Financial instability and geopolitical risks not enough of a direction catalyst; focus shifts to Federal Reserve for guidance

By Ian Dobbs*:

There has been a distinct lack of direction seen across most markets throughout the last week.

Not even the threat of financial stability issues in Europe, or ongoing geopolitical risks in Eastern Europe and the Middle East were enough to provide direction.

The core focus for the foreign exchange markets remains the US Federal Reserve, and the timing of their exit from the current emergency cash rate settings. Whilst no move is expected for a calendar year at least from now, the repercussions will be widely felt before then.

Last week’s mixed messages from the regional Fed members make the testimony from Fed Chair Janet Yellen later on today, all the more interesting.

From an Australasian perspective, an early start to the hiking cycle would finally provide some solid pressure on the Australian and New Zealand dollars, albeit this has been a long time coming. Nothing is clear on the exit of this unprecedented policy settling. However, it seems we are likely to see further periods of sideways price action ahead of volatility that will surely come at some point.

As the months pass, the detail of the economic data will become more important. In the meantime, the Australasian duo remain in demand, with the Christchurch rebuild continuing to provide an additional ongoing boost to the New Zealand dollar.

Major Announcements last week:

·  Canadian Ivey PMI 46.9 vs 51.3

·  NZIER Business Confidence Survey 32.3 vs 52 previous

·  Australian NAB Business Confidence 8 vs 7 previous

·  UK Manufacturing -1.3% vs .4% expected

·  Chinese Inflation 2.3% vs 2.4% expected

·  Australian Unemployment 6.0% vs 5.9% previous

·  Chinese Trade Balance 31.6B vs 37.3B expected

·  BOE leave monetary policy unchanged

·  Canadian Unemployment rate 7.1% vs 7.0% expected

NZD/USD

It has been a very quiet week for the New Zealand dollar which has traded a tight range above 0.8800 since breaking above there on Wednesday last week. The weeks high of 0.8831 is just shy of the post float high which comes in at 0.8842. The next few days could prove very interesting however, with a Global Dairy Trade Auction tonight, and inflation data tomorrow. The NZD has so far largely ignored a 30% decline in dairy prices, preferring to focus on the increasing interest rate differential between NZ and the rest of the world. But dairy prices matter, as they’re New Zealand’s biggest export, and sooner or later the currency will need to reflect that. Tomorrow’s inflation data could also be key, either reinforcing expectations for another hike by the RBNZ next week with a strong result, of perhaps making the central bank’s decision a lot more finely balanced should inflation print on the soft side. The USD also has a part to play in this pair and for the most part it has remained very subdued lately even in the face of improving data. This week we have some key numbers to focus on from the states with retail sales, producer prices, building permits and consumer sentiment along with testimony from Fed Chair Janet Yellen. Downside support around 0.8790 is the key area to watch. A move below there would likely signal a much broader pullback in the NZD is unfolding. Until we see that there is potential for further gains and even a move up through 0.8842.

NZD/AUD (AUD/NZD)

The New Zealand dollar made gains against the AUD in the first half of last week, but those gains stalled just above 0.9400 (below 1.0638), and since then we have seen mostly quiet trading below that level. Both currencies have had a quiet week and this is reflected in the ever decreasing range of the pair. This low volatility won’t last for long however and there is plenty this week that could spark a move. The RBA minutes are first up this afternoon, although they shouldn’t hold many surprises. Tonight we have another Global Dairy Trade Auction, and tomorrow we get NZ inflation data. Taking a look at the broader picture, we still view the current NZD strength as an opportunity to buy AUD’s. With resistance around 0.9400 (support 1.0640) capping the NZD topside, there is potential for a material correction lower.

NZD/GBP (GBP/NZD)

The past week has seen low volatility and a very gradual grind higher for the NZD in this pair. The UK Pound eventually succumbed to some slightly softer than expected data late last week and this caused the cross to drift up to resistance at 0.5160 (support at 1.9380). That level has capped the NZD gains for now and direction this week could well be dictated by a couple of key releases from NZ in the next 24 hours. Tonight we have another Global Dairy Trade Auction, and tomorrow we get NZ inflation data which certainly has the ability to influence expectations for next week’s RBNZ meeting. From the UK we also have inflation data tonight and this will be followed by employment numbers later in the week. The 0.5080 to 0.5160 (1.9380 to 1.9685) range remains in play for now, although we should have a much better idea of where the pair is headed by this time tomorrow.

