World First takes a look at the key trends of June and considers the many diverse events set to shape global currency markets in July.
AUD: Iron Ore Saves Aussie….Again
Month in Review
After an underwhelming start to the month, whereby CAPEX data (the measurement for private expenditure growth in Australia) proved poor to say the least, the Australian dollar has slowly gone about its business and proved that there’s still a lot of life in the commodity currency yet.
Paired with the US dollar, AUD rose a little over 3.5% in the month of June, lows being 0.7384 up to 0.7655, with the main catalyst being a resurgence in iron ore prices, which have soared to $62.33 a tonne, leaving it sitting at their highest level since May 22. This can be boiled down to China’s building boom proving more resilient than expected and should this trend continue many expect AUD/USD to punch through the 0.77 mark.
The other key focus for the month has been the RBA’s repeated standpoint on stability. After the decision to keep rates on hold, they reiterated their viewpoint that the economy will be growing more than 3% over the coming years and although housing prices have been rising significantly in some areas, there are signs these are starting to ease. There have been rumbles that the RBA would signal for a potential rate cut, however when you look at the concerns over the rising housing market and the current ability of investors to take on more debt, this seems an unlikely move.
Looking to July, most attention will be on whether or not iron ore can keep its current rally going, and although a flood of suspected buying from Chinese steel mills has helped close out a poor quarter for the commodity, many are not expecting to see a full-blown rally. As for other key events, we widely expect the RBA to keep rates on hold at 1.5% and the employment change has been downgraded from 42k in June to 21.6k.
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USD: Raising the Bar
Month in Review
As widely expected, the US Fed raised rates for the second time this year by 25 basis points, taking the overnight interest rate to a range of 0.75-1%. However, the Fed’s forward guidance seemed to talk down the future pace of monetary tightening and the US dollar Index fell over 1% in the month of June. Q1 US GDP revised higher to 1.4% on stronger consumption, the third estimate of Q1 GDP paints a better picture of the US economy. While growth in Q1 is still lower than the previous quarter, the slowdown is not as pronounced as previously stated.
Initial and continuing claims data suggests labour market conditions have improved slightly so far this year – at 244k, initial jobless claims stand about where they were in December (241k) while the four-week average at 242k is modestly below the 254k recorded at year-end.
The Senate is expected to discuss its version of the health care bill at the next sitting. The USD could find some mild support if a vote takes place, as it would remove one hurdle before the discussion in relation to tax cuts; however, opposition inside the GOP means further bargaining will be likely. Dwindling expectations for significant fiscal stimulus, coupled with slowing economic conditions could provide headwinds for the USD in the month ahead.
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Month in Review
It is fair to say things did not go to plan for British PM Theresa May. With an 18-point lead in the polls, the decision to call a snap election seemed like a reasonable manoeuvre and a chance to strengthen the UK’s mandate to negotiate their withdrawal from the EU. However, a resurgence in Labour popularity, helped by an increased turn out by younger voters, has seen the Conservative party lose their overall majority in an election they ultimately did not need to have. Having won the most seats, they have still been able to form government after securing a deal with the Democratic Unionist Party (DUP) of Northern Ireland. Together the two parties will have a two-seat majority in the House of Commons, giving them the ability to pass legislation. In exchange for the DUP’s support on key votes, Northern Ireland will receive 1.5 billion pounds over the next two years. The net result for the GBP was a sharp sell-off immediately following the election results and, although we have seen some recovery in recent days, the pound has finished the month lower against most of the majors, including a fall of 3.2% against the AUD at the time of writing. The exception was the GBP/USD, as some late month USD selling saw the GBP make back these post-election losses and finish the month slightly up.
Despite forming Government and battling to hold off an immediate leadership challenge, May’s position as Prime Minister is far from secure. Several Tory backbenchers have already warned more rebellions could be on the cards, vowing not to stand by and allow the pursuit of a hard Brexit based on ideology, rather than the needs of the economy. Further uncertainty will very likely continue to weigh on the pound.
On Brexit, negotiations have started in earnest and, with less than two years to negotiate a completely new trade deal with the EU, there is plenty to do. Reaction in sterling will remain contingent on the headlines emanating from May, Davis, Tusk and Barnier. Any commentary out of the Bank of England will also be closely watched, with Governor Carney recently dismissing speculation that a rate hike was coming, given the anaemic wage growth and mixed signals on consumer spending and business investment.
