G20 mindful of excessive risk build up in low interest rate and volatility environment; current conditions means risk in many markets is mispriced

By Ian Dobbs*:

After the United Kingdom dodged a bullet with the Scottish ‘no’ vote for independence the market turned its attention to the weekend’s G20 meeting. As usual there were a lot of sound bites, comments and quotes published, but nothing of real significance.

The communique mentions stronger economic conditions in some key economies, but says growth in the global economy remains uneven and below the pace required to adequately generate jobs. It also stated that the G20 were mindful of the potential for a build-up of excessive risk in the financial markets, particularly in an environment of low interest rates and low asset price volatility. This is an important point. The relative calm of the past year in financial markets is unlikely to last.

We are now entering a period where interest rate normalisation is on the horizon for many countries and this has the potential to create more than a few ripples across various asset classes.

Low rates, low volatility and quantitative easing policies have led to the mispricing of risk in many markets. As rates begin to rise the risk of disorderly moves will increase dramatically and it seems unlikely the normalisation process will all be smooth sailing.

Major Announcements last week:

• UK CPI 1.5% as expected

• Canadian Manufacturing Sales 2.5% vs 1.1% expected

• US PPI 0.0% vs 0.1% expected

• NZ GDT auction 0.0%

• NZ Current Account -1.07b vs -1.04b expected

• UK Average Earnings 0.6% vs 0.5% expected

• UK Claimant Count -37.2k vs -29.7k expected

• BOE minutes 2-7 vote to keep rates unchanged

• US CPI -0.2% vs 0.1% expected

• NZ GDP 0.7% vs 0.6% expected

• GBP Retail Sales 0.4% as expected

• EUR TLTRO 82.6b vs 150b expected

• Scottish Independence Vote “No”

• Canadian Core CPI 0.5% vs 0.2% expected

NZD/USD

Last Thursday’s FOMC statement caused a wave of US dollar buying and this helped to drive the New Zealand dollar down to recent cycle lows at 0.8079. Since then we have seen a small recovery and consolidation that has seen the pair trade up as high as 0.8177. However, this hasn’t impacted the broader downtrend that has been in play since mid-July and current risks remain skewed to further weakness. It would take a move back above 0.8200 to suggest a broader recovery might be unfolding, and until then we can expect further pressure with the target on the psychological level of 0.8000. This week is a quiet one for data from New Zealand, with only the trade balance of any note. While from the US we have new home sales, durable goods orders and weekly unemployment claims to digest.

NZD/AUD (AUD/NZD)

The New Zealand dollar has continued its correction higher against the Australian dollar over the past week and recently tested resistance around 0.9150 (support around 1.0929). Last week’s better than expected GDP data from NZ helped, as did a market friendly general election result over the weekend. But the AUD has also seen pressure recently from a negative report by Roubini Economics and further concerns about growth in China. The 0.9150 (1.0929) area should provide a tough barrier for the pair to overcome and selling current levels is recommended for those looking to purchase Australian dollars. I expect to see the pair eventually turn back down and head sub 0.9000 (over 1.1111) again over the coming weeks. The economic calendar is light from both countries this week with only the trade balance from NZ and the financial stability review and a speech by Governor Stevens from Australia.

NZD/GBP (GBP/NZD)

Price action in this pair over the past week has been dominated by movements in the value of the UK Pound in the lead up to, and during, the Scottish independence referendum. When results started to come in on Friday the GBP surged in value as it looked increasingly likely that Scotland would not vote to go their own way. This drove the cross to the NZD down to a low of 0.4918 (high of 2.0333). But this move was short lived and by the time the result was confirmed the GBP had given back much of its gains. A lot of this price action is due to speculative short term positions that were betting on a ‘no’ result and they quickly took profit as the GBP strengthened. Now that those positions will have largely been cleared out, the ‘real money’ flows should start to come back into the GBP. I expect these flows to cause grinding appreciation in the value of the GBP over the coming months as we get closer and closer to the first rate hike in the UK. Resistance around 0.5000 (support around 2.0000) looks like providing decent barrier on the topside and selling ahead of that level is recommended for those looking to purchase GBP’s. Those looking to sell GBP’s and purchase NZD’s should target the 0.4900 (2.0408) level in the near term. Further out a move toward 0.4750 (2.1053) is likely, but that could be a few months away yet. From NZ this week we just have the trade balance data on Wednesday, while from the UK we have mortgage approvals, public sector net borrowing, the house price index and CBI realized sales all set for release.

