Month: July 2016

The last week of July has a full schedule of first tier data releases and market events. These include the FOMC and BoJ meetings, the German IFO survey, Australian inflation data and GDP reports from both the USA and UK. In general, we believe the BoJ meeting will have more market impact than the FOMC meeting, the US GDP data could surprise to the upside and a weaker Aussie inflation report may not convince the RBA that an August rate cut is the appropriate course of action. 

However, we believe one of the most important data points for the week will be when the European Banking Authority stress tests are released after the NY close on Friday.

The financial markets have recently focused on Italian banks and their swelling non-performing loan book but there is an acute risk that other Euro-Zone banks, including large German, Austrian and French banks, will need to raise capital as well. It’s worth noting that the MSCI European Bank Index lost almost 25% of it’s value after the UK referendum, including a 28% drop in the shares of Deutsche Bank.

From a FX point of view, the main significance is that the correlation between the MSCI EZ Bank Index and the EURO currency has grown. Market statistics show that the running 60-day correlation between the value of EUR and the Index now stands at a positive 50%. This is the strongest reading on the 60-day correlation since Q1 2014 and adds to the growing negative fundamentals for the single currency.

At the beginning of the week, we expected yesterday’s ECB meeting to be a significant risk event for the single currency and offer trading opportunities on new policy measures or adjustments to current stimulus operations. But Mr Draghi said nothing that surprised the FX market. 

He acknowledged the resilience of the financial markets in the aftermath of the UK referendum and noted that upcoming data, combined with new staff forecasts in September, would give the ECB a better view to assess the macroeconomic situation in the Eurozone. He also pointed out that the risks to growth and inflation remain tilted to the downside going forward.

As a result, the EUR/USD traded in a narrow, 70 point range throughout the LDN and NY trading sessions; one of the most passive ECB meetings in recent memory.

However, about two hours before the ECB announcement, comments from Bank of Japan (BoJ) Governor Kuroda that the upcoming stimulus package would not include “Helicopter” money hit the BBC newswire. This headline sent the USD/JPY plunging over 160 points to just under 105.50. Once the BBC clarified that these comments were from a June interview, the pair regained the 106.00 handle but came nowhere near the intra-day high of 107.40 and casts doubts on the FX impact of final BoJ package to be released next week.

These two examples illustrate the non-linear impact Central Banks currently have on increasingly skittish financial markets. On one hand there was a highly anticipated ECB announcement, with a live press conference, which produced little in terms of EUR/USD price action, and on the other hand, there was the release of month old radio interview which spun the USD/JPY into three hour trading frenzy.

Because of the non-traditional stimulus measures used by G-7 Central Banks, and the resultant negative interest rate environment, we have reached the point at which investors are buying stocks to capture yield, buying bonds for relative capital gains and trading currencies as a correlative by-product of the previous two.

With this in mind, officials at the Federal Reserve are, once again, talking about a rate rise before the end of the year. This, along with weak economies elsewhere in the developed world has resulted in the value of the USD increasing over last three months. As such, we maintain a long USD bias even though the trajectory higher may have a higher level of volatility due to equity related risk on/off correlations.

US Macro

Watching the close of the financial markets early Saturday morning (Sydney time), we were thinking that this FX UPDATE would be discussing a change in leadership in Turkey and how that would impact the rest of the Eurozone economics…….tanks in Istanbul, helicopters strafing government buildings; it all sounded pretty grim for Mr Ergodan’s government.   

As it turned out, the coup failed and order has been restored in Turkey, for now.

However, there are several other data points in the Eurozone this week which will drive trade flow in the Euro and other G-7 currency pairs. The three events that FX traders will be following are; the German ZEW data on Tuesday, the German PPI report on Wednesday and the ECB meeting and rate decision on Thursday.

The preliminary forecast for the ZEW is for a sharp fall in business sentiment from 19 to 8. This is one of the first post-Brexit readings and would represent the weakest number of the year. Wednesday’s German PPI data is expected to fall from .4% to .2%. With this series, it’s not so much the actually number but the direction of the trend. German inflation was in negative territory earlier this year and turn back to a negative trajectory is worrisome for the ECB.