Markets at risk of being complacent around future risks; China optimistic 7% growth achievable

By Ian Dobbs*:

Financial market volatility has been at very low levels recently and this was magnified by the US holiday on Friday that saw a large part of the market take an extra-long weekend.

We are in fact back to the sort of volatility levels seen in 2007 and some are questioning whether the markets have become complacent with regard to future risks.

One of those risks is centred around China and the effect of its cooling property market on the economy. The Chinese are optimistic they can maintain growth above 7% and will fine tune policy to help small firms. But they have so far ruled out the further use of big stimulus preferring to use targeted measures instead.

Improving data in the United States is seeing adjustments to interest rate forecasts with some now expecting a rate hike in late 2015. In the UK a rate hike is expected in early 2015 although that could be brought forward if economic data and the housing market continue to perform strongly. In Europe however any upward adjustment to interest rates is a very long way off.

Major Announcements last week:

·  RBA leaves cash rate unchanged at 2.5%

·  UK manufacturing PMI  57.5 vs 56.7 expected

·  US ISM manufacturing PMI 55.3 vs 55.6 expected

·  Australian trade balance -1.91b vs -0.16b expected

·  UK construction PMI 62.6 vs 59.7 expected

·  Australian building approvals +9.9% vs +3.1% expected

·  Australian retail sales -0.5% vs 0.0% expected

·  UK services PMI 57.7 vs 58.1 expected

·  US non farm employment change +288k vs +214k expected

·  US ISM non manufacturing PMI 56.0 vs 56.2 expected

·  Canadian building permits 13.8% vs 3.1% expected

·  Canadian Ivey PMI 46.9 vs 51.3 expected

NZD/USD

The New Zealand dollar traded heavily in the latter part of last week weighed on by good employment figures from the US and a somewhat softer Australian dollar. The currency remained under pressure in the early stages of this week and traded down to 0.8714 around lunch time yesterday. Since then however we have seen a decent bounce which took the currency all the way back up to 0.8767 overnight. There was little in the way of news flow to justify the move and demand for the NZD has moderated this morning in the wake of the release of the Quarterly Survey of Business Opinion. Thursday’s NZ manufacturing index will be of mild interest with more importance put on the Fed meeting minutes set for release a few hours earlier. We also have a number of Fed speakers this week to watch out for. Expect the NZD to continue to find levels over 0.8770 tough to maintain with selling into strength recommended.

NZD/AUD (AUD/NZD)

This pair has recovered strongly since posting a 0.9063 low (1.1034 high) back in early June. A couple of technical indicators are however starting to signal that momentum is waning and this should help to keep further gains limited. Selling into strength above 0.9350 (below 1.0695) is therefore recommended with the target for an eventual pullback to support around 0.9200 (1.0870). This morning’s release of NZ’s Quarterly Survey of Business Opinion has seen demand for the NZD wane a touch and this only reinforces the view that levels above 0.9350 offer good value buying of AUD. The key release for this pair comes in the form of Thursday’s Australian employment data which will be closely watched. Expectations are for a gain of around 12.3k.

NZD/GBP (GBP/NZD)

This pair has remained relatively quiet over the past week. A slight downside bias was prominent last week with the cross trading to a low of 0.5085 (high of 1.9667). We did however see some healthy demand for New Zealand dollars last night which caused a bounce to 0.5120 (1.9531) although there was no real news flow to support the move. This morning’s QSBO release has seen that demand moderate and the pair has drifted back towards 0.5100 (1.9608).  UK manufacturing production data tonight will be watched and on Thursday we have the Bank of England rate meeting. No change is expected from the bank and data this week should continue to support the UK recovery. Any topside price action in the pair should be contained by minor resistance around 0.5160 (1.9380) over the course of this week. Dips however are proving to be somewhat limited and it looks like we need will need to see a bout of NZD weakness before 0.5000 (2.0000) trades again.

 NZD/CAD

The past couple of weeks had seen the Canadian dollar regaining some ground vs the New Zealand dollar with the pair trading down to 0.9287 heading into the weekend. We have seen a sharp reversal off those lows in the early stages of this week however thanks to a firmer NZD and a disappointing reading from Canadian Ivey PMI. The pair is now back just below minor resistance around 0.9360. If that level caps the gains then the cross could turn back down, but any move above 0.9360 will open the way for further strength. Still to come from Canada this week we have housing data and the all-important employment numbers. From NZ we only have the manufacturing index which shouldn’t impact the currency to a large degree.

NZD/EURO (EURO/NZD)

The New Zealand dollar has seen grinding appreciation again the Euro over the course of the past week. Recent cycle highs at 0.6460 (lows of 1.5480) are in sight with the pair looking like it might attack that level overnight. However this morning’s release of NZ’s QSBO has taken some of the steam out of the NZD and as such this pair has drifted back to the more comfortable 0.6430 (1.5552) level. The fragile nature of the Eurozone recovery is keeping the Euro under a little pressure although we have failed to see the broad weakness the European Central bank would have wanted to see after last month's policy easing. 0.6350 (1.5748) marks the first level of downside support and while above there the risk remain skewed to further gains.

