Equity markets react like a spoilt child; central banks race against contagion

By Sam Coxhead*:

The market sentiment was initially relatively stable, before nose diving again during the latter part of last week.

Safe haven investor rush into US dollars and Japanese YEN continued. There was little in the way of positive economic data across the globe. Equity markets were mostly down in excess of five percent across the board.

Precious metals saw aggressive selling, with gold selling off by fifty dollars in the space of an hour in Fridays session. As a consequence interest rates have moved lower across the board.

The US Federal Reserve (FED) confirming that they will maintain a low cash rate for the coming couple of years, whilst pushing down longer term rates by extending the maturity of their Treasury holdings. The equity markets reacted to the FED’s monetary policy announcement, like a spoilt child being told they were not allowed any more sweets. The European Central Bank (ECB) look poised to reverse their recent hike to the cash rate. And the Bank of England (BOE) are positioned to increase their quantitative easing (QE) program in the coming months.

Adding to fears was the news of a third straight month of contraction in the Chinese manufacturing sector.

Developments in the Euro-zone will remain of primary focus in the coming months, as authorities need to action initiatives to curb further debt contagion spreading.

Major Announcements last week:

· RBA monetary policy meeting minutes maintain staunch rhetoric divergent with interest rate market pricing
· German ZEW Economic Sentiment -43.3 vs -44.3 expected
· BOE monetary policy meeting minutes point towards increased quantitative easing at some stage
· Canadian CPI +.4% vs +.1% exp
· US Existing Home Sales 5.03million vs 4.76million expected
· NZD 2nd QTR GDP +.1% vs +.5% expected
· Chinese HSBC Manufacturing PMI 49.4 vs 49.9 previously (3rd straight month of contraction)
· Canadian Retail Sales 0.0 vs +.2% expected
· IMF and World Bank both lower global growth forecasts
· S&P downgrade Italian credit rating along with various Italian banks
· US FED announce new 'operation twist' to lower longer end interest rates, and makes downbeat assessment of the economy
· South African Reserve Bank leaves the cash rate unchanged and issues dovish statement
· South African inflation 5.3% vs 5.5% expected, and Retail Sales 2.8% vs 2.0% expected

NZD/USD 
The NZ dollar saw intense pressure from the US dollar in the later part of last week, as both domestic and external pressures took their toll. Locally this week the building and consumer confidence numbers on Thursday will be of interest. In the US consumer confidence, durable goods orders and final GDP numbers will be closely watched. The US FED chairman Bernanke’s speech Thursday morning Australasian time, will also be closely watched for any further insight to monetary policy. Expect the US dollars progress to be harder fought this week, as patient NZ dollar buyers emerge from the sidelines.

NZD/AUD (AUD/NZD)
After initially testing higher last week the NZD was unable to consolidate at the higher levels outside of its recent range. The double hit of a more “hawkish” (lower chance of a cash rate cut) RBA and horrible NZ GDP number ensured the NZD was under pressure from the AUD. The pair is now back in familiar territory. There is little in the way of top tier economic data on either side of the Tasman this week, but NZ building consents and consumer confidence numbers on Thursday with be watched.

NZD/GBP (GBP/NZD)
The risk off sentiment saw the NZD under pressure from the GBP in the latter half of last week. The disappointing 2nd quarter NZ GDP started the NZD weakness and then the heightened risk aversion provided the follow through for the move lower. Many will be happy to see this pair move a little back towards historical averages. Expect progress from the GBP to be hard fought this week, should the market nerves settle a little. With little in the way of economic data in the UK this week, expect some mild NZ focus on the building and consumer sentiment data on Thursday. A break and consolidation below the .4950 support (2.0200 resistance) would indicate another downward leg.

 
NZD/CAD
The New Zealand dollar saw pressure from the Canadian dollar last week following the 2nd quarter NZ GDP number. As the global risk aversion accelerated the NZD saw further downward pressure and the CAD easily pushed it down through the .8050 support level. The prospect of widening interest rate differentials before the end of 2011 is all but ended, and this has eased the way back towards more historically average levels for this pair. The NZD focus for the week will be on the building and consumer sentiment numbers on Thursday. In Canada the GDP number on Friday will be closely watched.

NZD/RAND
The NZD dollar hit the highs against the RAND as the fear dominated price action into the end of last week. The surprisingly lower than expected South African inflation number added to the weakness the RAND is currently experiencing, as an emerging market currency. There is an array of South African economic data this week, but most of the lead will come from general market sentiment, with regards to emerging market currencies.

