Commonwealth Bank - FX Strategy - New York Open
A bumper UK service sector PMI has been the main story for currency markets through the morning. The PMI for July soared to 60.2, a high since late 2006, and suggests that the UK economy may now be growing at an above-trend rate. GBP/USD had already been rallying through the morning and then spiked up further following the release reaching a peak of 1.5378 a little while ago. In Europe a little while earlier there was a slight downward revision to the composite PMI, largely on the back of a softer German services survey. The composite PMI was revised lower to 49.8 from the flash estimate of 50.4, putting the EUR under some modest pressure. However, EUR/USD is still holding in the 1.3275-1.3300 area, EUR/GBP has dropped to a low of 0.8636 so far this morning.
We expect GBP gains from this morning to fade over the week. A key focus for GBP this week will be the much anticipated August BoE Inflation Report (Wednesday), where the Monetary Policy Committee (MPC) is set to provide its assessment on forward guidance. We expect the BoE to announce forward guidance on interest rates in an effort to cap market interest rates to ensure the UK economic recovery remains on track. By limiting appreciation pressure in front-end UK yields GBP appreciation pressures should be limited. The extent of the impact on GBP will depend on the type of forward guidance the BoE announces (i.e. time contingent or based on intermediate economic thresholds such as unemployment and inflation). In its May Inflation Report, the BoE noted that a 25bpt rate hike “was not fully priced” until “late 2016”. The commentary by the BoE in July indicated that the lift in market rates relative to this benchmark was not justified by the recent economic developments. Hence, it appears that the market pricing of a first rate hike in late 2016 is the perceived line in the sand for the BoE MPC. Forward guidance based on economic thresholds that reinforces the MPC’s previous guidance should weigh on GBP.
EUR/USD continues to trade in a familiar range, centred on 1.3250. In our view, there is little on the schedule that is likely to push EUR/USD too far beyond a 1% range either side of 1.3250. The broader Eurozone economic developments continue to track in line with the ECB’s baseline expectations. As noted by ECB President Draghi developments have to be “significantly better than our baseline” for the ECB to change its forward guidance on interest rates. Current pricing by the money market rate of ECB rate hikes are “unwarranted” by the ECB’s baseline outlook. The ECB’s reiteration last week that it “expects the key ECB interest rates to remain at present or lower levels for an extended period of time” and that they “have not reached the zero bound” should continue to limit EUR upside.
More generally, the USD is likely to consolidate this week. The July non-farm payrolls numbers released at the end of last week disappointed expectations, weighing on long-term US bond yields and the USD. Payrolls increased by 162,000 in the month, and there were minor downward revisions to the previous two months. The 0.2% dip in the US unemployment rate to 7.4%, a low since December 2008, was again driven by a fall in the participation rate. While the July data disappointed, the momentum in the US labour market remains positive. The 6-month moving average in payrolls is now 200,000, while the 12-month moving average is at its highest level since March 2012. Nevertheless, the slightly softer payrolls outcome is likely to keep questions over when the Fed will commence a tapering of asset purchases alive, and this should act as a USD headwind. We have September pencilled in for a start data for Fed tapering but the risks reside with a later start date. Irrespective, we still expect tapering to commence in 2013. The only US data point of note this week is the July ISM non-manufacturing index (10am EST/3pm BST). Modest improvement is expected.
NZD/USD was under pressure in early Asian trade because of a New Zealand whey contamination scare, which could have trade impacts on the NZ dairy sector. Approximately 38 tonnes of whey product produced by Fonterra have tested positive for a bacterium that can cause botulism. It is reported that 8 customers in 7 countries, including NZ, have used the whey to make 870 tonnes of consumer product. NZ dairy exports total $11.5 billion (12 months to June 2013). In volume terms 2.76 million tonnes of dairy products are exported, so the product in question accounts for 0.03% of NZ dairy exports. So far, China and Russia have indicated a temporary ban on NZ dairy products. The extent of any long-term impacts will partly depend on Fonterra’s ability to reassure manufacturers and consumers of the quality and safety of NZ food exports. Fonterra has already announced the recall of various products. We do not expect a collapse in the NZD. Indeed, the NZD/USD has ground up 1% off the Asian morning’s lows, and has recovered over half of its 1.9% drop on the market open. We expect the NZD movements to be influenced by any further developments in the whey product recall. That being said, the NZD may also be heavy as trade resumes in Europe and the US today. The irony of the whey contamination scare is it could cause global dairy prices to lift, given Fonterra’s dominant position as a global dairy supplier, accounting for one third of international dairy trade each year.
AUD/USD failed to hang onto its gains after Friday’s US non-farm payrolls, and the spike to 0.8970 quickly faded. AUD/USD has weakened after this morning’s June Australian retail trade figures, and we expect that a rate cut from the RBA tomorrow (12.30 pm EST/5.30am BST) will see the AUD press lower, having already surpassed last week’s lows. Also of influence on the AUD this week is the July Australian labour force data (Thursday) and the regular monthly batch of Chinese data. July data is due for Chinese trade (8th), CPI, industrial production, and retail sales (9th). We expect the AUD will be vulnerable to any signs of weakness in the Chinese data – in particular, weakness in Chinese imports and industrial production. AUD/NZD spiked in the Asian morning as the NZD dropped. However, half of the spike has already unwound, and we expect the reversal to continue, given tomorrow’s looming rate decision from the RBA. New Zealand quarterly labour market data is also due on Wednesday. The New Zealand labour market data has a history of being somewhat unpredictable, and accordingly has the potential to add to AUD/NZD volatility this week
USD/JPY dipped back below 99.00 on Friday, reflecting a softer USD in the wake of Friday’s weaker than expected non-farm payrolls report, and has extended its fall sub 98.50 this morning. However, there hasn’t been any market reaction to the weekend’s earthquake in Japan. A magnitude 6.0 earthquake on Sunday was centred off the coast of the Miyagi Prefecture, but did not cause any tsunami alerts.Furthermore, there were no power outages and radiation monitors did not show any issues. This week’s focus is on the Bank of Japan’s policy meeting and the June current account balance (both on 8 August). We do not expect any changes from the BoJ this week. But while market participants continue to price in the Fed tapering its asset purchases later this year, the Bank of Japan will keep its massive asset purchases until at least the end of 2014. Another small current account surplus in the vicinity of ¥700bn is expected in June. The diverging outlooks for monetary policy and current account balances in the US and Japan suggest further upside in USD/JPY. USD/JPY has met resistance around 100 over late July and again lastweek. This resistance may be re-tested again this week, but ultimately we expect USD/JPY to press much higher over the medium-term.