 NZD/YEN

The relatively strong New Zealand dollar over the past five weeks has translated to this pair rallying from just below 86.00 to 89.54 mid last week. There are signs however that momentum in this move is waning and we may well have seen a top put in place at 89.54 for now. A sustained move below minor support around 89.00 would be the first signal that a broader pullback could be developing. From NZ this week we have manufacturing data on Thursday, while from Japan the focus turns to core machinery orders and the tertiary industry activity index.

AUD/USD

The Australian dollar came under some pressure in the second half of last week. It was weighed on by a poor trade balance result, negative comments from RBA Governor Stevens and soft retail sales data. We did get a much better than expected building approvals number but it did little to stem the negative sentiment that drove the currency down to a 0.9332 low. Trading since then has been pretty quiet with the US 4th of July holiday seeing a large part of the market take a long weekend. The currency has managed a small recovery that got a boost from this afternoon’s business confidence data. This has taken the AUD up through minor resistance at 0.9375. On Thursday this week we have the Fed minutes to digest and a few hours later we get Australian employment data. Those two releases should set the tone for the AUD heading into the weekend.

AUD/GBP (GBP/AUD)                            

The Australian dollar struggled last week on the back of poor trade balance data and soft retail sales. Comments from the RBA Governor also weighed and as a result the cross to the UK Pound traded down to a low of 0.5443 (1.8372). We have seen a small recovery off those lows but the long weekend in the US has made for a quiet few trading sessions globally. The GBP continues to find support from the ongoing economic recovery and data this week is expected to reinforce that. The Bank of England meets on Thursday although that shouldn’t hold any surprises. From Australia we have consumer sentiment and employment change to draw focus. The latter will likely set the tone for the pair heading into the weekend. While the market trades below minor resistance around 0.5500, the risks are skewed to further downside price action.

AUD/EURO (EURO/AUD)

For most of the past four weeks this pair has been ranging sideways between 0.6860 and 0.6960 (1.4577 and 1.4368). We did get a dip to 0.6851 (1.4596) last week as the Australian dollar came under some pressure after poor trade balance data and soft retail sales figures but the pair has recovered off those lows to currently trade around 0.6890 (1.4514). Data later this week in the form of Australian employment change will likely dictate near term direction. Ahead of that we have consumer sentiment to digest on Wednesday. European data this week is expected to reinforce the fragile nature of the economic recovery and should limit any potential Euro strength.

AUD/YEN

The Australian dollar lost ground to the Yen in the middle of last week on the back of poor trade balance data and soft retail sales figures. Since then however the pair has remained in a tight range around 95.50 thanks in large part to the long weekend in the US that saw volatility drop across all markets. Key downside support comes in around 95.20 and while above there we are likely to continue to see further range trading. Any move below 95.20 however would be a weak signal and warn that a broader pullback could be developing. Key data from Australia this week comes in the form of employment change on Thursday. From Japan we have core machinery orders and the tertiary industry activity index to digest.

AUD/CAD

Last week saw a resurgent Canadian dollar make good ground against the Australian dollar that struggled after soft data and negative comments from RBA Governor Stevens. The pair traded back below 1.0000 for the first time since March eventually making a 0.9938 low late in the week. We have however seen a good recovery off those lows thanks in part to a poor reading from Canadian Ivey PMI last night. The pair has now recovered to trade just above 1.0000, although the downside is still the risk. We have key employment data from both countries later in the week and these two releases will likely set the tone for the pair heading into next week.

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Market commentary:

Financial market volatility has been at very low levels recently and this was magnified by the US holiday on Friday that saw a large part of the market take an extra-long weekend. We are in fact back to the sort of volatility levels seen in 2007 and some are questioning whether the markets have become complacent with regard to future risks. One of those risks is centred around China and the effect of its cooling property market on the economy. The Chinese are optimistic they can maintain growth above 7% and will fine tune policy to help small firms. But they have so far ruled out the further use of big stimulus preferring to use targeted measures instead. Improving data in the United States is seeing adjustments to interest rate forecasts with some now expecting a rate hike in late 2015. In the UK a rate hike is expected in early 2015 although that could be brought forward if economic data and the housing market continue to perform strongly. In Europe however any upward adjustment to interest rates is a very long way off.

Australia

Last week proved to be a tough one for economic data from Australia and for the Australian dollar. Poor trade balance and retail sales figures were compounded by negative comments from the RBA’s Stevens. We did see a big bounce bank in building approvals data, although this did little to help overall sentiment. So far this week we have seen a couple of second tier releases that have been mildly encouraging. The Performance of Construction index jumped from 46.7 to 51.8, and Job advertisements for June are up 4.3% from a prior reading of -5.6%. Job ads are now 6% higher than they were at the start of the year and this is consistent with a very gradual improvement in labour demand. In the last couple of hours we have seen business confidence which has improved to 8 from last month’s 7. The business conditions component showed a bigger jump and is now at its highest level since January. Still to come this week we have consumer sentiment and the more important employment change data. That data will likely set the tone for the AUD heading into the weekend.

