Fed and BOE steering towards normalisation of monetary policy while ECB and BoJ moving in other direction to combat inflation

By Ian Dobbs*:

It has been a long time coming, but divergence between the major economies and the corresponding central bank policies looks to be almost upon us.

Whilst last weekend’s central bank symposium at Jackson Hole was a mostly dull after, its seems likely that the US Federal Reserve (Fed) and the Bank of England (BOE) will have divergent monetary policy changes from the European Central Bank (ECB) and Bank of Japan (BOJ) in 2015.

With the Fed and the BOE steering towards slight normalisation of monetary policy at some stage in 2015, the ECB and BOJ are pointing in the other direction as they look to starve off the prospects of deflationary pressures.

With interest rates providing fundamental drivers for the foreign exchange market overtime, these influences are likely maintain the spotlight in the coming years.

The obvious implications for the Australasian currencies are the move lower as interest rate differentials close up, albeit we are not at that point yet.

Major Announcements last week:

·  UK CPI 1.6% vs expectation of 1.8%

·  US building permits 1.05m vs expectation of 1.00m

·  US inflation 0.1% as expected

·  Bank of England vote 7 - 2 to hold rates steady

·  Canadian wholesale sales +0.6% vs expectation of +0.4%

·  Chinese manufacturing PMI 50.3 vs 51.5 expected

·  French manufacturing PMI 46.5 vs 47.9 expected

·  German manufacturing PMI 52.0 vs 51.7 expected

·  UK retail sales +0.1% vs +0.4% expected

·  Canadian inflation -0.1% vs +0.1% expected

·  Canadian retail sales +1.5% vs 0.4% expected

NZD/USD

The New Zealand dollar maintained its downside bias last week, losing further ground to the USD. The most interesting price action came early yesterday morning when for no apparent reason the NZD fell half a cent in a few short minutes. Market conditions at the time were very thin with only the NZ banks providing liquidity and this no doubt exaggerated the move. However, of more interest is the complete lack of any recovery since then. This keeps all the focus on the downside and a test of 0.8300, and possible even 0.8200, could well eventuate in the near term. US data remains positive and although Fed Chair Janet Yellen seems very unconvinced about economic strength whenever she speaks, the USD certainly seems to be developing a trend of appreciation. Key data from the US this week includes durable goods orders, consumer confidence and GDP. While from NZ we still have building consents and business confidence to come.

NZD/AUD (AUD/NZD)

The New Zealand dollar has maintained its downside bias, although the majority of losses this week came in the space of a few minutes yesterday morning. In very thin market conditions on Monday morning the New Zealand dollar came under heavy selling pressure in the absence of any fundamental news. It seems a flow came to market that triggered the selling and there may well have been some stop loss orders against the AUD below 0.9000 (above 1.1111) which exaggerated the move. The pair now looks very likely to test the key support area of 0.8920 (resistance at 1.1211) in the near term. I expect that level to contain the NZD downside for now, and we should see a significant bounce. Those looking to sell NZD and buy AUD should take advantage of any such bounce as the tide has certainly turned on this pair and it is increasingly unlikely we will see levels over 0.9200 (under 1.0870) again. Resistance on the topside comes in around 0.9050 (support around 1.1050) and then again around 0.9150 (1.0929) and one of those two level is likely to cap any potential bounce. From NZ this week we still have building consents and business confidence to come. While from Australia we have construction work done and private capital expenditure data to digest.

NZD/GBP (GBP/NZD)

Largely disappointing data from the UK last week was countered to a small degree by the BOE minutes that showed two members of the MPC voted for a rate hike. This helped the UK Pound outperform the New Zealand dollar that has been under intense pressure since the market opened here on Monday morning. Another test of the 0.5000 (2.0000) level looks likely in the near term with the New Zealand dollar downside still firmly in focus. Reaction at that level will be key with a sustained break below 0.5000 (above 2.0000) opening the way for a test of 0.4900 (2.0408) This week from the UK we  have mostly second tier data set for release in the form of mortgage approvals, CBI realized sales, the house price index and preliminary business investment. From NZ we just have building consents and business confidence data to digest over the coming days.

