It’s not a surprise to the forex landscape that market movement remains somewhat beholden to central bank rate announcements, and less so to geopolitical and fundamental risks. This week we still have two of the biggest central banks to report: the European Central Bank (ECB) and the Bank of England (BoE). What is currently happening in the forex space has been the traditional setup for the past 18-months. The low-rate, low-volume structure supports the traditional carry trade, in this case mostly Antipodean currencies funded by cheap EURs. Since last week, dealers have tried to turn over the market in favor of the dollar supported by yield differentials. However, that has been a tough act to follow through on just yet.
The USD sits atop key levels across the majors; some at yearly highs supported by improved U.S. fundamentals and a less dovish Federal Reserve. Presently, the mighty dollar is also picking up against emerging currencies, and with weaker emerging market fundamentals, it’s leaving that currency segment rather exposed. However, the Fed’s non-inflationary concerns, coupled with spare capacity in the labor market, is pushing investors to take a backseat until the Jackson Hole Economic Symposium in late August to gauge the Fed’s current thought process. By days’ end, investors should be in a position to better align their expectations on the pace of rate hikes for the foreseeable future.
Ukraine Conflict Weighs on Sentiment
Nevertheless, investors should be expecting current geopolitical tensions in Ukraine to keep their risk appetite somewhat in check. Germany’s June factory orders plunged, the U.K.’s June industrial production data is below expectations (+0.3% versus +0.6%), and Italy backed up again into a technical recession; it’s the perfect storm that has many investors seeking sanctuary on the sidelines. European bourses are taking a beating amid renewed concerns over the conflict in Ukraine and the toll it is taking on the euro region’s economy. The DAX is currently trading near its five-month low — hardly surprising given Germany’s deep trade and energy links with Russia.
This morning’s disappointing German factory orders highlights the underlying risks to the European economy. After a -1.6% fall in May, Germany registered a -3.2% decline in June. The headline was weak, while some of the details were not so bad. Regardless, in the current “tit-for-tat” European Union/U.S.-Russian sanction war, the rest of us will see this as an a reason to worry about Germany’s and the eurozone’s growth outlooks. Data like this can only hurt the EUR (€1.3358).
Troubling Eurozone Data Emerges
Aside from the potential interest rate differentials, investors are beginning to price in a negative impact from the Russian sanctions. Not helping the EUR’s cause this morning is the unexpected negative Italian second-quarter gross domestic product number (-0.2%). Italy’s is the third-largest eurozone economy and it has now fallen back into a technical recession. Investors should expect this to be a focus in President Mario Draghi’s Q&A tomorrow after the ECB rate announcement. Safe-haven trades will continue to put pressure on German bund yields (+1.15%) – the market will be looking to test the historic low yield of last week (+1.11%).
Reports from Ukraine will undoubtedly keep the market on its toes. Any signs of military escalation and the market will be seeking sanctuary in the traditional assets like gold, the yen, U.S. dollar and Swiss franc. Even the pound cannot make a go of it this morning (£1.6827). U.K. factory output rose at a weaker pace than expected in June (manufacturing +0.3%, month-over-month, or +1.9%, year-over-year, and industrial +0.3%, month-over-month, or +1.2%, year-over-year). It should not be considered too much of a surprise and certainly falls in line with the subdued eurozone industrial production in recent months over tensions in Ukraine and the Middle East. England’s Office for National Statistics has cut its estimate for second-quarter industrial output following this morning’s report. They now estimate production expanded +0.3% in the second quarter, rather than +0.4%. The International Monetary Fund still considers the U.K. to be the fastest growing “advanced” economy this year, and that’s reason enough why many expect the BoE to be the first to hike rates by year’s end. The BoE’s Monetary Policy Committee starts its two-day meeting today and a no-rate decision is expected, however, the market is looking to gauge the strength of dissent or hawks — it’s possible we will get to hear more “tightening talk.”