NZD/EURO (EURO/NZD)
The NZD gave up further ground against the EURO last week as the NZD was hit following the 2nd quarter NZ GDP number, and the risk aversion following the US FED’s monetary policy statement. Progress from current levels will be interesting. The downside bias remains in place with strong initial support around .5720. Exactly what pans out in Europe is impossible to predict, but what is certain is that it is a complex blend of economic (growth), financial (debt) and political (civil unrest) issues that need to be addressed, in order to see the peripheral member states and their debt issues contained. Current levels still represent fairly good value buying of EURO with NZD.

 
NZD/YEN (NZD/YEN)
The NZD gave up ground to the YEN at a rapid pace as the market risk aversion dramatically increased. Whilst this YEN strength and NZD weakness may continue, current levels represent good value buying of NZD with YEN. With the YEN strength the chance of intervention from the BOJ increases, but unless the YEN makes further ground against the US dollar, the likelihood of this is relatively low in my view. There are retail sales and inflation numbers in Japan this week, but more likely is the lead will come from the equity markets and their expression of risk appetite. Building and consumer sentiment numbers in NZ on Thursday will be followed, but expect relatively little impact as the global picture dominates.

AUD/USD
The Australian dollar saw increased pressure from the US dollar following the US FED’s announcement on monetary policy. Their downbeat assessment of the economy, chimed in with the 3rd straight month of manufacturing contraction in China, and it is easy to see how the sellers emerged of the AUD, being the global barometer for growth. There is little economic data of note in Australia this week. In the US we have consumer sentiment, durable goods sales and the final GDP reading which are of note. US FED chairman Bernanke also speaks on Thursday morning Australian time and this will be followed closely for any further communication on monetary policy.

AUD/GBP (GBP/AUD)                            
The Australian dollar weakened against the Pound  Sterling into the latter half of last week. This was in the face of the more “hawkish” than expected RBA, and the pressure created by the downbeat economic assessment of the economy by the US FED, at their monetary policy announcement. This coupled with the news of the 3rd straight month of contraction in the Chinese manufacturing sector, and path for a weaker AUD was easily found. This week coming there is little in the way of major economy data in either economy, so expect the lead to come from the general market appetite for risk.

 
AUD/EURO (EURO/AUD)
The Australian dollar weakened considerably against the EURO through the course of last week. The softening global growth profile in Europe, the US and potentially China, provided the rapid path lower for the AUD. This week is light on economic data in both economies, and the lead will come from the plans that come from European financial authorities, and its effect on risk appetite. If the pair consolidates below the .7200 support (1.3890 resistance), its opens the way for another leg lower from the AUD.

GBP/USD
This pair confirmed its move to a lower range last week as the safe haven bid for US dollars saw the Pound Sterling under pressure. Compounding sentiment were the minutes released from the BOE’s monetary policy meeting. These minutes confirmed discussions about increasing the QE program. It seems fairly likely that this will go ahead in the coming months, and should keep pressure on the GBP in the short term against the US dollar. There is little in the way of economic data in the UK this week. In the US we have consumer sentiment, durable goods sales and the final GDP number. US FED Chairman Bernanke also speaks late Wednesday, and as usual there is room for impact should he communicate thoughts on monetary policy.

GBP/EURO (EURO/GBP)
This pair stayed within its expected range last week, with the EURO just putting a little pressure on the GBP in what was “whippy” intra-day price action. The BOE monetary policy meeting minutes revealed discussions on further QE, this was counted by comments from the ECB  that they are likely to reverse their recent hike to the cash rate. The coming weeks are certainly going to test the structure and political will of Euro-zone members, as they are forced to make hard and fast decisions on how to contain Greece, and no doubt the volatility will increase as this is further fleshed out.

GBP/RAND
This pair has been incredibly volatile over the last week, with very sharp price changes seen every day. The lower than expected inflation number in South Africa saw the Rand weaken as chances of a further cut to the cash rate from the SARB increased. The BOE monetary policy meeting minutes revealed discussion of further QE by the BOE and this took a little wind out of the GBP sails. Expect the volatility to continue, especially because of the nature of the emerging market conditions at the moment. Liquidity is very low by most accounts, and this is lending to the big moves when large players exit the market. There is little or no economic data in the UK this week, and an array of second tier data in South Africa which should be of limited impact. Expect the lead to come again from the overall market appetite for risk, which obviously has a RAND weakening bias in the current environment.

Market commentary:

The market sentiment was initially relatively stable, before nose diving again during the latter part of last week.

Safe haven investor rush into US dollars and Japanese YEN continued. There was little in the way of positive economic data across the globe. Equity markets were mostly down in excess of five percent across the board.

