Markets wait for possible US downgrade and Euro continues to worry

By Sam Coxhead*:

In the US, an agreement has been reached to raise the debt ceiling.  It is expected to be passed into law on Monday. The primary issue now is whether or not the forecast budget cuts will be sufficient to placate the credit rating agencies and avoid a downgrade from the current AAA status. Adding to the uncertainty was Friday’s release of the advanced GDP numbers for the 2nd quarter. The 1.3% number was less than the market expectation of 1.8%, but even more alarming was the revision to the 1st quarter number, from 1.8% down to just .4%.

The European debt situation remains tenuous as well. Further credit downgrades for the Greek Government and bank entities have followed the bailout and in general the peripheral member costs of borrowing began to climb again.

In New Zealand the Reserve Bank (RBNZ) indicated that they would be removing the 50pts of emergency interest rate cuts in the near future.

In Australia, higher than expected inflation numbers have put the heat back on the Reserve Bank of Australia (RBA) and the market has reversed recent moves. The possibility of an interest rate hike by the RBA, to five percent in the cash rate at this week’s cash rate review, is now being contemplated by the markets.

In the UK, economic activity remains subdued as manufacturing and housing numbers remain mixed.

The Canadian economy has hit a soft patch, mirroring the slowdown in the US, with monthly GDP numbers showing a contraction. As Japan attempts to emerge from its natural disasters, the government has pledged another 25 billion in disaster relief.

Major Announcements last week:

· UK Preliminary GDP .2% vs .2% expected
· US CB Consumer Confidence 59.5 vs 57.1 expected
· US New Homes Sales 312k vs 321k expected
· NBNZ Business Confidence 47.6 vs 46.5 previous
· RBNZ leaves cash rate at 2.5% as expected
· Australian 2nd Quarter Inflation .9% vs .7% expected
· US Durable Goods Orders +.1% vs +.5% expected
· US Pending Home Sales 2.4% vs -1.5% expected
· Canadian Retail Sales +.5% vs +.2% expected
· Canadian GDP -.3% vs +.1% expected
· US Advanced GDP 1.3% vs 1.7% expected, but Q1 revised down from 1.8% to .4%
· Chinese PMI 50.7 vs 50.2 expected

NZD/USD 
The NZ dollar continued it appreciation against the US dollar last week. The debt ceiling debacle coupled with the clear message from the RBNZ that they would be removing the emergency 50pts of easing in the short term, has helped boost the NZD. The initial focus this week will be the debt ceiling situation playing out and the possible credit rating implications associated with it. Following from that, the employment numbers both in NZ and the US will be very closely watched. The NZ Labour Cost Index is on Tuesday morning and is followed by the employment numbers on Thursday. Friday sees the US employment numbers released. It is hard to put a topside target on the NZD at current levels. The elevated level of the NZD will have a material effect on the economic growth for New Zealand, in the second half of 2011, but given the current momentum, further appreciation cannot be ruled out.

NZD/AUD (AUD/NZD)
The NZ and Australian dollars traded a relatively small range over the past week. The higher than expected Australian inflation number pushed the NZD to the lows. Then came the RBNZ statement that they would be removing the 50pts of emergency easing in the coming months and the NZD recovered. This week sees the pair start at crucial levels. If the NZD can have a sustained push through current levels, it will open up the way for a move back towards more historically average levels. Tuesday sees the NZ Labour Cost Index for the 2nd quarter. Wednesday sees the RBA cash rate meeting which will likely see no change, but the statement will hold attention as usual. Wednesday sees Australian Retail Sales and Trade Balance numbers. The 2nd quarter NZ Employment numbers follow on Thursday, before the quarterly Australian Monetary Policy Statement on Friday. Medium term direction should be a little clearer by the end of the week, as the NZD attempts to push higher and break out of the recent range.

NZD/GBP (GBP/NZD)
The NZ dollar made further ground against the pound sterling last week. Whilst it again set new highs, its progress was harder fought and it was contained within the expected range. In the UK this week, we have various manufacturing, housing, construction and services data, along with the BOE cash rate announcement on Thursday. Expect no change from the BOE, and await the meeting minutes for further insight in two weeks time. In NZ the focus is labour orientated, with the labour cost Index on Tuesday and employment numbers on Thursday. Expect any further appreciation in the NZD to be harder to make from the current levels, close to all time highs.

 
NZD/CAD
The NZ dollar saw further appreciation against the CAD throughout last week. The bulk of the ground was made up in the US session on Friday, when the Canadian monthly GDP figure was released at -.3%, against an expectation of the +.1%. This coupled with the weaker US growth figures and it is easy to see why the way was opened for another move higher. The focus for both markets is employment data later this week. The NZ Labour Cost Index is due for release on Tuesday and employment numbers on Thursday. Canadian employment numbers come in on Friday to round out the week. If we end up seeing some kind of resurgence from the US dollar in the short term, this would be CAD positive.

