Low growth, weak tax collections will see more currency volatility

By Sam Coxhead*:

The last week of trading in the financial markets has been some of the most turbulent since the start global financial crisis in 2008.

Violent moves have been seen in almost all markets as levels of liquidity (depth of market) slumped dramatically.

The perfect storm of lower global economic growth expectations, and therefore lower expected tax revenues, accentuating the issues being faced Governments laden with debt. The sequence of events that have unfolded over the last few weeks have seen somewhat extraordinary measures being taken up around the globe.

In the US a pledge from the Federal Reserve (FED) to maintain its super low monetary policy for another two years. In Europe the European Central Bank (ECB) entered the secondary bond market to buy Spanish and Italian government bonds to stem the markets push of the bond prices to record low levels. And the Swiss and Japanese authorities continue to take measures to curb the excessive strength of their safe haven currencies.

The week ended on a positive note with better than expected US retail sales numbers adding further to the bounce from the lows in growth assets. Early indications are that a further follow through from Fridays positive tone in the week coming. But given the multiple factors at play, and the interconnectivity of the global markets, expect periods of volatility to continue over the short term at least.

Major Announcements last week:

· Australian Home Loans 0.0% vs +.7% expected
· Chinese CPI 6.5% vs 6.4% expected
· UK Manufacturing Production -.4% vs +.3%
· US Fed- Fed Funds rate likely to remain at 0<.25% until 2013
· Chinese Trade Balance 31.5B vs 27.3B expected
· Australian Unemployment rate 5.1% vs 4.9% expected
· Canadian Trade Balance -1.6B vs -.9B expected
· US Trade Balance -53.1B vs 47.9B expected
· US Retail Sales +.5% vs +.2% expected
· US UoM Consumer Sentiment 54.9 vs 63.2 expected

NZD/USD 
The recovery towards the end of last week from the lows should mean that the panic selling of risk assets has passed for the time being. The prospect of a rising cash rate in the coming months should support the NZD in periods of softness. In the absence of top tier domestic data means the lead will come from the equity markets for the most part. The bulk of the meaningful US economic data comes towards the end of the week with inflation, home sales and manufacturing numbers due for release on Thursday and Friday. If initial resistance at .8420 is broken, the way will be opened up for a test of stronger resistance at .8500.

NZD/AUD (AUD/NZD)
The Australian and New Zealand dollars have established a new .7900 (1.2650) to .8100(1.2345) range over the last couple of weeks. This pair is primarily driven by the interest rate differentials and this makes the Reserve Bank of Australia cash rate meeting minutes on Tuesday the focus of the week. Currently the market has around 120pts of easing priced in from the RBA by the end of the year. If the minutes are more hawkish than expected the NZD will see some pressure, but investigations towards the .7920 (1.2625) should see support for the NZD. Whilst the pair has moved back from the extremes seen earlier in the year, current levels represent fairly good value buying on NZD with AUD from a historical perspective.

NZD/GBP (GBP/NZD)
The NZD rallied back from its lows against the Pound Sterling as the market fears subsided in the latter half of last week. This week’s focus will be based in the UK and it starts on Tuesday with the monthly inflation numbers. Wednesday sees the Bank of England (BOE) Monetary Policy Committee meeting minutes released and these are likely to less significant after last week’s Inflation Report was more dovish than expected. The report pointed towards the cash rate remaining at its very low .5% possibly until 2013. Any dips in the NZD should find support with the prospect of a higher cash rate in NZ before the end of the year. UK retail sales figures on Thursday will indicate further on how the consumer is recovering in the wake of the Government austerity measures that have been put in place.

 
NZD/CAD
The New Zealand dollar recovered strongly from its brief dip below the .8000 level early last week when the risk aversion was at its peak. The price action was particularly volatile, but the pair finished the week close to where it started. This week is light on top tier data in NZ and the only significant release in Canada is the inflation number on Friday. For the most part the lead will come from the equity markets and general appetite for risk. Assuming that we do not see the violent price action of last week, expect the pair to remain within the expected range.

NZD/RAND
The RAND gave up a just a little ground against the NZ dollar over the last week. The bout of risk aversion saw both currencies sold in tandem which paved the way from a relatively stable ride for this cross. In the absence of any top tier economic data in either economy this week, expect the broader 5.7500-6.0500 range to remain in place. With the Reserve Bank of NZ poised to begin hiking rates before the end of the year, the bias for the pair is towards NZD appreciation in the short to medium term. Up towards the 6.3000 level represents great value buying of NZD with RAND from a historical perspective.