 NZD/CAD

The Canadian dollar was a strong performer last week helped by largely supportive data. Of particular note were the strong readings from manufacturing sales and inflation figures and these helped the CAD continue to outperform the New Zealand dollar. The pair traded down to a low of 0.8886 heading into the weekend and the NZ general election. The outcome of that election gave the NZD a small boost in the early stages of this week and this has combined with some ‘dovish’ comments from the BOC deputy last night to see the cross recover back up toward 0.8980. The pair could trade as high as 0.9050 without threatening the broader downtrend that has been in play for much of the past five weeks. There is little in the way of data from NZ this week with only the trade balance out tomorrow. Things don’t look much better from Canada with only retail sales tonight of any note.

NZD/EURO (EURO/NZD)

The past week has seen largely directionless trade for this pairing. We did see a small bout of strength early on Monday as the New Zealand dollar gained some ground after the election result, but the impact was only short lived. The pair has now fallen back into the middle of the week’s range and further sideways trade is expected.  This week is a quiet one for data from New Zealand with only the trade balance of any note. While from Europe we get manufacturing and service sector PMI’s along with the German IFO business climate index. Minor support toward 0.6280 (resistance around 1.5924) looks likely to contain the NZD down side in the near term.

 NZD/YEN

The Japanese Yen has been under pressure for much of the past five weeks and this has helped the cross to the New Zealand dollar make significant gains. The pair touched a recent high of 89.05 in early Monday morning trade as the NZD received a small boost from the market friendly general election result. We have seen a healthy pullback from those highs but as long as support around 88.00 isn’t compromised the risks remain skewed to further gains. There is little in the way of data from NZ this week with only the trade balance out tomorrow. While from Japan inflation data on Friday will draw focus.

AUD/USD

The Australian dollar has seen continued pressure from the USD over the past week and currently trades close to cycle lows at 0.8875. US dollar strength was seen in the wake of last Thursday’s FOMC statement, but recent losses have come on the back of AUD weakness. A negative report from Roubini Economics and further concerns about the Chinese growth have both weighted on the local currency. There is some support around 0.8850 however, and while the market holds above there potential for a corrective bounce exists. The market has seen a significant sell off from the 0.9400 level that was trading less than three weeks ago and it looks like downside momentum could be starting to wane. If we do get a significant break of support around 0.8850 the market will quickly turn its attention to the 2014 low of 0.8658. The economic calendar is pretty light from Australia this week with the financial stability review and a speech by RBA Governor Stevens the main highlights. From the US we have new home sales, durable goods orders and weekly unemployment claims to digest.

AUD/GBP (GBP/AUD)                            

The Australian dollar has seen relentless pressure from the UK Pound this week and currently trades close to the weeks low. The AUD did see a significant bounce on Friday afternoon driven by profit taking in the GBP as the Scottish referendum result became increasingly clear, but those gains didn’t last. Recent weakness in the AUD on the back of a negative report from Roubini Economics has again seen the pair under pressure and threatening to test 0.5400 (resistance 1.8519). For now the risk are still skewed to the AUD downside with the GBP expected to show grinding appreciation now that Scottish independence is off the table. The economic calendar is pretty light from Australia this week with the financial stability review and a speech by RBA Governor Stevens the main highlights. While from the UK we have mortgage approvals, public sector net borrowing, the house price index and CBI realized sales all set for release.