 NZD/CAD

The past week has seen the Canadian dollar the worst performer of all G10 currencies and as such the cross to the NZD has gained substantial ground. The big move came on the back of disappointing Canadian employment data on Friday and that helped the pair trade to its 0.9478 high. For its part the New Zealand dollar has been relatively quiet since mid-last week, although that could be about to change with another dairy auction tonight and inflation data tomorrow morning. These results will be closely watched with an eye on next week’s RBNZ rate meeting. From Canada there is also plenty to digest over the coming days with manufacturing sales, inflation, wholesales sales, and the Bank of Canada rate meeting all set for release.

NZD/EURO (EURO/NZD)

The New Zealand dollar saw continued appreciation against the Euro last week although gains have stalled for now just shy of the 0.6490 level (1.5408). Some relative Euro strength in the past 24 hours has seen a small correction in the pair which now trades around 0.6465 (1.5468). The broader trend is certainly up for the NZD and while the pair holds above minor support around 0.6450 (resistance around 1.5504) further NZ dollar gains are the risk. We do however have some key data from NZ over the next 24 hours that could easily influence. Tonight we have another Global Dairy Trade Auction, and tomorrow we get NZ inflation data. The latter could easily impact expectations for next week’s RBNZ meeting and therefore have a material impact on the NZD. From Europe this week focus turns to a speech from ECB President Draghi tonight which will be followed by German economic sentiment data and inflation later in the week.

 NZD/YEN

Price action in this pair over the course of the week was dominated by a fall from the 89.70 high, to the 89.00 low with a few hours on Thursday evening. This move was driven by a wave of risk aversion after fears of a Portuguese bank default spread through the market. Things quickly calmed down however and the move slowly reversed. This goes to show how nervous the markets are, even in the current low volatility environment. Taking a look at the broader picture, this pair has been appreciating since late May on the back of New Zealand dollar strength. Whether that continues will likely come down to three key upcoming events. Firstly we have another Global Dairy Trade Auction tonight and with prices already down 30% this year, another fall would have to weigh on the NZD. This will be followed by NZ inflation tomorrow and then next week we have the RBNZ rate meeting. We also have the Bank of Japan monetary policy statement this afternoon, although that shouldn’t contain any real surprises.

AUD/USD

The Australian dollar is largely unchanged from where it was trading this time last week. The week’s high and low both traded within a few hours of each other in the wake of last Thursday’s employment data, but since then a tight range has developed around 0.9390. For its part the USD has failed to find much support from recent improving data and this week we have an number of other key releases. Fed Chair Janet Yellen is set to testify to the Senate Banking Committee tonight and we also get retail sales, producer prices, building permits and consumer sentiment data over the coming days. Locally the immediate focus will be on this afternoon’s release of the RBA minutes which are likely show the central bank continues to view the currency as high by historical standards. The impact of any such statement is likely to be muted. Business confidence and the leading index later in the week will also draw attention. In terms of levels to watch, 0.9340 to 0.9440 broadly defines the trading range we have seen for much of the past five weeks and it is still very much in play.

AUD/GBP (GBP/AUD)                            

There hasn’t been a lot of direction in this pair over the past week although we are currently trading close to the highest AUD levels since early July. The cross has been driven here on the back some minor GBP weakness seen at the end of last week. This came after softer than forecast data finally weighed on the GBP to a degree. Minor resistance around 0.5500 (support around 1.8182) has so far contained the strength, but any move above there will open the way for a test of 0.5540 (1.8051). The immediate focus now turns to the RBA minutes set for release this afternoon. These will be followed by UK inflation tonight, and employment on Thursday.

AUD/EURO (EURO/AUD)

There has been no real direction in this pair over the past week with trading broadly contained between 0.6890 and 0.6920 (1.4450 - 1.4515). We did get a brief dip to 0.6868 (1.4560) in the wake of last Thursdays Australian employment data, but the pair quickly recovered. The fragile Eurozone recovery has kept the Euro subdued, while the AUD itself has mostly treaded water over the past week. We have the RBA minutes to digest in the coming hours and this could see some action, but markets in general have been pretty quiet lately, in part due to European summer holidays. ECB President Draghi is due to speak tonight and we also get the latest reading of German economic sentiment. This will be followed later in the week by inflation data. The broader trend for this pair is to the AUD topside and that will remain the case while the market holds above support around 0.6860 (resistance 1.4580).

