GBP under performance being generated through capital flows out of the UK

By Sam Coxhead*:

Last week encapsulated the broad themes that have driven the financial markets in 2012.

With a multitude of complex factors influencing the markets, I will attempt to simply explain the primary drivers involved.

The European Central Bank (ECB) met expectations with commitments to stem the funding issues in the European sovereign debt markets. It now is the turn of member state politicians to ratify their side of commitments in terms of the permanent “European Stability Mechanism” (ESM).

In the US, the focus for the week were the employment numbers released late on Friday. These were materially disappointing, and firmly increase the likelihood of further quantitative easing (QE) from the Federal Reserve (FED) at Thursday’s monetary policy announcement. Unsurprisingly this saw the US dollar weaker across the board.

The monthly economic data release from China came on Sunday and revealed a further slowing in their economy. In an effort to stem slowing growth China announced they are embarking on 150 billion US dollars worth of infrastructure spending.

The opposing forces of weakening global growth and further central bank policy accommodation continue. These forces point towards further movement within the broader 2012 ranges for most pairings.

Major Announcements last week:

·  Australian Retail Sales -.8% vs +.3% expected

·  UK Manufacturing 49.5 vs 46.1 expected

·  RBA leaves monetary policy unchanged

·  UK Construction 49.0 vs 50.1 expected

·  US manufacturing 49.6 vs 50.0 expected

·  UK Services 53.7 vs 51.3 expected

·  Australian GDP +.6% vs +.8% expected

·  BOC leaves monetary policy unchanged

·  Australian Employment -8.8k jobs vs +5.1k expected

·  BOE leaves monetary policy unchanged

·  ECB embarks on OMT program to support debt markets, cash rate unchanged

·  Canadian Employment 34.4k vs 9.9k expected

·  US Employment 96k vs 123k expected, but previous two months also revised lower by 41k

NZD/USD 

The NZ dollar saw some intense selling pressure last week. Following the disappointing Chinese manufacturing numbers the sentiment in the wider market towards the Australasian currencies remained weak. The turnaround started with the bounce seen at the Fonterra diary auction. This saw investors scramble to cover “sold positions” and this demand quietly started to drive the pair higher. Ultimately however, the real boost in demand came following the weak employment numbers in the US. With increasing odds of further policy accommodation from the FED at Thursday’s monetary policy, expect this renewed demand for the NZD to remain in the short term. US inflation and retail sales numbers on Friday will be closely watched , but will be of secondary importance. This week’s RBNZ announcement should hold few surprises, as Dr Bollard’s last announcement it makes sense for him to ensure a smooth handover to the incoming Governor Graeme Wheeler..

NZD/AUD (AUD/NZD)

This pair continued its recent yoyo price action within its contained .7730 - .7830 (1.2770 - 1.2940) range. The NZ dollar outperformed and is currently sitting close to the top of the recent range, consolidation through this .7830 (1.2770) level will enable further appreciation up towards the .7900 (1.2660) level. The RBA seemed increasingly poised to ease the cash rate lower as growth in China continues to slow, and this points towards further NZ dollar appreciation. The RBNZ is the sole focus for the week , but this should be of limited impact, given that it is Governor Bollards last meeting. At current levels the probability is weighted towards further NZD appreciation.

NZD/GBP (GBP/NZD)

The NZ dollar finally found some demand last week against the recently resurgent Pound Sterling. After seeing some initial weakness, the NZD outperformed in the second half of the week. It was more a case on GBP under performance, but the increased Fonterra auction prices will have definitely helped. The primary driver of the GBP under performance has been the GBP supply being generated through capital flows out of the UK and back into Europe following the pivotal ECB monetary policy decision. These flows are likely to continue in the short term and this should weigh on the GBP across the board. UK employment numbers on Wednesday will be closely watched ahead of the RBNZ monetary policy announcement on Thursday. However expect this to be of limited impact as the RBNZ leadership goes into transition. The resistance at .5100 (1.9600 support) is close by and will provide the initial barrier to further NZD appreciation.

 NZD/CAD

The NZD found its feet against the recently resurgent Canadian dollar last week. After seeing initial pressure the rebound has been relatively swift and the bulk of the move was done following the weak US employment numbers on Friday. These weak numbers increased the likelihood of further action from the FED at their monetary policy meeting this week. Further appreciation from current levels should be harder fought for the NZ dollar. The focus this week will come from the RBNZ monetary policy meeting on Thursday. This will be closely watched but will likely be of limited impact. The real drama will indirectly be produced by the FED as they announce their policy initiatives , also on Thursday.