Precious metals saw aggressive selling, with gold selling off by fifty dollars in the space of an hour in Fridays session. As a consequence interest rates have moved lower across the board.

The US Federal Reserve (FED) confirming that they will maintain a low cash rate for the coming couple of years, whilst pushing down longer term rates by extending the maturity of their Treasury holdings. The equity markets reacted to the FED’s monetary policy announcement, like a spoilt child being told they were not allowed any more sweets. The European Central Bank (ECB) look poised to reverse their recent hike to the cash rate. And the Bank of England (BOE) are positioned to increase their quantitative easing (QE) program in the coming months.

Adding to fears was the news of a third straight month of contraction in the Chinese manufacturing sector.

Developments in the Euro-zone will remain of primary focus in the coming months, as authorities need to action initiatives to curb further debt contagion spreading. Various media outlets have loosely reported behind the scenes plans to recapitalize European banks, use leverage to increase the power of the European Financial Stability Fund and conduct a controlled default of Greek debt. Some sources are claiming Greek bondholders may be asked to forgive up to 50% of their principle investments. This would enable Greece to move forward towards in a more tenable position. The other effect would be to take pressure off the likes of Spain and Italy, and of course the banks who are the main holders of the distressed debt. Political pressure will make this path awkward and volatile, and will ensure volatility levels remain elevated.

In the US the equity markets saw some wild swings, as the market showed how underwhelmed it was with the FED’s monetary policy announcement. The FED’s downbeat assessment of the economy sent the wider market into the tailspin that saw fears elevate. The one bright spot was a better than expected housing number. The US dollar is being helped by the sharp exit of emerging markets by investors, as part of the larger shun of growth assets. This coming week will see the focus on consumer sentiment numbers, durable goods sales, final GDP numbers and FED chairman Bernanke’s speech Thursday morning Australasian time. With the US dollar having risen so quickly of late, expect progress to be harder fought from current levels, in the absence of further negative news in Europe.

In New Zealand the 2nd quarter GDP number was a disappointing .1% rise, against an expectation of a .5% increase. The likelihood of a hike to the cash rate in NZ before the end of the year is quickly evapourating with the demise of the global economy. This week only sees building numbers and business confidence on Friday for the domestic focus. Most likely the NZD will be driven by global sentiment. Downside moves should be more orderly from current levels, given how far the NZ dollar fell last week. 

In Australia the Reserve Bank (RBA) monetary policy meeting minutes again re-iterated the RBA’s rhetoric with regards to inflationary pressure. Their position will have softened somewhat after last week’s global sentiment fall, but it is hard to see the 100 plus points of easing to the cash rate before the end of the year, that the interest rate market has been pushing for. The AUD has been under some periods of intense pressure, especially as the highly correlated copper market saw quick falls. There is little in the way of economic data this week, so moves will almost entirely be driven by external sentiment.

In the UK the GBP has seen some intense selling pressure also. The BOE monetary policy meeting minutes revealed that further QE was discussed and it seems likely that will eventuate in the coming months. The prospect of further QE should keep the pressure on the GBP against the major currencies. However it is likely the GBP will outperform the growth currencies (NZD, AUD) should the global economic picture continue to darken. This week has nothing in the way of top tier economic data in the UK, so expect the lead to be provided by developments in Europe.

The Canadian dollar has been under pressure from the majors, as it is pegged in the commodity basket along with the New Zealand and Australian dollars. It’s fall has been slightly less dramatic than its Australasian counterparts. Canada’s monthly inflation number was higher than expected and this will likely see the Bank of Canada forced to sit on their hands, in terms of cash rate movements over the next few months. This coming week sees the GDP number released on Friday and this will be the primary domestic focus for the week. Against both the NZD and AUD, the Canadian dollar is sitting at crucial levels. A further strengthening of the CAD against the two Australasian currencies will see the pairs move back towards more historic levels.

In Japan the pressure remains on the Bank of Japan. The strength of the YEN is materially affecting the exporting sectors and they remains poised to intervene. But they have curtailed any rumours that they would attempt to impose any kind of cap on the YEN, in the vein of the Swiss National Bank. On a positive note the USD/YEN pair has been relatively stable, and that will give them some kind of comfort for the time being.

In South Africa the lower than expected inflation number has eased the way for a potential interest rate easing from the South African Reserve Bank. This pull back in inflationary pressure could not be better in its timing, as the economy has started to slow. The RAND remains under intense pressure as the wider investor market exits the emerging market space.

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Sam Coxhead is a currency analyst with DirectFX You can contact him here >>