AUD/YEN

This pair was trading in a very tight range around 95.50 up until last Thursday when a couple of factors drove the pair lower. The first was Australian employment data that was a little disappointing with a big swing away from full time work. But the move extended to the down side later that evening when concerns about a Portuguese Bank default cause a wave of risk aversion to sweep through the market. The AUD was sold and the Yen got bought at the same time, which eventually saw the low of 94.73 trade. The markets fear quickly abated and since then the pair has slowly recovered, but it does go to show that even in this low volatility environment the market is a little jittery. Today’s RBA minutes will be closely watched and later in the week we have Australian business confidence. We also have the Bank of Japan monetary policy statement this afternoon, although that shouldn’t contain any real surprises.

AUD/CAD

Weakness in the Canadian dollar has been the main driver of this pair over the course of the week. Some mixed data early last week had little impact but Friday’s disappointing employment result saw the CAD lose significant ground. The pair broke back above 1.0050 in the wake of that release and has stayed above that level since. The Australian dollar saw some volatility around its own employment data on Thursday, but generally the local currency has been subdued for much of the past week. We do have the RBA minutes to digest in the coming hours and later in the week we get business confidence. From Canada there is also plenty to digest over the coming days with manufacturing sales, inflation, wholesales sales, and the Bank of Canada rate meeting all set for release.

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Market commentary:

There has been a distinct lack of direction seen across most markets throughout the last week. Not even the threat of financial stability issues in Europe, or ongoing geopolitical risks in Eastern Europe and the Middle East were enough to provide direction. The core focus for the foreign exchange markets remains the US Federal Reserve, and the timing of their exit from the current emergency cash rate settings. Whilst no move is expected for a calendar year at least from now, the repercussions will be widely felt before then. Last week’s mixed messages from the regional Fed members make the testimony from Fed Chair Janet Yellen later on today, all the more interesting. From an Australasian perspective, an early start to the hiking cycle would finally provide some solid pressure on the Australian and New Zealand dollars, albeit this has been a long time coming. Nothing is clear on the exit of this unprecedented policy settling. However, it seems we are likely to see further periods of sideways price action ahead of volatility that will surely come at some point. As the months pass, the detail of the economic data will become more important. In the meantime, the Australasian duo remain in demand, with the Christchurch rebuild continuing to provide an additional ongoing boost to the New Zealand dollar.

Australia

The two key releases last week from Australia were business confidence and employment. The business confidence number was positive improving from last month's reading, but the employment data wasn’t so flash. A big drop in full time and a big rise in part time work meant the report wasn’t as promising as the +15.9k headline suggested. The unemployment rate also ticked up to 6.0% from 5.9% previously. RBA Governor Stevens has suggested a number of times over recent weeks that some investors are underestimating the risks of a material fall in the Australian dollar at some stage and he was on the wires again late last week make the same point. The RBA release the minutes from their latest meeting this afternoon although they shouldn’t contain any real surprises. The central bank is firmly ‘on hold’ and will most likely stay that way into next year.

New Zealand

Last week’s Quarterly Survey of Business Opinion (QSBO) saw the index pull back from the very high levels registered earlier in the year. This pullback is in line with other business confidence indicators and also commodity prices, the most important of which is dairy. Tonight we have another Global Dairy Trade auction and it will draw a lot of attention as prices have already pulled back around 30% from their peak. This has resulted in many forecasters revising down their expected pay-out for the 2014/2015 season, and another decline could see a further moderation of expectations. The one thing that hasn’t been affected by the falling dairy prices is the level of the New Zealand dollar. How long the currency can continue to ignore such a significant pullback in the price of NZ’s major export remains to be seen. Also this week we get the latest reading on inflation and this could be a significant release with the RBNZ meeting coming up next week. The majority of forecasters expect another hike by the central bank and that is certainly the most likely scenario at this stage. But there are plenty of reasons to suggest a pause in the tightening cycle may not be far away, and a soft inflation figure tomorrow would certainly add to those. The RBNZ will have been happy to see yesterday’s real estate data that showed median prices falling in Auckland and volumes sagging across the country. The combination of LVR’s and higher interest rates are certainly having the desired impact on the property market.

