Commonwealth Bank - FX Strategy
Main event through the morning has been the eagerly anticipated BoE Inflation Report and press conference from Governor Carney. As expected the BoE announced forward interest rate guidance, but the general message and tone was mixed. GBP/USD sold off initially, dipping down over a big figure to a low on the day of 1.5223. However, it then spiked back higher through the press conference to trade up over 1.54 at time of writing. One cannot contest that the UK economy is recovering, a development which should be GBP supportive in the medium run. There is no real game changer in today’s announcements, just greater clarity about the BoE’s views, none of which are particularly surprising.
The forward guidance is to not raise bank rate from its current level of 0.5% until the LFS headline measure of the unemployment rate has fallen to a threshold of 7.0%. Currently it is at 7.8%. However, this is an initial level at which the MPC would e-assess the economy and outlook, it is a “way station” rather than a threshhold which would immediately trigger a change in policy stance. There are also three “knockouts” which if breached would cause the guidance to cease to hold. First, if in the MPC’s view it was more likely than not that CPI inflation 18-24 months ahead would be 0.5% or more above the 2% CPI inflation target. Second, if medium-term inflation expectations no longer remained sufficiently well anchored. And third, if the Financial Policy Committee (FPC) judges that the stance of monetary policy poses a significant threat to financial stability that cannot be contained by the FPC and its possible policy actions. Mr. Carney also indicated that the BoE remains ready for more bond purchases, or an expansion of QE, if deemed necessary.
On the economy, recent news is encouraging, the “recovery is taking hold.” However, the economy won’t reach its pre-crisis peak until next year. The Sustained robust growth is still needed to reduce slack. Growth forecasts were revised up to 1.5% in 2013 and 2.7% in 2014 to reflect the improvement in the economy that is underway. But the MPC forecasts the unemployment rate to remain above 7.0%, the new threshold, until at least QIII 2016. This implies that the guidance holds for at least three years assuming the economy evolves as expected. Rate hikes are therefore still at least three years away in the view of the MPC. Of course, this is not a “promise on rates”, it simply provides “greater clarity on policy”, making “policy more effective.”
Elsewhere there has been more decent economic news to report. German industrial production has soared 2.4% MoM in June taking annual growth up to 2.0 % YoY continuing the run of improving Eurozone data. It looks increasingly possible that the Eurozone economy already emerged from recession in QII, EUR/USD has rallied up to 1.3325 so far this morning, but remains in recent ranges for the time being.
USD/JPY has dipped to as low as 96.78 this morning, a low since late June. The Bank of Japan’s policy meeting is tomorrow (no set announcement time) and the June current account balance is also due (7.50pm EST/12.50am BST). We do not expect any changes from the BoJ at this meeting. But while market participants continue to price in the Fed tapering its asset purchases later this year, the BoJ will keep its massive asset purchases until at least the end of 2014. Another small Japanese current account surplus in the vicinity of ¥700bn is expected in June. The diverging outlook for both monetary policy and current account balances in the US and Japan suggest further upside in USD/JPY. Although USD/JPY has eased over the week, and looks set for further volatility today, ultimately we expect USD/JPY to press higher over the medium term.
NZD/USD has now lifted more than 1.0% above last week’s close, more than reversing Monday’s lower opening in the NZD caused by the weekend news of the dairy (whey contamination scare. NZD/USD is now around 2.7% above Monday morning’s low, and showed no lasting reaction to today’s NZ labour market data which was in line with expectations (NZ employment rose 0.4% QoQ in Q2). Yesterday’s dairy auction was of more interest than usual, given it provided the first chance for any price/demand implications to be observed after the contamination issue surfaced. In the event, the auction showed an overall very muted move in price: the trade weighted index dipping 2.4%. This is in keeping with the normal volatility of the fortnightly auction results (+/- 5.3%). The auction result suggests little apparent long-term concern (at this stage) over Fonterra dairy products.
AUD/USD has eased lower through the morning and is trading around 0.8940 at the time of writing. Today’s Australian housing finance data did not affect AUD/USD, which has held onto most of yesterday’s gains following the RBA’s removal of its easing bias. The next AUD focus is tomorrow’s Australian July labour market data (9.30 pm EST/2.30am BST). CBA economists expect an above-consensus 12K gain in employment (market expectations centred on 6K growth). Such an outcome should offer the AUD a degree of support, but the greater influence on the AUD over the coming weeks is likely to come from participants adjusting their short term interest rate outlook to incorporate the RBA’s neutral stance. The RBA are no longer indicating that the inflation outlook may provide them with some scope to cut interest rates should it be required, unlike their commentary at every monthly meeting so far this year. However, this does not mean the risk has changed that the RBA will cut again. The RBA have indicated in yesterday's statement that "the Board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the inflation target over time." Our take is that Australian swap rates will temporarily grind a bit higher as some near-term easing risks dissipate. However, the RBA will maintain a close eye on the unemployment rate and the Q3 inflation date (due late October before being tempted to cut again. We believe the AUD/USD can get back above the 30-day moving average of 0.9140. However, the RBA is maintaining that the AUD is still at a "high level" and a further depreciation "would help foster a rebalancing of growth in the economy". Furthermore, the other variables pressuring the AUD lower have also not changed. Hence, we would maintain a strategy of selling into AUD rallies, but would wait until AUD/USD lifted back above 0.9140 before establishing fresh AUD/USD short positions. AUD/NZD is set to remain heavy.