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EUR: A Shift in Monetary Policy?
Month in Review
The Euro had another stellar month, thanks to the ECB providing further hints that its super-accommodative monetary policy is set to end. ECB president Mario Draghi gave a boost to the shared currency, in conjunction with advancing not only European bond yields, but also those around the world with his comments. Most telling was the following, “As the economy continues to recover…the central bank can accompany the recovery by adjusting the parameters of its policy instruments, not in order to tighten the policy stance, but to keep it broadly unchanged”. This slight change in rhetoric coming from the ECB combined with a raft of positive data from the region reflects increasing confidence in the European economy and that a more hawkish stance to monetary policy is on the near horizon. In fact this is also the view from the NAB, who are forecasting a tapering of quantitative easing at the September meeting.
If the ECB starts to unwind its asset-purchasing program (which is looking more and more likely) then we will see a steepening of the yield curve, which will support the Euro. Expect to the see the Euro continuing to rally as these hints are released by the ECB over the coming weeks.
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NZD: Consolidated Gains
Month in Review
The NZ dollar has consolidated its gains against the USD in the 0.7200 to 0.7300 trading range over the last two weeks. There has not been any sufficiently negative news to deter the buyers and holders of Kiwi dollars. Whilst the GDP growth outcome for the March quarter at +0.50% was less than consensus and RBNZ forecasts, the forward outlook for economic expansion remains extremely positive with both consumer and business confidence surveys returning to high levels.
A nation’s currency value can be likened to a share price on its economy and right now with the New Zealand economy performing so well it is difficult to see what would cause a sustainable depreciation of the NZ dollar. However, foreign exchange markets are always looking 6 to 12 months forward as to the likely future economic conditions and performance.
Therefore, historical GDP and other economic measures may not be reliable indicators as to future NZD/USD direction as future expected conditions may not be the same as the past. It also must be remembered that New Zealand’s economic health and direction is only one side of the two sided equation that makes up the NZD/USD exchange rate.
How the US dollar itself is moving in global forex markets against all currencies determines the NZD/USD direction as well. Right now the USD is marooned at $1.1200 against the Euro with the international financial and investment markets remaining very unsure as to whether the Federal Reserve (projecting four 0.25% interest rate increases over the next 12 months) will be correct, or will the US short-term interest rate markets be correct with their forward pricing (projecting just one 0.25% interest rate increase).
Much depends on the trend of US inflation from here. If the US’s inflation and economic data supports the Fed’s outlook over coming weeks/months, then the US dollar should recover and appreciate back to below $1.10000 against the Euro. A stronger USD on the world stage will pull the NZD/USD back towards 0.7000.
Over coming months’ two potential risks that may prove to be negative for the Kiwi dollar in its own right will come into the focus of the FX markets:
Three months ago the Trump administration announced a three month study/investigation as to what imported products into the US from what countries were replacing US manufacturing jobs. The results of that investigation are due very soon and it is likely that new US import tariffs and trade protectionism will be the recommended solution. If the new trade barriers extend to agriculture products, then the NZ dollar will be sold down by the markets, just as it was in early May when President Trump tweeted that dairy products could be added to tariffs imposed on Canadian lumber coming across the border into the US.
Political risks on the NZ economy and NZ dollar exchange rate are set to increase over the next three months in the run up to the late September General Election. From an offshore investor and currency speculator’s perspective the prospect of a potential change of Government to a more left-leaning Labour/Greens coalition would appear very strange to them given how well the economy is travelling. The NZ voting public rejecting the economic and employment growth for some other objectives would cause those overseas investors into NZ shares and bonds to reduce their holdings (thus become sellers of the NZ dollar in doing so). It does appear that the election campaign will be fought over immigration, housing and environmental issues (not financial/economic issues), therefore the incumbent National Government faces a real challenge to be re-elected for a record fourth term. Typically, political risk in New Zealand is not rated by overseas players as that influential for the currency. However, the prospect of a hung Parliament with NZ First’s leader Winston Peters calling the shots as to whom he will support to form a new Government would have to be unsettling for any foreign investor in the Kiwi dollar.
Political opinion polls will be as important as inflation, GDP growth and export commodity prices as a lead indicator and direction driver for the Kiwi dollar over the coming period.
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