New Zealand

It has been a very quiet period for data out of New Zealand. Last week was dominated by further declines in business confidence and dairy prices which helped to cap the NZD to a degree. We got another reading on business confidence this morning with the release of the Quarterly Survey of Business Opinion (QSBO) and it confirmed last week’s result with a decent pull back from the very high readings seen earlier in the year. Overall however the index is still high by historical standards and consistent with continued economic expansion. Yesterday’s release of QV house prices for June showed gains moderating to an 8% year on year increase, which is down a touch from May’s 8.2%. The slowing of house price gains should continue with interest rate rises combining with the LVR restrictions to take some heat out of the market. The only other data of note this week will be Thursday’s manufacturing index, although it’s unlikely to have much impact on the level of the NZD.

United States

A long weekend in the United States means there has been no data of significance released since last Thursday’s employment report. That result did surprise many coming in on the strong side at +288k. As a result we have started to see a few institutions bring forward their expectations for rate rises in the US. The adjustments are only mild however with expectations now for a hike in late 2015 as opposed to early 2016. A lot can happen between now and then and so far these changing expectations have had little impact on the value of the USD or longer term bond rates. But it is a trend to watch as it may gain momentum, especially if history repeats itself and we get a very strong bounce back in growth after the shocking weather affected first quarter. We have a number of Fed speakers of the coming days along with the release of the minutes from the latest Fed meeting set to hit the wires on Thursday morning.

Europe

Data from Europe last week only served to confirm what we already know. The economic recovery there is very fragile and has very little momentum. Inflation is dangerously low at 0.5% and unemployment is hovering around 11.6%. The one thing that is certain is that interest rates are going to stay low for a very long time in Europe. After last week’s ECB meeting President Draghi suggested that the door was still open for quantitative easing (QE) should the economy warrant it. But comments from other officials since then suggest the bar for enacting that sort of policy is set very high. Draghi is more than likely hoping the threat of QE will help to weaken the Euro which has remained stubbornly strong despite recent central bank action. We will hear more from Draghi this week with a speech scheduled for Thursday morning. We also have the German trade balance, French industrial production and the ECB monthly bulletin to digest.

United Kingdom

The United Kingdom economy continues to perform well and data last week was generally supportive of the outlook going forward. Manufacturing and construction PMI’s both came in better than expected and while the services PMI did undershoot forecasts it is still at very healthy levels overall. The housing market remains a focal point and is probably the biggest risk to future economic stability. The latest reading of house price gains showed +1.0% last month with the yearly gains running at 11.8%. The bank of England does not want to raise rates prematurely just to cool the housing market and as such they are open to using a range of macroprudential tools to rein it in. They have recently imposed lending restrictions on banks and further measures are a possibility. At the end of the day however, historically low interest rates are the driver of these gains and one has to question whether a 0.5% cash rate is still appropriate for an economy performing as strongly as the UK’s. At this point an interest rate hike in the first quarter of next year seems likely, but the risks are that it may have to come earlier. The Bank of England meets this week although with no change expected we will have to wait for the minutes to be released in two weeks’ time to get a feeling for the range of views with the Monetary Policy committee (MPC).

Japan

The highlight from Japan last week was the release of the quarterly Tankan report. It was a bit of a mixed bag with current sentiment taking a knock, thanks in large part to April’s sales tax increase. This was largely offset by firms ratcheting up plans for capital spending which will be pleasing for the government and the Bank of Japan. Governor Kuroda was on the wires yesterday saying Japan’s economy continues to recover moderately as a trend and this is likely to continue. He sees Japanese inflation hovering around 1 -1.5% for some time, and said the BOJ will continue with current policy for as long as needed to achieve the 2% price target. Later in the week we have core machinery orders and the tertiary industry activity index to digest.

Canada

A couple of data points from Canada last week had little impact on the Canadian dollar that continued to recover ground across the board. A slightly weaker reading on GDP was offset by the trade balance that printed a touch better than expected. Last night we saw building permits data that raised a few eyebrows. The 13.8% gain was much stronger than the expectations for just +3.1%, and a big jump from last month’s +2.2%. The Bank of Canada are hoping for a ‘soft landing’ in the housing market but gains like this suggest that might be hard to engineer. The positive impact on the currency from this data was short lived however after the Ivey PMI result disappointed the market coming in at 46.9 vs expectations of 51.3. This is the second reading in a row below the key 50 level that denotes expansion or contraction. The Ivey PMI index is considered a leading indicator of economic health and we have now seen a consistent fall in the index since March’s peak of 57.4. This was also reflected in the Bank of Canada’s business outlook survey released last night. The overriding theme from that is that business are hesitant to fully commit to investing with many firms yet to see signs of a notable and sustained strengthening in demand. Still to come this week we have housing starts data and the key release of employment change.

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