Overnight, all everyone is talking about is China. The Shanghai Composite – the country’s main stock index – is 5% lower on the session. A combination of falling commodity prices – including oil and iron ore – and yesterday’s rather disastrous trade balance release have brought market expectations of Chinese overall growth lower and damaged the People’s Bank of China’s efforts to stimulate the economy.
Despite recent cuts in interest rates within China, local commercial banks have been raising rates to protect deposit outflows. Outflows will increase in the coming days if equity markets continue to plunge through the week. In currency terms, despite the PBoC trying to increase the fix on the yuan in the past couple of days, the CNY has been losing ground. This year the CNY was allowed to trade in a 2% band around the central bank’s fix; this is a precursor to becoming a fully free floating currency. Unfortunately for policy makers it means that markets can push the currency the other way.
Other obvious laggards are the commodity currencies that spent yesterday in the red after China’s poor trade balance number. AUD/USD has made fresh four year lows this morning while NZD/USD is at its lowest level since 2012. USD/CAD has tested the 1.15 level this morning. The main beneficiary has been the Japanese yen as, despite all the pushes from the monetary authorities for a weaker currency, it still has a job to fulfil as a regional haven currency for when the proverbial hits the fan.
The dollar strength has been driven onwards by the market continuing to express a great deal of joy about Friday’s jobs report. It is almost like when you leave the house and the last song playing is the one that you continue to hum through the day. The last decent song the markets heard was one of a surprisingly strong US jobs market. They are still humming this morning.
The next reaction, or verse, if I can extend this metaphor a little more, is what the Federal Reserve will do. As we highlighted in yesterday’s Morning Update video, it is all about the language changes that the Fed can make as a result. The tone of recent policy communications has been becoming more and more hawkish as the data has improved. That is to be expected. A major shift however would be as a result of the FOMC dropping language that signals that rates will stay at current levels for a “considerable time”. Should that be got rid of at the Fed’s meeting next Wednesday, then you can expect the market to focus its rate rise thoughts for the summer of 2015.
Bank of England policymaker and resident hawk Martin Weale prompted a little run in sterling yesterday as he argued that productivity weakness could engender a strong inflationary bump higher for the UK economy. Speaking in London yesterday Weale said that “persistently slower productivity growth would have two implications for interest rates. In the short term, interest rates would need to be higher in order to prevent demand running ahead of supply. But over the medium term, interest rates may remain lower than they were before the crisis, reflecting weaker underlying growth.”
Inflation expectations remain quite elevated in the UK at the moment. A survey by the Bank of England showed that UK consumers overestimated the level of inflation in the UK by a fair margin. CPI currently sits at 1.3%, and the average respondent thought inflation was running at 2.7% at the moment. The UK’s 5y5y inflation swap remains at around 3.38% this morning.
Some unconfirmed M&A rumours in the market also drove GBP higher against EUR yesterday.
European data this morning has confirmed the negativity around the German economy. German imports fell by 3.1% in October on falling domestic demand although the exports component only slipped by 0.5% on the month. It is the Eurozone that is dragging the export number lower. Sales to non-EZ countries was up 7% on the month. The main release of the day is UK manufacturing and industrial production due at 09.30 and with this comes a balancing act – the positivity of the falls in energy and other commodity complexes against the negativity in demand from our main trade partner, the Eurozone. We look for a gain of 0.3% on the month.