NZD/EURO (EURO/NZD)
The NZ dollar managed to recover last week from the intense pressure it was under as the risk aversion peaked on Tuesday. The equity markets provided the lead early in the week before the  focus intensified once again on the debt situation in Europe with yields on Italian and Spanish debt pushed out to record levels. The European Central Bank (ECB) came to the rescue to reduce market fears by buying the under pressure bonds on the secondary market. This week sees the focus continue to be in Europe as the equity markets look to stablise. French and German officials have an emergency meeting to discuss a plan to quell the crisis spreading further. Anecdotal reports of the Germans softening their stance on concept of joint “Euro bonds” will remain a political hot potato, and these discussions will be closely followed.

 
NZD/YEN (NZD/YEN)
The NZD saw intense pressure from the YEN early last week as the market risk aversion peaked. The subsequent equity market recovery has enable the NZ dollar to recover the bulk of its losses. Again this week the lead will come from the equity markets. The just released preliminary Japanese GDP number was the only piece of top tier economic data scheduled and it showed an -.3% decrease against an expectation of a -.6% fall in activity. Adding to the mix will be the Bank of Japan as they remain poised to intervene in the market should the YEN see another round of appreciation. Should the initial resistance at 65.00 hold throughout the week, we may see another test to the downside for this pair.

AUD/USD
The Australian dollar has almost recovered all of its losses that it saw against the US dollar as it was gripped by the market risk aversion early last week. With equity markets leading the way for the most part, the week has started with a positive tone. Last week’s higher than expected unemployment rate means the Reserve Bank of Australia (RBA) will be closely watched as the monetary policy meeting minutes are released on Tuesday. The interest rate market currently around 130pts of easing price in before the end of the year and anything less than dovish meeting minutes will be reacted to. Given that the US Federal Reserve are poised to leave there cash rate unchanged until mid 2013, further softness in the AUD should see support from investors looking to pick up yield. US inflation ,home sales and manufacturing numbers on Friday will be closely watched also.

AUD/GBP (GBP/AUD)                            
The Australian dollar bounced back strongly from its five month low against the Pound Sterling last week. It recovered as the general market risk aversion abated, and the Bank of England (BOE) Inflation Report indicated that the UK cash rate was likely to remain at its .5% level into 2013. This week sentiment starts off being driven by the positive equity markets ahead of the release of the Reserve Bank of Australia monetary policy meeting minutes on Tuesday. These come ahead of the UK inflation numbers also on Tuesday. Wednesday it is the turn of the BOE to release their meeting minutes ,but after last week’s inflation report these are likely to have limited impact. The weeks focus is rounded out by the UK retail sales number on Thursday, which will give a good indication of the state of the UK consumer as the government austerity measures really start to take hold. Expect possible tests to the topside in the absence of calamity in the equity markets.

 
AUD/EURO (EURO/AUD)
The Australian dollar staged a solid recovery from the lows it set against the EURO early in the week. The weakness was caused by strong market risk aversion. The recovery was especially impressive when you take into account the higher than expected Australian unemployment rate released on Thursday. The focus was again all about the European Government debt issues and it was the turn of larger non-peripheral members Spain and Italy to see their bonds under pressure. This week has two major events of focus for this pair. Firstly the Reserve Bank of Australia (RBA) monetary policy meeting minutes due for release on Tuesday. These should give a further guide as to the thought of the RBA with regards to the cash rate. Secondly is the emergency meeting of German and French officials to discuss plans to quell the debt crisis before it spreads further. This is potentially a pivotal meeting as rumours of the concept  of a “Euro Bond” are to be discussed.

GBP/USD
The Pound Sterling lost ground to the US dollar throughout the course of the last week. The US dollar ironically benefitted from safe haven demand as equity markets saw intense selling pressure. Expect further trading in the broader 1.6000-1.6500 range we have seen for most of 2011. With both respective central banks intimating their cash rates will remain unchanged at historically low levels until 2013, there will be no interest rate differential drivers in the short term. This week in the UK sees inflation numbers released on Tuesday, Bank of England Monetary Policy Committee meeting minutes on Wednesday, and retail sales on Thursday. In the US inflation, homes sales and manufacturing numbers on Friday will be closely watched. If equity markets continue to stablise, expect the GBP to see grinding appreciation over the US dollar.

GBP/EURO (EURO/GBP)
Last week was a game of two halves for this pair. Initially the GBP was under pressure as the equity markets were aggressively sold. As they stablised and the focus turned to that of the Spanish and Italian debt issues the GBP recovered most of its lost ground. The pair remains in a familiar range. The key focus for the week will likely be any details that emerge from the emergency meetings between French and German officials to discuss further measures to contain the European debt issues. The various economic data releases in the UK will be followed, but will likely be of secondary importance.