 NZD/CAD

Data from Canada late last week was overall supportive of the CAD. Better than forecast results from wholesale and retail sales, outweighed the small fall in inflation that was seen. These results saw the CAD start to outperform the NZD and that trend continued in early Monday morning trade as the local currency came under heavy selling pressure. There was no fundamental news to drive the move in the NZD and thin market conditions didn’t help. But a telling signal was the NZD’s failure to recover. The currency is still under pressure and that may well drive this pair to test levels toward 0.9100 with the risks still all skewed to the downside. Later this week from Canada we get current account and GDP data, while from NZ we have building consents and business confidence data to digest.

NZD/EURO (EURO/NZD)

Both the Euro and the New Zealand dollar have seen periods of pressure over the past week, although it is the NZD that has dramatically underperformed in the past 30 hours. The local currency was thumped lower in early Monday morning trade yesterday and the failure to show any significant recovery has only encouraging further selling. The risks are all still skewed to the downside. There is some support for the pair just below 0.6300 (resistance above 1.5873) and it looks likely that will be tested in the near term. If we do get a bounce in NZD demand from that level it will run into resistance toward 0.6360 (support toward 1.5723) and I expect that to cap any potential NZD strength for now. From NZ this week we just have building consents and business confidence data to digest. While from Europe we get German unemployment and retail sales, along with Eurozone inflation and unemployment.

 NZD/YEN

The New Zealand dollar saw grinding appreciation against the Yen for much of the past week. That all changed yesterday however, when in early Monday morning trade as the local currency came under heavy selling pressure. A lack of liquidity was certainly a factor in the sharp drop for the NZD, but a telling signal was its failure to recover. This keeps all the focus on the downside for the pair with the NZD under pressure again as I write. We can expect further investigations toward 86.00 in the near term as the local currency should continue to underperform. The data focus for Japan this week is centred on Friday when we get have a raft of releases. These include household spending, inflation, industrial production and retail sales. While from NZ this week we just have building consents and business confidence data to digest.

AUD/USD

Although the Australian dollar lost a little ground to the USD this week it was still one of the better performing currencies. A bout of USD strength saw the pair dip down to a low of 0.9242, but the AUD quickly recovered. Further tests lower are likely as the USD continues to appreciate, however there is plenty of support around 0.9200 which has contained any downside price action since late March. Until that level broken we can expect the pair to continue to range between 0.9200 and 0.9400. Later this week from Australia we get construction work done and private capital expenditure data. While from the US we have the key releases of durable goods orders, consumer confidence and GDP.

AUD/GBP (GBP/AUD)                            

For much of last week the Australian dollar was one of the best performing currencies only losing a little ground to the USD, while all others saw much bigger declines. This helped to drive a number of AUD crosses higher and against the GBP was no exception. Softer than expected UK inflation and retail sales data didn’t help either, although the market was happy to see a split in voting at the MPC when the Bank of England minutes were released. Unfortunately for the AUD this week hasn’t started off so positively with the local currency coming under some pressure in the past 24 hours. There has been no fundamental news to drive this recent bout of AUD weakness and it may just be that resistance between 0.5600 and 0.5630 (support 1.7857 and 1.7762) is proving to tough for the pair to overcome. For a domestic Australian lead we have to wait until tomorrow to get construction work done data, and then on Thursday we get private capital expenditure figures. From the UK this week we have mostly second tier data set for release in the form of mortgage approvals, CBI realized sales, the house price index and preliminary business investment.

AUD/EURO (EURO/AUD)

The Australian dollar completely outperformed the Euro last week which drove the cross to its 0.7067 high (low 1.4150). Data out of Europe continues to disappoint and this is seeing the EUR remain under pressure. ECB president Mario Draghi also signalled the central banks willingness to undertake QE when he spoke over the weekend and this weakened the EUR further. However we have seen something of a correction lower at this start of this week as the pair has pulled back from those recent highs. This correction could see the pair fall as low as 0.7000 (rally up to 1.4285) without threatening the overall Australian dollar uptrend. Later this week from Australia we get construction work done and private capital expenditure data. While from Europe we get German unemployment and retail sales, along with Eurozone inflation and unemployment.