United States

Last week’s release of the Fed meeting minutes provided little new insight into the thinking at the central bank and if anything were a little less ‘hawkish’ than the market had hoped for. Readings from the employment market continue to signal strength with JOLTS job opening data and weekly unemployment claims both beating expectations last week. However, the US dollar remains firmly on the back foot and with little to show for the improving data. Long-time Fed watcher / reporter Jon Hilsenrath suggested in a weekend article that debate is intensifying among the Fed’s regional presidents about whether to push rates up from zero sooner than planned. This was backed up by comments from the Fed Plosser who said the Fed is closer to a rate increase than many think and waiting too long could cause a ‘bumpy ride’. On the other side of the coin however, both the Fed’s Lockhart and Evans were quoted over the weekend say they would be comfortable letting inflation overshoot the 2% target before hiking. It is extremely unlikely Janet Yellen will even acknowledge that debate when she testifies in front of the Senate Banking Committee on Wednesday. Along with her testimony this week we have retail sales data, producer prices, building permits and consumer sentiment figures.

Europe

Last week saw mostly soft data from the Eurozone. Industrial production data from Germany, France and Italy all disappointed with negative readings and this was reflected in the broader Eurozone figure released last night which came in at -1.1%. This is a significant fall from the prior month's reading of +0.7%. The only bright spot last week was German trade balance which did much better than forecast. The +18.8bln surplus was well above expectations for +15.7bln and is the highest reading since last October. This was a pleasing result considering German retail sales, manufacturing and employment all weakened in May raising concerns about the ability of the Eurozone to generate growth going forward. The fragile nature of the region’s economic recovery was highlighted by the, albeit short lived, turmoil in financial markets on the back of a Portuguese banking scare. Germany's Andrea Merkel summed it up nicely over the weekend when she said “The example of a Portuguese bank showed us in the last few days how quickly the so called markets are roiled, how quickly uncertainty returns and how fragile the whole euro construction still is”. ECB President Draghi is set to speak tonight and we also get a reading on German economic sentiment. Later in the week Eurozone trade balance and inflation data will draw focus.

United Kingdom

For the most part data from the UK last week had no material impact on the current economic outlook, or the value of the GBP. The market took weaker readings from manufacturing and industrial production in its stride as they haven’t affected the broader picture at all. The Bank of England (BOE) held their rate meeting and as widely expected made no policy adjustments. The GBP eventually saw a small amount of weakness after Friday’s construction output data also disappointed coming in at -1.1% vs expectations of +0.8%. This week should prove more interesting with the key readings of inflation and employment set for release. The inflation data is out tonight and the market is expecting a small uptick from 1.5% to 1.6%. Thursday’s employment figures are also forecast to be decent with a fall in unemployment claims of -27.1k and the unemployment rate ticking down to 6.5%.

Japan

Recent data from Japan is starting to raise questions about the economy's ability to recover from the impact of April's sales tax hike. Core machinery orders data last week was shocking coming in at -19.5% vs +0.9% expected. That’s the largest decline on record and it was followed up by a disappointing reading from the Tertiary Industry Activity index. Economic sentiment is also struggling to recover and recent report stated that a new tax free savings plan introduced in January has been poorly received by the Japanese. Clearly there is plenty of work still to be done on the economic front and the BOJ will likely reiterate their commitment to maintain current policy settings until the 2% inflation target is reached at their meeting today.

Canada

The Canadian dollar came under some pressure last week on the back of some disappointing data. We did see better than expected readings from building permits and housing starts, but these were completely outweighed by soft results from the Ivey PMI and employment change. The Ivey Purchasing Managers Index fell to 46.9 from a previous reading of 48.2. Expectations had been for an improvement to 51.3. This was followed on Friday by employment change which printed at -9.4k vs forecasts for +20.7k. The unemployment rate also ticked up to 7.1%. Looking into the detail of the report provided some relief with gain in full-time employment of +33.5k offset by a fall in part-time employment of 43k, but the damage had already been done to the CAD which ended up being one of the worst performers on the week. There is plenty of data to digest over the coming days with manufacturing sales, inflation, wholesales sales, and the Bank of Canada rate meeting all set for release.

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