CBA FX Strategy - New York Open
The EUR has come under sharp selling pressure this morning as European political and debt concerns re-surface. Portugese government bond markets have tanked following the resignation of two government ministers, the 10-year yield is back up over 8%. Two leading members of the Portuguese cabinet, including the finance minister, have resigned over recent days. Finance minister Gaspar was one of the key policymakers overseeing the Portuguese bailout. It is not yet clear whether another election will be required or the government can be held together. Plainly, austerity fatigue is taking its toll. Other peripheral markets have sold off through the morning, bunds are sharply higher and equity indices are 1.5%-2.0% lower at time of writing. EUR/USD has dipped down to a low of 1.2925 so far this morning, EUR/GBP to 0.8490. News that Troika discussions with Greece are also hitting a stumbling block have simply added to the market nervousness. Reports suggest the Greek government has been given 3 days to appease its lenders that it can meet conditions of its bailout. A funding gap appears to have developed. The IMF has previously indicated its reluctance to provide more funds to Greece if the long-term debt outlook is deemed unsustainable. If the lenders are dissatisfied with Greece’s progress, the next bailout tranche could potentially be withheld, or at the very least, delayed. The next bailout tranche is set to be used to repay €2.7bn worth of Greek bond redemptions and coupons due on 20 August. The Eurozone Finance Ministers are meeting to discuss Greece on 8 July. Of course, there is nothing new in these periods of stalemate and uncertainty. But the bias to the EUR and risk assets more generally is plainly to the downside while markets refocus on European crisis issues.
On a more positive note, the UK service sector PMI soared to a high of 56.9 in June, a 2-year high. The UK economy is accelerating through the summer, growth is running around trend rates at the current juncture. GBP spiked up following the print which was a full 2.4 points stronger than consensus going into the release. UK economic data has surprised increasingly positively over the past couple of months, a development that the MPC will be noting closely. GBP/USD has traded up to 1.5260 so far this morning, but should remain dominated by the broader theme of USD strength. Tomorrow’s BoE meeting is the next major GBP-specific event. We continue to believe GBP/USD is biased to the downside in the remainder of the week. Prospects of a relatively dove-ish statement following tomorrow’s MPC meeting are high. Governor Carney will vote in his first monetary policy meeting. Markets will be intrigued to see whether he is as “dove-ish” as has been assumed in the much-hyped run-up to his tenure. We believe that it is highly likely he is in this dove-ish minority and pushes for more stimulus right from the outset. However, this will only be revealed in a couple of weeks time in the minutes.
The USD upward trend now appears firmly in place, particularly with European nervousness resurfacing. Yesterday’s comments by New York Fed President Dudley that Fed tapering is more likely to begin next year and the first lift in the Fed funds rate “is very likely to be a long way off” did nothing to dampen firm USD sentiment. The Eurozone PPI fell more than expected during the month of May and continues the run of declining global inflation pressures. Lower global inflation continues to be a function of negative output gaps. (excess capacity). Negative output gaps apply downward pressure to industrial commodity prices and the commodity currencies of AUD, NZD and CAD are under-performing. There were further declines in base metal prices yesterday, but a modest increase in global dairy prices, contributing to a heavy AUD/NZD (the pair touched a four-year low today in the wake of the AUD developments today). China’s policy tightening is set to maintain the downward pressure on commodity prices, and keep AUD/USD heavy. The USD tends to out-perform in an environment of declining global inflation because reduced global inflation pressures applies less upward pressure on emerging market interest rates and exchange rates. There is subsequently less foreign exchange intervention and in turn less USD diversification. Despite Dudley’s comments that the first lift in the Fed funds rate “is very likely to be a long way off”, the prospect of divergence in monetary policy cycles between the US and the remaining G4 plus the RBA continues to encourage USD strength.
AUD/USD endured a choppy Asian session, but has held essentially stable through the European morning despite more general market nervousness. AUD spiked just prior to the release of Australian trade and retail sales data, only to drop briefly below 0.9100 on the headlines from the Stevens speech entitled “Economic Conditions and Prospects.” Australian retail sales for May were weaker than expected (+0.1% MoM vs. 0.3% expected, and a downwardly revised -0.1 in April). The trade surplus was better than expected in May (AU$670mil. vs. +$53mil. expected, and an upwardly revised $171mil. in April). The comments from Stevens’ speech that the "board deliberated for a very long time yesterday" were not in the prepared remarks, but were made off the cuff, and made Bloomberg headlines. This appears to have triggered the AUD’s drop, as well as a decline in Australian swap rates. Based on the market reaction, the threshold for a rate cut in coming months may be lower than participants thought after yesterday's RBA meeting statement. In terms of the outlook for monetary policy, Governor Stevens stated that the RBA will continue to do its part, consistent with its mandate, to "assist the transition" in sources of demand in the economy. This is in line with the RBA's long standing easing bias. CBA has a 25bpt RBA rate cut pencilled in for the 6 August RBA meeting. The OIS market is now pricing in a 57% chance of a 25bpt cut at the next meeting, and this will likely weigh on the AUD over coming sessions. In addition, the Australian sharemarket was the weakest in the region today, down around 2% at the time of writing, adding to the weight on the AUD. Most other indices in the region were also in the red, but the losses were more modest.
USD/JPY has dipped back below 100.00 this morning as markets correct. Lower volatility, a firmer USD as the Fed becomes the first of the G-3 central banks to step back from easing, and a narrower Japanese current account surplus, should see USD/JPY track higher this week and over the medium term. Even a disappointing US non-farm payrolls report on Friday is unlikely to push USD/JPY significantly lower for an extended period because of the fundamental factors mentioned.