AUD/YEN

All currencies lost ground to the USD last week, but the Australian dollar managed to hang in better than most. As such the AUD appreciated on most cross rate and against the Yen was no exception. The pair continued its march higher trading up to 97.22 early yesterday morning. The break above resistance at 96.50 is significant and that level now provides initial support on the downside.  However, in the past 24 hours we have seen something of a correction lower and this could happily extend to the 96.00 area without threatening the overall uptrend. Later this week from Australia we get construction work done and private capital expenditure data. While from Japan we have to wait until Friday when household spending, inflation, industrial production and retail sales data is all released.

AUD/CAD

The Australian dollar has seen a gradual appreciation against the Canadian dollar this week. The AUD was actually a standout performer last week making gains on most crosses, but gains against the CAD were somewhat limited due to some relative CAD strength as well. This came as both wholesale sales and retail sales in Canada came in significantly above expectation. These results outweighed the negative impact of slightly weaker Canadian inflation data released on Friday. There is resistance on the topside toward 1.0240 and this should cap AUD strength in the near term. Later this week from Australia we get construction work done and private capital expenditure data, while from Canada we have current account and GDP data do digest.

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Market commentary:

It has been a long time coming, but divergence between the major economies and the corresponding central bank policies looks to be almost upon us. Whilst last weekend’s central bank symposium at Jackson Hole was a mostly dull after, its seems likely that the US Federal Reserve (Fed) and the Bank of England (BOE) will have divergent monetary policy changes from the European Central Bank (ECB) and Bank of Japan (BOJ) in 2015. With the Fed and the BOE steering towards slight normalisation of monetary policy at some stage in 2015, the ECB and BOJ are pointing in the other direction as they look to starve of the prospects of deflationary pressures. With interest rates providing fundamental drivers for the foreign exchange market overtime, these influences are likely maintain the spotlight in the coming years. The obvious implications for the Australasian currencies are the move lower as interest rate differentials close up, albeit we are not at that point yet.

Australia

When RBA Governor Stevens spoke last week he seemed to downplay the chance of any further monetary policy easing’s. He highlighted the limitations of monetary policy in fine tuning economic outcomes over short periods and said rate cuts are not the answer to rising unemployment. Those issues need to tackled by government policy and it certainly seems that barring a big shock of some sort, the RBA will be on hold of the foreseeable future. It may have been that the governor taking rate cuts off the table helped the Australian dollar to be one of the best performers last week. While it did lose a little ground to the USD, it didn’t lose anywhere near as much as other currencies and as such the AUD gained on many crosses. The focus the week will be on private capital expenditure figures released Thursday. Ahead of that we also get construction work done data on Wednesday.

New Zealand

Last week saw a couple of releases that helped to push the New Zealand dollar lower. Producer prices came in very weak and inflation expectations also declined. These kept pressure on the NZD and then early yesterday morning, in thin market conditions, the currency lost half a cent to the US in complete absence of any news flow. There has been some speculation that maybe the RBNZ intervened, but that seems very unlikely. If they weren’t selling at 0.8700 and 0.8800 why would they be selling at 0.8400 when the NZD is already going the way they want it to? It’s more likely just a flow that has come into the market at the worst time of the week and perhaps triggered stops in the NZDAUD below 0.9000 (buying AUDNZD 1.1110). The most interesting aspect of the price action is the complete failure of the currency to recover since. The NZ dollar downside remains the more vulnerable. In the last few hours we have seen trade balance data which showed a bigger than forecast deficit. A fall in exports was the driver lead by dairy and pine logs.

United States

I think it’s fair to say the market was left largely uninspired by Fed Chair Janet Yellen’s speech at Jackson Hole this past weekend. It was so balanced she almost said nothing. The USD has made some gains in the wake of the speech, but only because she wasn’t as ‘dovish’ as she could have been. She did say that faster progress towards the Fed’s goal may bring rate rises sooner, but that’s far from signalling any confidence in the matter. US data over past few weeks has for the most part been extremely positive. If a recent Reuters article is to be believed, pressure is building within the Fed for officials to clearly acknowledge improvements in the economy and lay the groundwork for the first interest rate hike in a very long time. History has shown that holding rates too low for too long only creates bigger problems down the road and the time has come for Yellen to jump off the fence and lead from the front. We get further key pieces of the economic puzzle this week with the release of durable goods orders, consumer confidence and GDP.