NZD/EURO (EURO/NZD)

It was in interesting one for this pair last week. After seeing initial weakness the NZ dollar recovered and the pair see sawed as both currencies saw periods of solid demand. Expect this to continue in the short term. Assuming the European debt markets do not see renewed pressure, demand for the EURO should stay at these renewed levels for the time being. The NZ dollar demand has been driven by increased expectations of further policy action from the FED on Thursday. The RBNZ also have their monetary policy announcement on Thursday, but this should be of limited impact. On further NZD appreciation the initial resistance should come in at .6400 (1.5625 support).

 NZD/YEN

This pair tracked sideways for the first half of last week. However the ECB announcement of their OMT program gave the risk assets a boost and the NZ dollar put in a strong performance immediately following that announcement. Interestingly this saw further sideways tracking following the US employment numbers. This underlines the broad US dollar weakness  following that number. After today’s final Japanese GDP number of +.2% , there is limited top tier data in either economy. The RBNZ monetary policy announcement of Thursday will be closely watched, but should be of limited impact. The pair is now well back in its previous comfortable 62.50 – 64.50 range.

AUD/USD

It was an interesting week for this pair last week. The first half of the week saw the AUD under renewed pressure. This was started off by the weak Chinese manufacturing numbers the week prior. However the market seemed to be a little nervous with its “sold AUD” positions and following the close to expectation GDP and employment numbers, there was a scramble to cover these positions. This only increased with the successful ECB announcement of its OMT program, and the following weak US employment numbers. Whether or not this change in momentum can be continued remains to be seen. It is undoubted that the mining sector and hard commodity markets are under extreme pressure due to reduced Chinese demand. The big focus this week is the FED monetary policy announcement on Thursday. US inflation and retail sales numbers on Friday will also be watched, but will be secondary to  Bernanke’s latest presentation of the monetary policy stance.
 

AUD/GBP (GBP/AUD)                            

After opening the week under renewed pressure the AUD saw some periods of demand through the latter part of the week. There was an element of scrambling to cover “sold AUD” positions and positive reaction to the ECB OMT program,  this added to the AUD demand. The GBP has underperformed following the ECB decision as major capital flows were seen returning from the UK into Europe as the ECB stance buoyed investor confidence. It is uncertain if this momentum can be continued. With further Chinese data coming at the low end of expectations over the weekend, the announcement of 150 billion USD of Chinese infrastructure investment has done little to buoy sentiment to start the week.

 AUD/EURO (EURO/AUD)

It was an interesting week for this pair last week. The AUD went some way towards arresting its recent downward momentum against the EURO. Direction from the current levels is not clear. If the FED initiate further accommodative policy on Thursday, the AUD will react positively. Countering this potential pickup in demand, the continued bad news from China is likely to weigh on sentiment. In Europe the pressure is now on countries to ratify their contributions to the permanent ESM. The debt market reaction following the ECB’s monetary policy announcement has been positive, and if this continues, this should underpin demand for the EURO.

 AUD/YEN

This pair tracked sideways as the market waited for the ECB monetary policy announcement last week. The positive reaction to the ECB plans saw the markets increase demand for growth assets. This demand pushed the pair straight through the 80.50 level before consolidating above 81.00. From there it has ebbed and flowed with wider market sentiment. This week is light on top level economic data in either economy, following today’s release of the final 2ndquarter GDP number in Japan. Expect further rhetoric from BOJ officials to temper any really enthusiastic YEN demand. Its seems a foregone conclusion that we will see further policy accommodation to boost Japanese growth at some stage. With Chinese data showing continuing softness, there may be further sideways trading within the broader range for this pair.

AUD/CAD

The Australian dollar managed to climb off its lows against the Canadian dollar last week. The wider market reacted positively to the ECB OMT program and this helped boost the AUD. This continued through to the release of the weaker than expected US employment numbers. The increased likelihood of further quantitative easing at this Thursday’s FED monetary policy announcement should underpin this pair around current levels. There is little economic data of note for either economy this week, so expect the FED to provide the bulk of the lead, along with any headlines of note emanating from Europe.

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Market commentary:

Last week encapsulated the broad themes that have driven the financial markets in 2012. With a multitude of complex factors influencing the markets, I will attempt to simply explain the primary drivers involved. The European Central Bank (ECB) met expectations with commitments to stem the funding issues in the European sovereign debt markets. It now is the turn of member state politicians to ratify their side of commitments in terms of the permanent “European Stability Mechanism” (ESM). In the US, the focus for the week were the employment numbers released late on Friday. These were materially disappointing, and firmly increase the likelihood of further quantitative easing (QE) from the Federal Reserve (FED) at Thursday’s monetary policy announcement. Unsurprisingly this saw the US dollar weaker across the board. The monthly economic data release from China came on Sunday and revealed a further slowing in their economy. In an effort to stem slowing growth China announced they are embarking on 150 billion US dollars worth of infrastructure spending. The opposing forces of weakening global growth and further central bank policy accommodation continue. These forces point towards further movement within the broader 2012 ranges for most pairings.

