Bank of International Settlements warns against adding further monetary stimulus to a global economy that was past the height of the crisis

By Ian Dobbs*:

As the markets digest the changing landscape after the US Fed’s announcement on tapering last week, the Bank of International Settlements has released its annual report, which includes a timely piece on stimulus.

They warned of adding further monetary stimulus to a global economy that was past the height of the crisis. They also believe adding more extraordinary stimulus was becoming increasingly perilous and that central banks cannot do more without compounding the risks they’ve already created. Timely indeed.

We’ve seen how the markets react to the threat of a mere reduction in stimulus from the US Fed.

The repricing of risk assets across the board (in currency terms both the AUD and NZD are classed as risk assets), as stimulus is withdrawn, and eventually stopped,  will continue to reverberate in markets for the foreseeable future.

The moves we have seen over the past couple of weeks in the form of a stronger USD, higher long term interest rates, and volatile stock markets, could all be the start of much broader trends.

Major Announcements last week:

·  Ben Bernanke signals ‘tapering’ in coming months

·  New Zealand GDP 0.3% vs 0.5% expected

·  Chinese manufacturing PMI 48.3 vs 49.4 expected

·  UK retail sales +2.1% vs 0.8% expected

·  Canadian CPI 0.2% vs 0.3% expected

·  Canadian retail sales -0.3% vs 0.00 expected

NZD/USD 

After the sharp move lower on the back of the Fed announcement last week the New Zealand dollar has spent the past few days consolidating those losses. Sideways trade between 0.7700 and 0.7800 has contained much of the action. There was however a short lived dip to a new cycle low at 0.7685 last night. The NZD quickly recovered though to trade back around 0.7750. Talk from Fed officials that the markets have overreacted has done little to weaken the USD in general. The risks for the NZD are still on the downside as any potential strength should be capped at resistance around 0.7900. Along with NZ trade balance and business confidence this week there is plenty of US data to keep the market on its toes.

NZD/AUD (AUD/NZD)

After trading up over 0.8500 (under 1.1765) as the Australian dollar wore the worst of the selling in the wake of the Fed announcement, the NZDAUD cross has pulled back considerably and now trades just below 0.8400 (above 1.1905). This is a familiar area for the pair as it has spent much of the past three weeks trading around this level. It seems try as it may the NZDAUD just can’t seem to hold onto gains above 0.8400 (below 1.1905). I still expect good support for the pair around 0.8350 (1.1976) and this should contain the downside for now. More choppy trade between 0.8350 (1.1976) and 0.8450 (1.1834) is likely over the course of this week.

NZD/GBP (GBP/NZD)

A combination of the Fed announcement and weaker New Zealand GDP saw this pair trade down to key support around 0.5000 (2.0000) late last week. So far that support has contained the downside but there has been little in the way of a meaningful bounce. The pair has traded a tight range with 0.5050 (1.9800) capping any upside pressure. As long as that is the case, further tests of support at 0.5000 (2.0000) seem likely. If we see a sustained move below that support level, then the next target will be 0.4750. However, the more likely scenario is a move back above 0.5050 (1.9800) that will see the immediate downside pressure relieved. That will signal the pair is comfortable trading within the broader 0.5000 -0.5200 range for the time being.

 NZD/CAD

The NZDCAD suffered last week as the CAD materially outperformed the NZD in the wake of the Fed announcement on tapering. A weaker GDP reading for New Zealand only magnified the move as the pair trade down below 0.8000. However Friday night saw Canadian retail sales and inflation hit the wires and both pieces of data disappointed. This caused increased selling pressure on the CAD as it played some catch-up to weakness in the NZD. As a result the cross has recovered substantially and it is now close to where it was before the Fed announcement. Currently trading around 0.8150, there is easily potential for a test to resistance at 0.8250. Look for support around 0.8000 to continue to contain the downside for now. Canadian GDP is out at the very end of the week but before that we get trade balance and business confidence from New Zealand.

NZD/EURO (EURO/NZD)

The NZDEUR touched cycle lows last week after a combination of the US Fed announcement and weaker NZ GDP weighed on the NZD. Since then we have seen a small recovery with the pair trading back above 0.5900 (below 1.6949). The bounce has been less than convincing though, and the risks are still skewed to the downside. It will take a move back above 0.5950 (below 1.6807) to relieve immediate downside pressure. That would turn the focus on to further gains and a test of 0.6060 (1.6502). Until then further tests of support around 0.5850 (1.7094) are likely. This week sees lots of second tier Euro-zone data out, as well as NZ trade balance and business confidence to focus on.