Europe

ECB President Mario Draghi gave a speech this past weekend at the Jackson Hole symposium that could mark a real turning point for how Europe deals with its very lacklustre recovery. Draghi drew focus to declining inflation expectations and said the central bank “stands ready to adjust our policy stance further”. Some sort of quantitative easing could well be on the cards for Europe over the coming months, but in his speech Draghi highlighted the need for action on both supply and demand side policies. He clearly highlighted the need for fiscal policy changes to help boost demand. Fiscal policy is the domain of governments, and it seems even Draghi is now urging Europe to move away from the German imposed ‘austerity policies’ to something more growth friendly. Support for the idea was immediately seen from the French economy minister who on Sunday said the time has come for France to resist Germany’s “obsession” with austerity and promote alternative policies across the Eurozone that support household consumption. With the ECB now clearly in their corner the rest of Europe could unite and force a back down from Germany over near term deficit reduction. This could only be positive for Europe's economic outlook. Last night’s release of the German Ifo business climate index saw a weaker than expected result as the index moderated further from the peak set earlier in the year. Still to come this week we get German unemployment and retail sales. While from the Eurozone as a whole we have inflation and unemployment to draw focus.

United Kingdom

The minutes from the Bank of England’s (BOE) most recent meeting were released last week and they showed that two of the nine monetary policy committee (MPC) members actually voted for a rate hike. This is the first split in the voting pattern seen for a long time and we may well see other members move across into the ‘hawkish’ camp over the coming months. Last week’s data won’t have helped that cause however, with inflation and retail sales both coming in somewhat softer than forecast. But the real hurdle holding Governor Carney and the others back from voting for a hike is the lack of wage growth in the economy. Carney believes low wage growth is an indicator of ‘slack’ or ‘spare capacity’ in the economy and therefore the economy can be allowed to grow at a faster rate without creating inflation pressure. Trying to quantify spare capacity is extremely difficult at the best of times, and there could be other factors at play restraining wages. Growth in the UK is strong and there are now more people in employment than at any other time since records began in 1971. If Carney and co are wrong in their judgment of spare capacity, they could find themselves well behind the curve. This week sees only second tier data set for release in the form of mortgage approvals, CBI realized sales, the house price index and preliminary business investment.

Japan

The only data of note from Japan last week was the trade balance and manufacturing PMI. Although the trade balance came in below forecast we did see an improvement in exports which could be a positive sign going forward. Manufacturing PMI on the other hand did see an improvement over last month coming in above expectation at 52.4. BOJ Governor Kuroda spoke at the Jackson Hole symposium this weekend and he suggested that Japan was “halfway” to achieving its goal of price stability. He added the labour market is showing significant improvement, although wage growth was critical to reverse deflation. To reverse deflation there needs to be some kind of coordinated mechanism. He believes monetary policy still has power over the economy and accommodation will continue until price stability is seen. There is no data of note until Friday when a number of key releases hit the wires. These include household spending, inflation, industrial production and retail sales.

Canada

Last week saw some mixed data from Canada, but overall the impact on the currency was positive. Wholesale sales came in better than forecast at +0.6% and this was followed on Friday by a very strong reading for retail sales. They came in at +1.5% against expectation for +0.4%. This is also a big improvement over the previous reading of just +0.3%. That retail sales number completely outweighed the negative impact of inflation data that actually declined a touch. Core inflation was down 0.1% on the month vs expectations for +0.1%. Year on year for July inflation was 2.1% vs expectation of 2.2%. This won’t be of much concern for the central bank who are firmly on hold for the foreseeable future. Governor Poloz says the economy has “lots of room to grow” and we can expect interest rate to stay where they are well into 2015.

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