Australia

A weaker than expected retail sales number came ahead of the RBA monetary policy decision last week. The RBA held the cash rate unchanged at 3.50%, and remains flexible to act if further softness becomes evident in the economy. Of note will be the continued decline of the hard commodity prices in recent months, and this has led to a huge pull back in mining infrastructure spending expectations from Australia’s largest mining companies. Economic growth and employment numbers came in slightly below expectations and legitimise the careful tone being taken by the RBA. The economic indicators from China remain under pressure and this impacts sentiment for the Australian economy. Balancing these factors is the announcement of the 150 billion USD infrastructure spending injection by Chinese authorities, coupled with the potential for further QE from the FED on Thursday. This should provide some reasonable support for the AUD this week. With no top tier economic data in Australia this week, expect the lead to come from any actions from the FED , and any further news emanating from China.

New Zealand

There was no economic data releases of note in New Zealand last week. However, the NZ dollar was buoyed by news that the Fonterra diary auction had seen renewed demand. On a trade weighted basis the prices fetched were up 6%, as the ongoing drought in the US continues to boost the grain markets. Also of note were announcements from Rio Tinto and Solid Energy. Rio Tinto announced 100 job cuts as it struggles to contain costs at its Bluff based Tiwai aluminum smelter. Solid Energy suspended operations at its Spring Creek mine following the recent, but dramatic fall in the global coal demand. This week sees the Reserve Bank of New Zealand (RBNZ) as the focus. Expect no change to monetary policy, and an appropriately short statement from Governor Bollard at this final monetary policy announcement.

United States

The US employment numbers on Friday dominated the focus in the US last week. The numbers were materially weaker than expected and the labour market now appears to be stuck in neutral. The recent Jackson Hole speech by FED Chairman Ben Bernanke pointed toward further policy accommodation if the numbers came in weak. Accordingly expectations for further action have increased since the employment numbers were released. This has undermined demand for the US dollar in the short term. Expectations are for an extension of the guidance for the current 0-.25% cash rate through into 2015. In addition to that further QE should be forthcoming. Alongside the FED’s monetary policy announcement on Thursday, we have inflation, retail sales and preliminary consumer sentiment numbers on Friday.

Europe

ECB President Mario Draghi backed up his words with action at last week’s monetary policy announcement. The frame work is now in place to support the stressed European debt markets, and the Outright Monetary Transactions (OMT) is at the core of that frame work. This involves the buying of member government bonds at a level and in a quantity at the discretion of the ECB.  The cost of funding (bond yield) has dropped dramatically for the likes of Spain and Italy following the announcement. Consolidation at these lower levels, or making of further progress lower, is definitely EURO supportive in the short term. The focus now turns to the Euro-zone leaders and their ability to ratify the implementation of the ESM. Once the structural framework is implemented the economic outlook will again become the focus. The focus this week will come from the German Constitutional court ruling on the ESM and industrial production on Wednesday and inflation numbers Friday.

United Kingdom

It was an interesting last week in the UK. Whilst slightly off the radar, UK manufacturing and services data beat market expectations. The Bank of England made no change to monetary policy as expected and next week’s meeting minutes will be closely monitored to gauge the tone of the meeting.  This week sees the release of the latest house price number, trade balance and unemployment numbers. Wednesday’s employment numbers will be the focus, with employment growth expected to be close to flat. Interestingly the GBP lagged towards the end of last week, this has been attributed to large volumes of selling GBP and buying of EURO following the ECB announcement. Given the capital flight from Europe to the UK in the previous few months, this trend may well continue in the short term at the very least. The move towards more normal bond yields will calm investor fears, and make the EURO more attractive.

Japan

It was a quiet week for economic data in the Japanese economy last week. Rhetoric from Bank of Japan (BOJ) board members continued to flow freely. Comments regarding bold policy action if required intimated that further policy accommodation is likely to be forth coming. The high level of the YEN continues to be the major dampener on the economy as exporters continue to struggle. Final 2nd quarter GDP numbers were released at just .2% growth for the quarter this morning. Tomorrow sees the release of the latest manufacturing index and machinery orders on Wednesday.

Canada

The Bank of Canada (BOC) left monetary policy unchanged as was completely expected last week. In their accompanying statement they said they see widespread slowing in both developed and emerging economies. They also said the next move in monetary policy would likely be higher, but given the global economy the timing of such a move would have to be carefully weighed. Friday saw the building permit data come in below expectation. The unemployment rate was as expected at 7.3% with a higher than expected 34.4k jobs added for the month of August. Manufacturing numbers also beat expectations as demand from the US continues to strengthen. The sole focus for this week will be the trade balance numbers on Wednesday, however these should be of limited impact.

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