GBP/RAND
The Pound Sterling appreciated against the RAND over the last week. The high for this pair was set as the overall market risk aversion peaked and liquidity was very low. The Rand was the worst performing of the top 16 traded currencies globally last week. Expect moves this week to mirror the fortunes of the equity markets. There is an absence of top tier South African data releases to follow, so most of the focus will remain on the UK data. Inflation numbers on Tuesday are followed Bank of England Monetary Policy Committee meeting minutes on Wednesday. The week is rounded out retail sales numbers on Thursday. If market risk aversion remains subdued, expect the Rand to outperform.

Market commentary:

The last week of trading in the financial markets has been some of the most turbulent since the start global financial crisis in 2008.

Violent moves have been seen in almost all markets as levels of liquidity (depth of market) slumped dramatically.

The perfect storm of lower global economic growth expectations, and therefore lower expected tax revenues, accentuating the issues being faced Governments laden with debt. The sequence of events that have unfolded over the last few weeks have seen somewhat extraordinary measures being taken up around the globe.

In the US a pledge from the Federal Reserve (FED) to maintain its super low monetary policy for another two years. In Europe the European Central Bank (ECB) entered the secondary bond market to buy Spanish and Italian government bonds to stem the markets push of the bond prices to record low levels. And the Swiss and Japanese authorities continue to take measures to curb the excessive strength of their safe haven currencies.

The week ended on a positive note with better than expected US retail sales numbers adding further to the bounce from the lows in growth assets. Early indications are that a further follow through from Fridays positive tone in the week coming. But given the multiple factors at play, and the interconnectivity of the global markets, expect periods of volatility to continue over the short term at least.

In New Zealand there was little of domestic focus last week. The likelihood of a sharp 50pt rise in the cash rate is now off the agenda for the September meeting of the Reserve Bank of New Zealand (RBNZ). But the market still have over 50pts of tightening priced by the end of the year. This should see the NZ dollar supported in periods of weakness, barring calamity in offshore credit markets. Last week saw the continuation if the retreat of the NZD on a number of currency pairs, but expect any decline to be less rapid this week.

In Australia the unemployment rate bounced higher to 5.1% from 4.9% last week. The weaker jobs growth will pave the way for a lower cash rate from the RBA should the domestic economy continue to show softness that has been seen of late. A reassuring statement from Australian Treasurer Swan over the weekend pointed towards the relative strength of the Australian economy, and its close association with Asia, and China in particular. Tuesday sees the release of the  previous RBA monetary policy meeting minutes and these will be closely followed. It is reasonable to expect some sideways trade from the Australian dollar as the market stablises after last week’s action. Given last week’s retracement from the extreme highs on various cross rates, expect any weakness to be more shallow from the AUD.

In the US we can expect the economic data to remain patchy at best. The slowdown in the 2nd quarter threatens to continue, and given the public sector belt tightening is likely to continue into the next election. Consumer sentiment is likely to remain low as evidenced from Friday’s retail sales release detailed below. The Federal Reserve’s unusual step of stating that the cash rate will likely remain low until mid 2013 should reassure businesses looking to invest. The potential of further quantitative easing from the FED should ensure that longer term interest rates remain low also. But it can be expected that for any further initiatives of this kind will be kept for the most dire of circumstances.

The long road back to recovery in the British economy continued last week with weaker than expected manufacturing numbers. The Pound Sterling did manage to take back further ground against the Australasian currencies as the risk aversion gained momentum. But given the prospect of the very low cash rate being continued into 2013, the prospect of a trend reversal remains a fair way off. This week’s interest will be based around the inflation numbers on Tuesday, Bank of England (BOE) meeting minutes Wednesday and retail sales data on Thursday. 

In Europe the focus remains steadfastly on the spiraling Government debt issues. Over the weekend the Italian Government passed further austerity measures into law in an attempt to convince the market of its commitment to balancing its books. With the ECB committing to buy Spanish and Italian debt, further calls for a single Euro-zone bond issuance entity are again emerging. German enthusiasm to this concept remains the key, and a move towards this would be unlikely unless the situation deteriorates further and the prospects becomes more politically palatable. Asian central bank demand for EUR remains in place and provided much needed support over the last week. A high level meeting between German and French officials this week will offer further insight to plans to stablise the debt issue on a wider scale and will be closely followed.

In Japan the preliminary 2nd quarter GDP number was released at -.3% versus an expectation of a larger -.6% decrease in activity. Interestingly however export revenues were lower, in line with recent data in Hong Kong and Singapore.  The YEN remains very strong and Finance Minister Noda stated that authorities remain poised to intervene to curb the strength on the YEN. If the stablisation of the equity markets continues throughout this week, expect the YEN to come under some pressure as the Swiss efforts to curb CHF gained momentum to start this coming week.

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