECB is withholding from any significant post-Brexit action until after the expected Bank of England easing is announced and the full effects of Brexit have hit the Euro economy. With a cut to the official bank rate a virtual certainty, and economic conditions worsening in the Eurozone, weighed down by stubbornly low inflation, it is only a matter of time until necessity drives the ECB’s next move. Further rate cuts are likely, but at this stage it is expected that the ECB will only announce another QE injection.
Two thirds of European government bonds now fall outside the eligibility criteria for QE, raising questions about both the effectiveness of QE and how much more room is left to continue this policy. QE aside, the only other remaining strategies the ECB will be left with would be deeper cuts to the already negative interest rates.
Looking ahead, all eyes will be on Europe’s banking sector. The European Banking Authority’s most recent round of stress testing, conducted on 51 EU lenders, offered some assurance as to the region’s overall banking stability, but also highlighted some worrying results. Monte dei Paschi, the world’s oldest bank, spectacularly failed the ECB’s adverse stress test, coming in at -2.4% well below the regulatory minimum of 4.5%. While Allied Irish Banks was the only other bank to fall below the regulatory minimum, 12 of the worst performing banks included Deutsche Bank, Commerzbank and Barclays. So far a bailout for Monte dei Paschi has been ruled out, with the bank having already been bailed out twice by the government since 2009.
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NZD: Rate cut on the horizon
Month in Review
The once positive mood and sentiment in forex markets towards the NZ dollar has been reversed as global financial market events move past Brexit and the RBNZ throw a curve ball to the local market.
The demand for the Kiwi dollar over the past two months that drove the NZDUSD rate from 0.6800 to 0.7300 was due to interest rate yields offering 3% in a world of 0% interest returns. The expectation by many was that the RBNZ was finished with cutting the OCR due to relatively strong NZ economic data and New Zealand being seen as a safe-haven destination, whilst there was so much uncertainty in the UK and Europe with the Brexit referendum.
The Key Trends
The retreat from the highs has been swift, caused by a combination of developments.
Firstly, The Reserve Bank has signalled further cuts in the Official Cash Rate (OCR) are likely after it warned the 6% rise in the New Zealand dollar since its last OCR decision on June 9 was making it hard for the Reserve Bank to meet its 1-3% inflation target. It said a decline in the currency was needed. A 25 basis point cut in the OCR on August 11 is almost certain, along with the potential for a further cut later in the year.
The Bank, rather than Governor Graeme Wheeler, said the prospects for the global economy had diminished since June 9, despite very stimulatory monetary policy and low oil prices; and there were many uncertainties about the outlook.
The big question for the Kiwi dollar is whether international yield seekers have been put off by the upcoming RBNZ cutting of the OCR. If these capital inflows into NZ reduce in volume, the Kiwi dollar can easily drop another cent or two on the actual OCR action during August.
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