AUD/EURO (EURO/AUD)

Weakness in the Australian dollar has been the main driver of this pair over the past week. In the past 24 hours a negative report from Roubini Economics has weighed on the AUD further and this has seen the pair trade down just under 0.6900 (over 1.4493). For the time being the risks are skewed to further weakness and only a quick recovery back above 0.6930 (below 1.4430) will negate this. The economic calendar is pretty light from Australia this week with the financial stability review and a speech by RBA Governor Stevens the main highlights. While from Europe we get manufacturing and service sector PMI’s along with the German IFO business climate index.

AUD/YEN

Both the Australian dollar and Japanese Yen have seen periods of pressure this past week which have resulted in some decent swings in the cross. Support around 96.40 has been tested on four separate occasions over the past month and so far it has held firm. The pair looks like is it once again trying to stage a bounce from that level after testing it a couple of hours ago. A break below there would certainly be a negative signal, but until that happens the risk remain for a recovery back up over 97.00. The economic calendar is pretty light from Australia this week with the financial stability review and a speech by RBA Governor Stevens the main highlights. From Japan we just have inflation data on Friday to draw focus.

AUD/CAD

The Canadian dollar was a strong performer last week helped by largely supportive data. Of particular note were the strong readings from manufacturing sales and inflation figures and these helped the CAD continue to outperform the Australian dollar. The pair traded down to a low of 0.9743, before seeing a small bounce in the past 24 hours. The broader downtrend is still in play, as long as resistance around 0.9840 contains this near term strength. A move above that level would warn a much bigger correction higher is under way which would target 0.9950 initially. The economic calendar is pretty light from Australia this week with the financial stability review and a speech by RBA Governor Stevens the main highlights. While from Canada we just have retails sales data tonight to digest.

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Market commentary:

After the United Kingdom dodged a bullet with the Scottish ‘no’ vote for independence the market turned its attention to the weekend’s G20 meeting. As usual there were a lot of sound bites, comments and quotes published, but nothing of real significance. The communique mentions stronger economic conditions in some key economies, but says growth in the global economy remains uneven and below the pace required to adequately generate jobs. It also stated that the G20 were mindful of the potential for a build-up of excessive risk in the financial markets, particularly in an environment of low interest rates and low asset price volatility. This is an important point. The relative calm of the past year in financial markets is unlikely to last. We are now entering a period where interest rate normalisation is on the horizon for many countries and this has the potential to create more than a few ripples across various asset classes. Low rates, low volatility and quantitative easing policies have led to the mispricing of risk in many markets. As rates begin to rise the risk of disorderly moves will increase dramatically and it seems unlikely the normalisation process will all be smooth sailing.

Australia

There has been little in the way of economic releases from Australia since last Tuesday’s RBA minutes. The Australian dollar has been under some pressure this week thanks to a report from Roubini Economics that predicted the currency would fall to 0.7500 against the USD. They believe slower Chinese growth will be a big headwind for the Australian economy in 2015, that this will see GDP dip to 2% and that the RBA will cut rates again. That is certainly a very bearish view. There is little doubt however, that 2015 will see lower growth in China, and there is the risk it could be a lot worse than that. The huge amount of debt created in the Chinese economy of the past few years has been a point of concern for many China observers. If things start to unravel, it will be led by a major correction in their housing market. This is why a recent report in the Chinese press has raised eyebrows. The report says that in Handan, a third-tier city in Hebei province, a full-scale housing collapse is under way and that it will take 10 years to digest the current housing inventory. It seems unlikely Handan will be the only city to suffer such a result. Tomorrow we have the RBA financial stability review, and on Thursday Governor Stevens is set to speak.

New Zealand

The New Zealand dollar started this week on a slightly firmer footing, thanks in part to the market friendly election outcome. Last week’s stabilisation in dairy prices and the better than forecast GDP result have also helped improve sentiment toward the currency. There is little scheduled for release this week with only the trade balance on Wednesday of any note. Yesterday we did get the Westpac Consumer Sentiment index which saw a pull back to 116.7 from 121.2 previously. This is a quarterly survey and although it did decline somewhat current levels are still very healthy.