NZD/RAND
The New Zealand dollar and the RAND traded within the expected range over the last week. There is potential for movement in the coming week, if we see an escalation of the striking in South Africa. In New Zealand we have the labour cost index on Tuesday and the employment numbers on Thursday. In the absence of an extreme number in each, expect the pair to remain in its recent range.

NZD/EURO (EURO/NZD)
The NZ dollar has set new record highs against the EUR, as risk assets rally in the wake of the agreement to raise the US debt ceiling. The EUR remains under pressure from the peripheral member debt situation, in what looks to be a long and bumpy road to travel. This coming week sees the NZ Labour Cost Index released on Tuesday, followed by the quarterly employment figures on Thursday. In Europe the ECB announce the cash rate on  Thursday and this is widely expected to be unchanged at 1.5%. Given the NZ dollars current momentum, we may see further progress higher from current levels.  In the short term, a general market switch towards risk aversion is the most likely chance of the EURO outperforming.

 
NZD/YEN (NZD/YEN)
Last week the NZ dollar saw fairly sideways movement against the YEN. Since the announcement of a debt ceiling agreement in the US, the NZD has appreciated strong. Growth assets have all rallied and the YEN is under a little pressure as a result. This week sees a mostly NZ focus, with the labour cost index on Tuesday, followed by the quarterly employment numbers on Thursday.  The Bank of Japan (BOJ) do meet to announce monetary policy on Friday, but no change is expected at this meeting. 

AUD/USD
The Australian dollar set new post float highs against the US dollar after the higher than expected Australian inflation number last week. Of course easing the path higher has been a weak US dollar, with the back drop of the debt ceiling debate and lower 1st and 2nd quarter GDP numbers. With the debt debate now seemingly moving to the background, the focus shifts to the upcoming releases. Tuesday sees the RBA cash rate review. Whilst the cash rate is expected to remain unchanged at this meeting, the accompanying statement will be very closely read. Along with the usual slurry of economic data in the US, of note will be the employment numbers on Friday. Expect further appreciation from here to be harder to make for the AUD, in the absence of a credit downgrade in the US. Obviously current levels represent great value buying of USD with AUD.

AUD/GBP (GBP/AUD)                            
The Australian dollar continued to appreciate against the pound sterling last week, to set another post float high. Stimulation for the move came from the higher than expected inflation number in Australia. This brings the RBA back into the equation, to deal with the inflationary pressure, with cash rate hikes. Both central banks hold cash rate announcements this week. The BOE are not expected to change their monetary policy, and we have to wait for two weeks until they release the meeting minutes, to learn more about their discussions. The RBA are also not expected to change the cash rate at this meeting, but the accompanying statement will be closely read, as will their quarterly Monetary Policy Statement due on Friday. Expect the pair to remain at these extreme levels, in the absence of general market risk aversion.

 
AUD/EURO (EURO/AUD)
The Australian dollar saw further appreciation over the EUR last week, to go close to the records highs seen over the new year period. The news continues to be difficult for the Euro-zone, with credit down grade’s continuing to flow for various government and bank entities of the peripheral states. This coming week sees quite a full economic calendar. European unemployment comes late on Monday, Australian building approvals and the RBA cash rate decision on Tuesday, Australian retail sales and trade balance numbers Wednesday, the ECB cash rate review and statement Thursday and the quarterly RBA Monetary Policy Statement on Friday. Expect no change from the RBA or ECB, but their respective statement will be closely watched for future direction, especially in the case of the RBA.

GBP/USD
The pound sterling outperformed the US dollar last week, as the US debt ceiling debacle and poor US GDP reading forced the US dollar slump. This week sees the usual full economic calendar from both sides of the Atlantic. But of focus will be the BOE cash rate decision on Thursday and the US employment numbers on Friday. No change is expected from the BOE at this meeting and the discussion of the committee will be reviewed in two weeks, when the meeting minutes are released. If we see further deterioration of US employment growth, expect the US dollar to come under renewed pressure. The credit rating agency reaction to the forecast budget cuts accompanying the US debt ceiling agreement will also be of major baring.

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GBP/EURO (EURO/GBP)
The pound sterling appreciated against the EUR last week, as the relief rally in the EUR following the agreement of the Greek bailout extension faded. This week sees a myriad of economic data due for release, covering the manufacturing, construction, housing and services sectors in the UK, along with the BOE cash rate meeting on Thursday. In Europe the focus starts with the unemployment numbers on Monday, retail sales Wednesday and the ECB cash rate decision on Thursday. Expect no change at both respective cash rate announcements. Of note last week was Asian central bank intervention to curb US dollar weakness. Often these US dollar purchases are diversified into EURO, and this may provide some EURO demand, through any weakness this week.

