A plethora of economic data releases coupled with central bank rhetoric is expected to have a meaningful impact on forex market volatility this week and it can’t come too soon.
Overnight in Australasia, it was the Bank of Japan (BoJ) and the Reserve Bank of Australia (RBA) that got the ball rolling. However, both have been trumped by price data out of the U.K. and a consumer sentiment survey in Germany ahead of the stateside handover.
U.K. Inflation on the Rise
U.K. inflation accelerated last month and house prices continued their upward march in May; signs that the British economy continues to strengthen and that a change in interest rate policy at the Bank of England (BoE) is getting closer.
In June, the U.K.’s annual rate of inflation rose +1.9% from +1.5% in May; buoyed by the usual suspects (food, drink, clothing, and seasonal airfares). The pickup in prices finds inflation hovering just below the BoE’s +2% target rate. This is the seventh consecutive month that inflation has been at or near the bank’s target price. However, it’s not inflation alone that’s going to convince the Old Lady. U.K. policymakers want to see unemployment fall further and average wages rise before they ever consider a hike in rates. The futures market is pricing in a U.K. rate hike at the beginning of next year. But persistent inflation spikes will force the BoE’s hand possibly by the end of this year. The U.S. Federal Reserve, on the other hand, is priced in to raise its rates by mid-2015.
Mind you, higher June inflation numbers may prove temporary, as inflation pressures elsewhere remain weak (wage growth remains subdued and prices charged by factories in June only increased +0.2%, year-over-year, while raw material prices was down -4.4%, year-over-year). Rising prices only seem to be an issue in the U.K. housing market where prices rose +10.5%, year-over-year, dragged higher by London’s record rise of +20.1%.
Obviously numbers like this favor the pound, at least until the whole story has been digested. GBP has managed to spike to £1.7145 from around £1.7075, having traded at a fresh monthly low of £1.7059 earlier in today’s European session. GBP is also having an impact on the crosses with EUR/GBP dropping to £0.7935 after touching a two-week high earlier this morning (£0.7982). In money markets, September gilts managed to shed around 20-ticks on the price inflation headline and currently trades 12-ticks in the red at 1110.52 and the 10-year cash yields are at +2.62%. Any hint of central bank rate divergence brings forth more opportunities.
German Sentiment Disappoints
The EUR is being squeezed on the crosses; however, not helping its cause was the fact the German economy is slowing down. This morning’s disappointing German ZEW economic sentiment print revealed economic expectations slipped to 27.1 from 29.8 against a forecast of 28.0 while current conditions plummeted to 61.8 from 67.7.
This is another negative piece of news that extends the string of softer core eurozone data of late. Last Monday, the eurozone’s industrial production numbers beat some expectations however they were still down -1.1% on the month in May. This morning’s weaker data has given bunds a lift (which is also supported by Portugal’s Banco Espirito Santo drama) and is trying to push the EUR lower through the psychological €1.3600 level with some conviction. The single currency has managed to wipe out today’s gains against the dollar, certainly impacted by the sharp selloff of EUR/GBP. The next line of significant support appears around €1.3570-75. One thing is for sure, the European Central Bank has to remain on its toes to continue its fight against deflation.
No Surprises from Tokyo
In the overnight session, the BoJ’s policy decision produced little reaction in Japan in either equities or the currency markets. As rumored, the BoJ cut its 2014-15 gross domestic product (GDP) forecast to +1.0% from +1.1% as part of its quarterly review of targets, but it also maintained projections from 2015-17 for GDP as well as for its consumer-price index. Japanese policymakers have also maintained their economic assessment for the 12th consecutive meeting, reiterating their views on all segments of the economy.
Regarding its forward outlook, the BoJ added the, “effects of decline in demand following a front-loaded increase prior to the consumption tax hike are expected to wane gradually.” Also of note, the Japanese press speculated the Cabinet Office would boost its economic outlook in the upcoming monthly report for the first time since January. Overall, Japanese officials seem to feel little urgency to add to their aggressive stimulus measures. USD/JPY (¥101.58) continues to remain contained and influenced more by outside variables. The markets will now begin focusing on Fed Chairwoman Janet Yellen’s semiannual two-day testimony on Capitol Hill. It’s here that traders are hoping for more clues on when the Fed will begin raising interest rates.
RBA Sticks to its Script
The RBA’s July board meeting minutes were largely a reiteration of the bank’s previous statement, solidifying expectations of rates remaining unchanged (+2.5%) despite the “historically high” level of the exchange rate.
RBA member John Edwards says that higher Aussie yields are behind the AUD’s strength ($0.9363) and does not expect the AUD’s strength to fall until the Fed begins hiking rates. Immediately after the release of the statement, the AUD saw a brief and modest lift, with fixed-income markets tipping back in favor of a rate hold over the 12-month period.
Edwards’s remarks clearly shows the RBA is getting more concerned with its currency’s value. Perhaps the RBA needs to indicate a potential rate cut sooner rather than later. A low volatility and volume trading environment promotes the carry trade and the AUD with its higher yields has been a currency in demand. The popular carry trade is funded mostly by borrowing EURs to purchase the AUD — this has certainly become a crowded trade and any effort designed to weaken the Aussie should cause a huge cleanout on the left-hand side. It’s interesting to see lower commodity prices not having a larger negative impact on currencies like the AUD or CAD. The AUD in particular does not seem to have traced commodity price falls this year.
Yesterday, gold dropped -2.3% while the AUD stood tall, mostly supported by the carry trade interest. A high domestic currency will only further pinch the earnings of Aussie exporters.
EUR and GBP Are Committed To CFTC Reports