GBP:
Lifted by Dollar Weakness
CAD: Big Disappointment in Retail Sales
AUD: Sharp Decline in BHP Earnings
NZD: Trade Balance on Tap
JPY: Sharp Deterioration in Trade
The U.S. dollar fell sharply against all of the major currencies after the FOMC minutes showed a surprising degree of dovishness within the central bank. Economists and investors (ourselves included) expected very little fireworks from the release of the minutes because the FOMC statement did not contain any major changes and the latest comments from Bernanke suggested that policymakers are reluctant to pull the trigger on QE3 unless absolutely necessary. However, according to the minutes from the August meeting, Federal Reserve officials were much closer to easing monetary policy than many people had anticipated.
The most important sentence in the FOMC minutes was the one that said “many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.” Unlike Bernanke who was skeptical about how long depressed job growth would last, other Fed officials were very concerned that the deterioration in the labor market would become an enduring trend.
While U.S. economic data has improved quite a bit since then with job growth accelerating and retail sales turning positive, the fact that the Fed was so close to easing monetary policy this month means that they are not as adverse to introducing a third round of Quantitative Easing as many people had believed.
Judging from the minutes alone, if nonfarm payrolls grew by less than 100k in July or retail sales fell for the fourth consecutive month, the Federal Reserve would pull the trigger this month. What this means instead is that at the first sign of slower growth, QE3 will be back on the table. The confusion created by the misalignment between Fed policy and economic data will make the August 31st speech by Ben Bernanke in Jackson Hole even more important because it will go a long way in clarifying the Fed’s outlook. The main question will be whether one month of data improvements is enough to change the minds of policymakers.
However, additional Quantitative Easing is not the Federal Reserve’s only option. According to the minutes, Fed officials also discussed the possibility of extending the low rates pledge from 2014 to a later date and said it could be an effective change in monetary policy if combined with a statement that pledges to maintain a highly accommodative stance as the economy recovers.
They also discussed tying the low rate pledge to changes in the economy but deferred this decision to the September meeting when their economic forecasts will be updated. The renewed uncertainty created by the surprisingly dovish FOMC minutes was extremely negative for the U.S. dollar. It will now be up to Bernanke to clarify the outlook but we warn against reading too much into his views because in the past, they have been in conflict with changes in Fed forecasts and the views of other FOMC members.
New home sales are scheduled for release today along with the weekly jobless claims report. According to Wednesday morning’s existing home sales report, the housing market recovered slightly last month with sales of previously owned homes rising 2.3%. In June, sales dropped 5.4%, which means today’s rise represents nothing more than a rebound and unfortunately the increase was smaller than economists had anticipated.
Short Covering Drives EUR/USD Higher
The euro broke above 1.25 to trade sharply higher against the U.S. dollar. Dovish FOMC minutes altered the market’s attitude towards the greenback, which suffered from renewed concerns for QE3. The euro on the other hand continued to benefit from the recent decline in Spanish and Italian bond yields.
While ten-year Spanish yields ticked up slightly on Wednesday, they have fallen sharply in recent weeks to one-month lows, reducing the strain on peripheral countries. Five-year Spanish yields saw an even steeper decline, reaching its lowest levels since April. The absence of any eurozone economic data did not threaten the rally in the EUR/USD as investors hold onto the hope that the ECB and Germany will take further action to support troubled nations in the region. This belief along with the dollar negative FOMC minutes triggered a wave of short covering in the EUR/USD.
Eurogroup leader Juncker is also meeting with Greek Prime Minister Samaras and he sounds like he is quickly losing patience with the Greeks. While Juncker admitted that a Greek euro exit would put the entire region at risk, he said an extension to their austerity depends on the results of the Troika report and the ball is in Greek’s court as this is their last chance to follow through on their promises. No decision on Greek extension or aid will be made this week, leaving the October EU Summit as the main forum for any major announcements.
The eurozone’s August PMI numbers will be released on Thursday. Economists are not looking for any major changes with only a small improvement expected in eurozone manufacturing activity and a small deterioration expected in service sector activity. Based on the decline in German factory orders, industrial production, retail sales and the ZEW survey, we believe there’s scope for a downside surprise.
GBP: Lifted By Dollar Weakness
Like the euro, the British pound was driven higher by dollar weakness. It was another quiet day in the U.K. with no major economic data on the calendar. Chancellor of the Exchequer George Osborne urged UK business leaders to do more to boost growth. Osborne’s government is accused of doing “too little, too slow” to help bolster the economy. A poll of 1,277 members of the Institute of Directors published today found that a majority of London groups thought Prime Minister David Cameron and Osborne had been “ineffective” at reducing taxes.
Osborne is under pressure after Britain unexpectedly released a budget deficit yesterday. Corporation taxes plummeted 10.4% from April to July, raising the risk that Osborne will miss his deficit target of GBP 120 billion. Osborne has resisted demands to make further changes and defended himself by saying that his plans helped insulate Britain from the eurozone crisis. No major economic reports are expected from the U.K. tomorrow.
CAD: Big Disappointment in Retail Sales
The Australian, Canadian and New Zealand dollars recovered all of their earlier losses to end the day higher against the greenback. Canadian retail sales fell 0.4% in June against expectations for a 0.1% rise. While the market was surprised, our readers shouldn’t be because in yesterday’s note we wrote about how the decline in wholesale sales pointed to weaker retail sales. Yet comments from Bank of Canada Governor Carney continue to be at odds with data.
The central bank Governor said today that higher borrowing costs “may become appropriate” if the country maintains its domestic demand-driven expansion, even if slow global growth is impeding Canada’s. He added that growth is expected to accelerate through next year as the economy’s momentum remains in line with potential output. During the Asian trading session, the Australian dollar took a beating after BHP Billiton reported a -35% decline in earnings and stated that there would be no major new projects initiated in 2013 due to commodity market volatility.
The mineral business, which is a critical growth sector for the Australian economy is being affected by many of the world’s problems such as weakening demand from China, sluggish growth in the US and the crisis in the eurozone. The earnings report is at odds with the slightly more optimistic tone in the RBA minutes. Tonight, New Zealand trade balance and Australian leading indicators are scheduled for release. RBA Governor Glenn Stevens will also testify before the House of Representatives Standing Committee on Economics.
JPY: Sharp Deterioration in Trade
The dovish FOMC minutes drove the Japanese Yen higher against the U.S. dollar. Last night, Japan reported significantly weaker trade numbers but when it comes to the price action of USD/JPY, U.S. fundamental always dominates. Economists only expected the trade deficit to rise to 270 billion yen but instead it printed at 517.4 billion yen last month. The trade deficit was wider than expected due to the eurozone crisis, slower demand for exports from China and higher oil prices, which boosted imports. The trade balance has been in a deficit for 8 out of the past 10 months.
The persistently strong yen and slow global growth threaten to constrict Japan’s exports. Exports plummeted 8.1% on the year, which was short of the expected 2.9%. Imports were up 2.1% against a forecast for an increase of 3.0%. The trade data adds further pressures on the government to increase spending and/or monetary easing. No major economic reports are expected this evening.