GBP/RAND
This pair saw mostly sideways trade over the last week, after the high was set early on in the piece. The union strikes in South Africa will be of concern for the South African economy, but given its status as a risk asset, it will probably benefit in the news that the debt ceiling has been raised in the US. In the UK, we have various construction, housing manufacturing and services numbers to absorb, as well as the BOE cash rate decision on Thursday. The BOE will most probably leave the cash rate unchanged at .5% at this meeting. Expect further sideways trade in the broader range to continue, in the absence of evidence of a change in monetary policy from either reserve bank.

Market commentary:

The waiting game continued through the course of the last week for the financial markets. The US debt ceiling debacle has been painful to watch as the various factions within both the Republican and Democrat parties vied for their two minutes in the spotlight. As a consequence of this process, the US dollar has been under pressure, especially from the Australasian currencies. The European debt situation remains tenuous as well. Further credit downgrades for the Greek Government and bank entities have followed the bailout and in general the peripheral member costs of borrowing began to climb again. In New Zealand the Reserve Bank (RBNZ) indicated that they would be removing the 50pts of emergency interest rate cuts in the near future. In Australia, higher than expected inflation numbers have put the heat back on the Reserve Bank of Australia (RBA) and the market has reversed recent moves. The possibility of an interest rate hike by the RBA, to five percent in the cash rate at this week’s cash rate review, is now being contemplated by the markets. In the UK, economic activity remains subdued as manufacturing and housing numbers remain mixed. The Canadian economy has hit a soft patch, mirroring the slowdown in the US, with monthly GDP numbers showing a contraction. As Japan attempts to emerge from its natural disasters, the government has pledged another 25 billion in disaster relief.

In the US, an agreement has been reached to raise the debt ceiling. It is expected to be passed into law on Monday. The primary issue now is whether or not the forecast budget cuts will be sufficient to placate the credit rating agencies and avoid a downgrade from the current AAA status. A credit down grade at the Federal level would have a meaningful impact across the US economy. JPMorgan analysts suggest that it would add 100 billion to the interest costs over the medium term. In addition to this, the higher borrowing costs will filter through to corporate and consumer funding. Adding to the uncertainty was Friday’s release of the advanced GDP numbers for the 2nd quarter. The 1.3% number was less than the market expectation of 1.8%, but even more alarming was the revision to the 1st quarter number, from 1.8% down to just .4%. The US economy is very slow, and this week’s employment numbers are unlikely to surprise to the upside, with the unemployment rate likely to remain at elevated levels.

The higher than expected inflationary pressure in Australia has helped the Australian dollar break through to new highs against the US dollar and Great British Pound. It was just a couple of weeks ago the Australian interest rate market was contemplating cash rate cuts. Now the bias has definitely moved towards a 25 pt hike to 5%, although no change is expected at this week’s cash rate review from the RBA. The picture should be more clear after this week, as we have the statement accompanying the cash rate decision on Tuesday. Also the quarterly Monetary Policy Statement is due for release on Friday, and will be closely watched. Current levels represent great value buying of various different currencies with Australian dollars.

In New Zealand the RBNZ has made it clear that the 50pts of emergency easing to the cash rate will be removed in the coming months. Additional hikes to the cash rate remain a possibility, but Governor Bollard will no doubt use the time to make assessments and probably not pre-commit. The exchange rate is at highs against the US dollar and Great British Pound, and this will be materially impacting the performance of the economy in the second half of 2011. With food and forestry commodity prices showing signs of fatigue, and the uncertain nature of the global recovery of late, any comments from Dr Bollard will be closely watched. This week is all about employment, with the labour cost index on Tuesday being followed by the employment growth numbers on Thursday.

The economy continues its patchy recovery in the UK. Preliminary GDP figure for the 2nd quarter showed a .2% growth rate, which was exactly as expected. House prices stablised for the month which is an encouraging sign. This coming week sees the release of the usual fodder of manufacturing, services and construction numbers, and the Bank of England (BOE) cash rate decision on Thursday. Expect no change to monetary policy from the BOE. As usual, we have to wait for another two weeks for the actual meeting minutes to be released, to find out if the dynamic has changed on the voting committee. For those holding GBP and looking to buy NZ or Australian dollars, further patience look’s to be required. Given the difference in yield, the time value of money is something that should be considered when thinking of transfers at current rates.

In Europe the last week was slightly less eventful than the previous few. The relief seen after the Greek bailout extension has been relatively short lived, as should have been expected. The long hard road for peripheral member economies is starting, and the credit rating agencies remained poised for further downgrades of both Government and bank debt. The only material scheduled release for the week, is the cash rate announcement from the European Central Bank (ECB). Expect no change from the current 1.5% cash rate.

In South Africa the “strike season” is in full swing, with mining and petroleum workers unions looking to ramp up pressure on employers. Unions have been demanding 10 - 15 percent pay increases, while inflations sits around 5%. In the gold mining sector alone an estimated 25 million USD a day is being lost in output. The coming week has little in the way of top tier economic data due for release, so direction is likely to be led by offshore moves and any developments with regards to the striking unions.
 

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Sam Coxhead is a currency analyst with DirectFX You can contact him here >>