Flash Eurozone PMIs were a little softer than expected in October, the composite PMI dipped to 51.5 mainly due to a weaker services PMI. German readings in particular were a little softer than anticipated. EUR/USD dipped down half a big figure following the release after having pushed up to 1.3820 early in the session. However, the pair has pushed back up to 1.3810 despite the disappointment and looks poised to inch higher ahead of next week’s FOMC decision and statement. In the UK the CBI business optimism balance improved to a 3-year high of 24, but GBP/USD has been fluctuating either side of the 1.62 level. EUR/GBP has inched higher accordingly. Looking beyond the near-term, the risk is the move higher in EUR/USD is becoming overdone. Fundamental factors, such as the German-US yield differential, continue to suggest EUR/USD should retrace some of its recent moves higher over the medium-term. EUR/USD is also over 4% higher than the ECB’s 1.3200 technical assumption in September forecasts (see chart below). If the divergence continues, it may prompt comment from ECB President Draghi, as we observed in February this year. The ECB next meets on 7 November.
After reaching our daily target of the 200-day moving average, and then correcting lower, AUD/USD is now likely to consolidate between the 30-day moving average (0.9460) and the 200 day moving average (0.9744) over the next few weeks. We continue to think yesterday’s market reaction to the intra-day spike in Chinese short-dated repo rates was an over-reaction. Seven day repo rates lifted further today, but the AUD showed little direction reaction. The current vibrations in the short dated Chinese Shibor market reflect the PBoC withdrawing some build-up in liquidity, and appear nothing more than that. The previous experience of the 3 month Chinese Shibor rate spiking in early June in order to dampen the activities of the Chinese non-bank financial sector has not occurred again. The 3-month Shibor rate remains quite stable. All the activity of the last few days has been in the 7 day repo market (and follows some similar activity last week in the 14 day repo market). But neither of the 7 day or 14 day Chinese repo rates appear out of whack with recent activity over the last few months. Chinese banks remain very profitable with low non-performing loans and most of the profitability still driven by net-interest income (see chart below). The near-term outlook for this source of profits (net-interest income) is still pretty solid in China given the interest rate liberalisation by the PBoC has not progressed all that far in China (mortgage interest rates are still regulated). Furthermore, as the RBA noted in their recent semi-annual Financial Stability Review, Chinese bank’s “reported regulatory capital ratios have increased the Chinese banking system's buffer to adverse shocks”.
AUD/USD edge slightly higher today on the back of a bigger than expected lift in the October flash estimate of the China HSBC PMI (50.9 vs. 50.4 expected and 50.2 in September). But the pair has dipped back down to 0.9620 again through the morning. The lift in the HSBC China PMI provides another piece of evidence highlighting the improving trend in the Chinese economy. RBA Deputy Governor Lowe added little new in his speech entitled “Investment and the Australian Economy”. Lowe reiterated that the investment boom has been a key driver of the Australian economy, but mining investment should decline over coming years. The lower interest rates, and improved confidence are supporting the transition in the Australian economy, but according to Lowe, this would be helped along by a further depreciation in the AUD.
NZD/USD has dipped down to 0.8360 through the European morning. A smaller-than-expected trade deficit for September was encouraging. Exports leapt higher in September, led by a strong recovery in dairy exports following trade disruptions in August caused by the Fonterra whey contamination scandal. Nonetheless, looking beyond the impact of the trade disruptions, dairy exports are very strong. Dairy accounts for around a quarter of NZ merchandise exports. Reports of a strong start to the dairy production season and very elevated global prices means the outlook for dairy exports is very encouraging. The next key NZ event is the RBNZ official cash rate review in a week’s time. A full RBNZ preview is attached.
USD/JPY fell yesterday, and remained heavy in Asia and Europe today because of the safe-haven bid triggered by the PBoC’s fine tuning of liquidity (discussed above). We think these concerns about the PBoC will recede and reverse the safe-haven flows, supporting USD/JPY. USD/JPY is sitting on good support levels at the 200-day moving average. While not normally a market mover, the weekly portfolio investment report published by Japan’s Ministry of Finance has recently showed large Japanese institutional investors buying fewer overseas assets as Japanese excess saving declines. The decline in Japanese excess saving is reflected in the slump Japanese current account surplus, supporting a rise in USD/JPY. We predict Japan will record its third current account deficit in three decades on 11 November.
USD/CAD spiked higher yesterday following the Bank of Canada meeting and has inched up further over 1.04 this morning. The Bank of Canada maintained the 1% target rate, and trimmed its inflation and growth outlook, as we expected. Adjustments have brought the BoC’s forecasts more in line with our own. What was unexpected was the BoC’s shift to a neutral policy stance, and the Bank’s concerns about the downside risks to inflation. The OIS market pricing continues to imply the BoC will remain on hold for the next year, and risks of unwanted reacceleration in household credit growth means the BoC is very unlikely to cut rates. But the BoC’s cautious stance has caused the CAD to weaken, as we suspected would occur in our weekly currency views. However, we haven’t changed our Canadian economic outlook, and CAD forecasts. Over the coming weeks, USD/CAD direction is likely to be a function of US developments, and we maintain our view that USD/CAD will drift gradually higher over the year ahead, as the USD firms.
Upcoming Economic Calendar Highlights Important for Exchange Rates
USD – Retail sales (29 October), FOMC meeting (30 October).
AUD – No more important data this week.
EUR – Germany IFO (25 October)
GBP – Q3 GDP (25 October).
NZD – RBNZ Official Cash Rate review (31 October).
JPY – BoJ policy meeting (31 October).