 NZD/YEN

The last few days has seen more sideways action for this pair in what has been a surprisingly tight range. It seems unlikely this tight range will hold for too much longer with plenty of Japanese data out late this week. Household spending, inflation, retail sales and industrial production are all set for release out of Japan, while New Zealand gets readings on the trade balance and business confidence. Which way the pair will break remains to be seen, but with the broader trend down, the risks remain for further losses. The picture will quickly change however with sustained move above 77.50. That would be the first signal  that a broader correction is underway with an initial target of 80.00

AUD/USD

The sharp move lower in the Australian dollar after the Fed announcement last week has taken a pause as the market consolidates the losses. A brief move to cycle lows at 0.9148 was short lived last night and the AUD bounced back above 0.9250. Key topside resistance around 0.9400 should cap any near term strength as the focus remains on the downside. Private sector credit is the only data of note out of Australia this week, however there are plenty of US releases to focus on.

AUD/GBP (GBP/AUD)                            

After trading down to fresh lows last week after the Fed announcement, the AUDGBP has managed a small bounce to currently trade just below 0.6000 (1.6667). The recovery has been less than convincing though and has failed at the first line of resistance around 0.6020 (1.6611). This leaves the pair looking heavy and further tests lower cannot be ruled out. It will take a move up through 0.6020 to take the immediate pressure off the downside. If the pair can overcome that level the focus will turn to a test of the next resistance at 0.6160. There are plenty of UK releases this week which will likely decide near term direction. We hear from the BOE on inflation, get a speech from governor King, have the financial stability report and government spending review, along with consumer confidence and final GDP readings.

AUD/EURO (EURO/AUD)

The Australian dollar traded new cycle lows against the Euro late last week after the Fed announcement. Like most AUD crosses, since then there has been a small recovery. However this bounce has yet to overcome any real resistance levels and this leaves the risks still skewed to the downside. That been said, the pair currently trades around 0.7060 (1.4164) which is just shy of key resistance at 0.7080 (1.4124). A move up through there would be the first sign that a broader correction could be underway. The target would then be on a test of 0.7240 (1.3812). With little out of Australia this week Euro-zone data is likely to drive the pair. German consumer confidence, retail sales and unemployment will be closely watched.

AUD/YEN

Through much of the currency action in the past week the Australian dollar versus the JPY has been surprisingly quiet. It has maintained a tight range trading sideways between 89.00 and 91.00. It’s hard to say whether this is just a pause in the broader downtrend or the pair is building a base for a corrective rally from here. But as long as 89.00 continues to support, the chance of a bounce toward 93.00 is very real. There is plenty of data out of Japan this week to spark a move, while Australia only has private sector credit to focus on.

AUD/CAD

In the wake of the Fed announcement late last week the Australian dollar saw heavy selling and materially underperformed against the Canadian dollar. The cross traded to a low of 0.9485 before the AUD managed to recover somewhat. Then late on Friday night two piece of Canadian data hit the wire that saw the CAD come under pressure. Both inflation data and retail sales for Canada came in under expectation and the CAD played catch up to weakness in the AUD. This saw the cross rate recover all of its post Fed losses. It now trades just below 0.9750. This pair has fallen a long way in the last couple of months and could easily see a bigger corrective rally to resistance around 0.9950. For that to happen, the cross will need to hold above minor support at 0.9640. Canadian GDP later this week could impact along with Australian private sector credit set for release on Thursday.

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Market commentary:

As the markets digest the changing landscape after the US Fed’s announcement on tapering last week, the Bank of International Settlements has released its annual report, which includes a timely piece on stimulus. They warned of adding further monetary stimulus to a global economy that was past the height of the crisis. They also believe adding more extraordinary stimulus was becoming increasingly perilous and that central banks cannot do more without compounding the risks they’ve already created. Timely indeed. We’ve seen how the markets react to the threat of a mere reduction in stimulus from the US Fed. The repricing of risk assets across the board (in currency terms both the AUD and NZD are classed as risk assets), as stimulus is withdrawn, and eventually stopped,  will continue to reverberate in markets for the foreseeable future. The moves we have seen over the past couple of weeks in the form of a stronger USD, higher long term interest rates, and volatile stock markets, could all be the start of much broader trends.

