There’s chatter in the market that the two-day central bank symposium getting underway in Jackson Hole, Wyo., today could be a currency event, another type of Plaza Accord. Up until now, the market had been solely on the lookout for any hawkish comments from Federal Reserve Chair Janet Yellen’s presentation at the forum tomorrow to gauge timing of a change to the U.S.’s low interest rate policy. Maybe the Fed’s agenda is about to expand?
The historic 1985 Plaza Accord, signed at the Plaza Hotel in New York City, was a pro-growth agreement signed by what was then known as the Group of Five industrialized nations (U.S., U.K., France, Japan and Germany) to depreciate the USD in relation to the JPY and German DEM. Central banks directly intervened in the currency market after the greenback appreciated by about 50% against the yen, pound, French franc, and Deutsche Mark.
Back then, devaluing the dollar made U.S. exports attractive and more affordable for the signing partners. In turn, more U.S. goods and services would be bought, giving the American economy a boost. This time, the focus is not on the U.S. but on Japan and specifically Europe, whose growth prospects continue to flounder or regress. Any colluded decision would require the EUR and JPY to depreciate against the USD. Both economies are in trouble, Europe more so especially with the knock-on effect of European Union and American sanctions aimed at Russia.
If this does happen to hold true, then it would be a game-changer for the forex market that has long been handcuffed to a low-rate environment where the lack of volatility has been dominant. Expect the market to wait on every word that is uttered by the Queen of Doves, as Yellen has been dubbed.
Hawkish Fed Supports the Dollar
The mighty buck trades atop of its 11-month high against a basket of major currencies this morning, gathering its second wind after yesterday’s Federal Open Market Committee (FOMC) minutes for July sounded hawkish. The U.S. dollar index is still enjoying renewed support from Tuesday’s upbeat U.S. housing data, climbing as high as +82.28, straddling a level not seen in almost a year. The FOMC minutes indicated that U.S. policymakers debated on whether interest rates should be raised earlier given a surprisingly strong jobs market recovery. Most officials, however, wanted further evidence before changing their view on when rates should be lifted. Be aware, the continuous traction seen by the dollar is expected to come from a more hawkish Fed, but maybe not from Yellen directly when she makes her address tomorrow.
Weak Chinese Data Hits Aussie
Growth in China’s vast factory sector slowed to a three-month low (50.3 versus 51.5) in August as output and new orders moderated despite the recent burst of government stimulus, according to the private HSBC flash purchasing managers’ index (PMI). The lukewarm reading came as China’s economic growth appears to be faltering again, with recent indicators ranging from lending to output and investment all pointing to weakness. Psychologically, it remains above the coveted 50 points that separate expansion from contraction. The softer conditions could imply that more policy support may be needed in the coming months to bolster growth and offset the downdraft from the cooling housing market. The disappointing headline has caused a regional knock-on effect on the AUD (China is Australia’s largest trading partner). The Australian dollar slumped following the data, falling to $0.9246 from $0.9280. China’s Shanghai Composite Index fell -0.4%, while Hong Kong’s Hang Seng Index lost -0.4%.
Mixed European Data Fails to Register
European equity bourses are taking their cue from the U.S., where equities continue to rise despite the hawkish undertones from the Fed yesterday. Investors, it seems, remain comfortable that monetary policy will stay supportive for the only game in town: stocks. Global inflation is fairly benign, and investors will only worry when rates do begin to move higher.
European PMI data released this morning continues to show a slower-than-expected expansion in regional manufacturing and service activity again this month. The data continues its recent downturn, which saw economic growth stagnate in the second quarter, amid concerns that the conflict in Ukraine will hold back an already fragile economy.
The focus is always on Germany, the backbone of Europe. Germany’s composite PMI (manufacturing and services) has come in at 54.9 versus 55.7. Digging deeper, manufacturing has held up well (52 versus 51.8 expected) while services have slipped (56.4 versus 56.7). The only takeaway for investors is that the “ugly across the board weakness” was avoided, which the market had feared. The European compound figure has fallen to 52.8 from 53.8, pressured mostly by a slipping manufacturing print (50.8 versus 51.3). The data has managed to apply pressure to the EUR (€1.3261) and provided some tentative support for Bunds (10-year Bunds continue to trade below +1%). The data indicates that no recovery has taken root just yet, although Germany is showing some signs of improvement. It remains important to watch the prices component, they are still being cut — composite output prices fell to 48.9 versus 49.
Sterling Dips on Disappointment
Other data released this morning shows that U.K. retail sales were weaker-than-expected in July (+0.1%, well below the expected +0.5% increase). The disappointing headline print may now take some of the pressure off Bank of England Governor Mark Carney to raise rates any time soon. Inflation data earlier this week also showed that U.K. price pressures were subdued. Yesterday’s 7-2 Monetary Policy Committee result is but a distant memory when GBP was trading above the £1.67 handle with some conviction. On the year, retail sales were up +2.6%, down nearly 1% from +3.4% in the 12 months through the end of June. For the time being, sterling has found a bid ahead of some option barriers (£1.6555) but it should be weighed down by the patchy sales data.
The market will continue to be guided by the relatively hawkish minutes from the Fed’s rate-setting committee which should fuel further gains for the dollar, especially with the European Central Bank (ECB) likely to maintain its ultra-loose policy for some time. The ECB, and especially the vocal French, will be happy to see the EUR gaining traction in underperforming. It has taken a while, but this year’s patience trade (short EURs) is gathering much needed momentum.