United States

The main focus in the US last week was the FOMC rate statement on Thursday. The market took the statement to be a touch more ‘hawkish’ than previously and as such it was supportive of the USD. However, much of the other data out over the week was not quite as supportive, with a number of key releases coming in below expectation. Inflation, industrial production, building permits and housing starts all disappointed somewhat and these have helped to limit the recent USD gains. We can add existing home sales to that list after it also came in below forecast when it was released last night. We have a number of Fed speakers this week to draw focus. The Fed’s Fisher was quoted late last week as saying he wants to see the first move on interest rates in the Spring of 2015. He is however, one of the more “hawkish” members of the FOMC. A speech by William Dudley last night was probably more reflective of the FOMC current view. He said that the economy needs to run a little hot given that inflation is tame due to economic slack, subdued expectations, and weak growth abroad. He added that rate rise guidance will be driven by economic data, although it will make him happy to see rates go up in 2015. Data wise this week the highlights will be new home sales, durable goods orders and weekly unemployment claims.

Europe

We saw a mixed bag of data from Europe last week. Economic sentiment in Germany improved, but declined overall in the Eurozone. The final reading of inflation came at 0.4%, which is a touch better than the 0.3% forecast, but the take-up of the ECB’s first targeted LTRO was much lower than expected. This raises a number of questions about loan demand in the region. ECB President Draghi spoke last night to parliamentarians in Brussels and he offered a somewhat gloomy view of the Eurozone’s economic prospects. He said economic risks are clearly on the downside with unemployment remaining unacceptably high. He reaffirmed monetary policy will be expansionary for a long time and added the ECB’s efforts will fall flat if governments fail to make far reaching reforms to their economies. He also said the results from last weeks targeted LTRO should be taken in conjunction with the next offering which is in December. We get manufacturing and service sector PMI’s over the coming days along with the German IFO business climate index.

United Kingdom

Attention in the UK last week was dominated by the Scottish independence referendum. That provided such a big one-off risk event that all other data was side-lined with the market squarely focused on the outcome of the vote. In the end is seems fear of the economic consequences of a split swayed many votes and common sense reigned. The GBP rallied hard as the results started to come in, but by the time the outcome looked assured it had given back much of those gains thanks to profit taking by short term traders. With the referendum out of the way and the market ‘noise’ around the event now gone, the focus will turn back to prospects for a rate hike in early to mid-2015. Recent data has been supportive with an uptick in core inflation, better than forecast employment and solid retail sales figures all suggesting pressure will only build within the Monetary Policy Committee to signal rate hikes are on their way. This should see the GBP slowly start to appreciate as trend over the coming months. Data this week is mostly a second tier affair, with mortgage approvals, public sector net borrowing, the house price index and CBI realized sales all set for release.

Japan

There hasn’t been much in the way of data released from Japan over past week, although there have been a couple of significant announcements. The first was from the Japanese Cabinet Office who released their September Economic assessment on Friday afternoon. They downgraded their assessment for the first time in five months sighting weak consumption. The added that improvements in corporate profits appear to be pausing with firms cautious about current business conditions. The other significant announcement came from Japan’s economy minister Amari. He signalled the second tax hike will go ahead, saying it was necessary to meet rising costs for social security and prevent a collapse in confidence of Japan’s ability to rein in its vast budget deficit. The Yen has weakened dramatically over the past month and this is starting to get the attention of officials who suggest rapid moves in the exchange rate are unhelpful. The former BOJ deputy Governor Iwata said the weak Yen puts Japan at risk of recession. Rising import costs are squeezing corporate profit margins and eroding consumer capacity to spend. This week we have inflation data to draw focus on Friday.

Canada

The Canadian dollar has been a strong performer recently and last week’s data was very supportive for the most part. The only disappointing data was wholesale sales that came in on the soft side, but other releases on the week in the form of manufacturing sales and inflation, were both much stronger than forecast. Last night we did see some slightly ‘dovish’ comments from Bank of Canada (BOC) Deputy Wilkins. She said the neutral interest rate was lower than before the crisis and that Canada may need loose policy even at full capacity. Tonight we have retail sales data to digest which is the only release of note on an otherwise empty economic calendar.

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