Australia

There has been little out over the last few days to materially change the outlook for the Australian economy. The AUD made a fresh cycle low over night, but only by a handful of points, before staging a decent bounce. A liquidity squeeze in the Chinese banking system is getting a lot of coverage at the moment. Mostly because the Peoples Bank of China is so far refusing to step in and alleviate the pressure. It seems they are sending a signal to their banks to tighten up lending standards. This is however a dangerous game they are playing. Short term credit markets in China are starting to look like they did in the US before the Lehman’s collapse in 2008. The rest of the week offers very little in the way of fundamental data for Australia, with only private sector credit figures set for release on Thursday.

New Zealand

There has been little of importance released in New Zealand since last week’s softer than expected GDP data. We will have to wait for this Thursday to get readings on the trade balance and business confidence. In the meantime the New Zealand dollar will continue to be influenced by offshore factors. The currency has seen mostly sideways action bouncing around its cycle lows since the US Fed announcement last week. Longer term interest rates have also increased in line with offshore markets over the last few days.

United States

Last week’s announcement by Ben Bernanke that a scaling back of asset purchases is just around the corner has continued to reverberate through the markets. Bond yields have backed up a long way and equities are volatile. The sharp move higher in the USD has taken a pause the last couple of days, but it seems likely this move is just that start of a broader trend. There have however been a number of Fed officials releasing comments in the last two days stating that the markets have over-reacted to the news. They have stressed that the Fed is not exiting stimulus but merely dialing back liquidity. The Fed have created this monster and caused a mispricing of risk assets across the board. If they thought the road to an exit was going to be smooth, they are sadly mistaken. If this truly is the beginning of the end for quantitative easing, then the next 12 month will see much more volatility and some of it I suspect will be very painful with unforeseen ramifications.

Europe

Two pieces of data out in the last few days have been somewhat supportive of the Euro-zone outlook. Firstly we saw current account data on Friday that showed a continued healthy surplus. Then last night we got a reading on German business sentiment that has improved from last month.  The EUR itself has been quite volatile on the back of flows and position adjustments after the Fed announcement last Thursday. There was however an interesting article published (here) early this morning focusing on Italy. It states that Italy could be in need of an EU rescue in the next six months. The Euro-zone crisis has gone off the boil lately thanks in large part to the ECB. But the structural issues are yet to be fixed, and an Italian rescue would take things to a new level. The rest of the week sees lots of German data hitting the wires. Unemployment, retails sales and inflation data for Germany will all be released along with French consumer spending. We can also expect lots of talk from officials at the Euro economic summit later in the week.

United Kingdom

There has been little to change the slightly brighter outlook for the UK and the Pound Sterling over the last few days. Late on Friday there was the release of public sector borrowing data which showed an improving trend. The UK’s Osborne says austerity is still needed to avoid an economic relapse. He delivers his spending review this Wednesday and says spending is still too high. He is committed to finding another GBP11.5 billion in savings over the coming fiscal year. We will hear plenty from outgoing Bank of England governor King over the next couple of days. He’s reporting to a parliamentary committee tonight on the inflation outlook, then is scheduled to release an on the record speech tomorrow. Later in the week we see figures on the current account and a final reading on GDP.

Japan

This week we will get readings on the Japanese consumer with household spending and retail sales both set for release on Friday. Until then we will no doubt continue to get comments from BOJ officials. Over the weekend Governor Koroda was on the wires with a very upbeat assessment of the economic outlook. He sees a pickup in exports helped by the recent weakness in the currency and expects Japan’s economy to return to moderate growth. He said the BOJ will continue easing to achieve stable price growth, and sees no problems in Japan’s financial system. He also believes the markets will settle down as they reflect Japan’s recovery. Let’s hope he is right because recent volatility in stocks and bonds is not something you would want to see continuing in the long run.

Canada

The Canadian dollar out-performed many currencies last week in the face of the US Fed’s announcement on tapering. This was especially noticeable against the NZD and AUD as both cross rates to the CAD sank in the hours after the Fed meeting. However on Friday night Canada had economic data in the form of retail sales and inflation figures released. Both releases came in under expectation and disappointed the market. Core retail sales actually contracted on the month against an expectation of being flat. Inflation was also weak and both pieces of data weigh on the Canadian dollar. It has now started to play a little bit of catch up to weakness in the NZD and AUD. The only data of note this week is GDP, which won’t hit the wires until early Saturday morning, so current sentiment could keep the CAD heavy over the coming days.

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Ian Dobbs is a currency analyst with Direct FX You can contact him here »