By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Central Banks Step Up Verbal/Physical Intervention
- GBP: BoE Not as Dovish as we Fear
- AUD Soars on Rise in Employment
- CAD Lifted by 3% Rise in Oil
- NZD Pressured by Rate Cut
- EUR/USD Breaks 200-Day SMA
Central Banks Step Up Verbal/Physical Intervention
Central banks around the world have been extremely active this summer intervening in their currency on a verbal and physical basis. At first it seemed that these efforts were beginning to subside, but overnight the Chinese yuan jumped 1%, its largest one-day rise ever, raising speculation of central-bank intervention. A senior Japanese lawmaker also talked about increasing the Bank of Japan's Quantitative Easing program, a day after Prime Minister Abe pledged to cut interest rates. Between the big moves in the U.S. dollar and the wild swings in Chinese stocks, countries around the world trembled at the impact on their economies. In recent weeks we have seen moves by India, Brazil, Turkey, Russia, South Korea and Indonesia to prop up their currency. Other countries like Japan are actively talking about measures that would the weaken yen.
Central banks in developed and emerging-market countries are becoming desperate. They are looking at the landscape and seeing little chance of a turnaround in the Chinese economy and an upcoming rate hike from the Federal Reserve. Tightening by the world's most important central bank not only impacts the U.S. economy but countries around the world. On its most fundamental level, a rate hike usually leads to a stronger dollar, which can affect the value of commodities, emerging-market currencies, their exports and economy. In order to ease the pain, these central banks have dug deep, and the reserve levels of some nations are dangerously low. We recently learned that China's reserves dropped $94B in August. The Asian leader still has a large coffer but countries like Malaysia and Indonesia are running out of money fast. With emerging-market nations contributing 40% of global output, a further slowdown in China and a rate hike by the Federal Reserve could trigger more fiscal, monetary and currency intervention.
While the U.S. economy is not directly impacted by these intervention efforts, the competitive devaluation has undercut the market's confidence in central bank economic management, and that uncertainty has increased the volatility in the market. The Federal Reserve faces a very difficult decision next week. 60% of economists surveyed by Bloomberg are still looking for a rate hike but Fed fund futures are pricing in only a 30% chance of a move. Based on the performance of the U.S. economy alone, the Fed should raise rates. But they do not operate in a vacuum and between the volatility in international equities, a dovish ECB and the actions by central banks, it will be difficult for Yellen to pull the trigger. Even if they raise interest rates, the chance of another hike in 2015 is slim. In other words, one-and-done is all we'll get from the U.S. central bank this year.
GBP: BoE Not as Dovish as we Fear
The British pound traded higher versus the U.S. dollar Thursday after the Bank of England left monetary policy unchanged. We were admittedly looking for a decline in the currency following the rate decision and while sterling seesawed, it did not end the day lower as we anticipated. Only 1 member of the monetary policy committee voted to raise interest rates, but the central bank as a whole did not sound overly concerned about global developments or domestic conditions. While they lowered their Q3 growth forecast, they made no mention of the downside surprises in the PMIs and instead said productivity has begun to increase and core inflation may be firming. They believe that domestic demand will help to erode spare capacity in the coming year. On China, the MPC felt that "Although the downside risks emanating from overseas had risen, it would be premature to draw strong inferences from this month's events for the likely path of activity in the United Kingdom." Translation -- the central bank is still looking to raise interest rates next year. However they are in no rush to tighten. Before raising rates, they will want to see how the market responds to a Fed rate hike first.
AUD Soars on Rise in Employment
The best-performing currency Thursday was the Australian dollar, which saw a 1% gain versus all major currencies. This overwhelming strength was driven by a strong labor-market report. A total of 17.4K jobs were created in August as full-time and part-time work increased. This, along with the drop in the participation rate, helped to drive the unemployment rate down to 6.2% from 6.3%. These were good but not great numbers from Australia. If the participation rate did not decline we would have been more excited about this report but we are still skeptical about the overall strength of Australia's economy. Consumer inflation expectations fell sharply in September and we firmly believe that the Reserve Bank of Australia should be considering a rate cut. Next week's RBA minutes could show growing concerns. With that in mind, we believe that investors should start looking for opportunity to sell the Australian dollar. The New Zealand and Canadian dollars also ended the day in positive territory. CAD received a boost from the rebound in oil prices and despite Thursday's bounce in NZD, the currency should be trading lower as the Reserve Bank warns of further easing.
EUR/USD Breaks 200-Day SMA
Five days have now past without a pullback in EUR/USD. Weaker U.S. import prices and wholesale inventories triggered a move that gained momentum on profit taking of long dollar positions ahead of next week's FOMC rate decision. Friday's U.S. economic reports are expected to give investors fresh reasons to reduce exposure to the greenback. The decline in import prices points to lower producer-price growth, while investors most likely grew less optimistic after the recent volatility in the financial markets and the slowdown in job growth. Technically, EUR/USD closed above the 200-day SMA, which signals the possibility of a strong rise to 1.14.