Fundamental Analysis 05.12.2017 - Market Outlook

AUD was the big winner after retail sales beat estimates and the Reserve Bank of Australia (RBA) turned slightly more optimistic on inflation. The Reserve Bank of Australia eliminated a line from their previous statement that said “inflation is likely to remain low for some time…” and another that said “(t)he higher exchange rate is expected to contribute to continued subdued price pressures in the economy.” These deletions suggest the Bank is somewhat less concerned about deflationary forces and a bit more confident that inflation will eventually return to its target level. That change in nuance contributed to a stronger AUD even though the Reserve Bank of Australia’s forward guidance however remained exactly the same. I think AUD could gain further today ahead of the Q3 GDP report, which is expected to show solid momentum in the economy.

NZD also gained after Reserve Bank of New Zealand (RBNZ) Acting Governor Grant Spencer said in a speech that there is “some risk on the upside for inflation and interest rates.” He explained that the Reserve Bank of New Zealand was assuming that global inflation would remain low; if this assumption turns out to be wrong, then rates could rise. The market ignored the fact that he also warned of the opposite risk: the Reserve Bank of New Zealand’s assumptions could be wrong in the other direction too and domestic inflation could fail to accelerate as expected, which could force them to consider rate cuts. I think NZD was simply dragged higher along with AUD and this rally is likely to unwind during the day.

CAD also gained as Friday 1st December 2017’s solid employment report and the slight change in the Reserve Bank of Australia’s tone raised hopes that the Bank of Canada might also turn more hawkish on Wednesday. We could see CAD continue to rally into the Bank of Canada meeting, but I expect that after back-to-back rate hikes the Bank of Canada will want to pause for a while.

GBP was little changed as investors waited to see what happens with the Brexit talks. There are more talks scheduled this week, but the difficulties remain. The European Commission College of Commissioners will discuss the issue today and make its recommendation on whether “sufficient progress” has been made to take the talks to the next level.

Today’s market

It’s another relatively quiet day for indicators today. The final service-sector PMIs (Purchasing Managers' Index) for the major Eurozone economies will be released today, plus the UK service-sector PMI. The UK index is expected to be down slightly. The UK manufacturing PMI and yesterday’s construction PMI both beat expectations soundly however, raising the possibility that this one beats expectations too. Nonetheless, I think at this point people are probably more focused on the Brexit negotiations than the PMIs.

Then when the US opens up, we get a view of how global trade is going. The US trade deficit is expected to widen significantly. This data series is seasonally adjusted, so the decline is significant, even if it means only a slight widening in the deficit on a 12-month moving average basis. This data series is not as important for USD as the advance trade statistics, which come out about a week earlier. That could be particularly positive for CAD and JPY (although the former depends largely on the Canadian trade data, which comes out at the same time).

The Canadian trade deficit on the other hand is expected to narrow slightly, although it’s expected to remain much wider than it was at the beginning of the year. This figure is also seasonally adjusted so it does show a narrowing of the deficit. Canadian exports are doing well and energy prices are rising, although there was a strike in the auto industry that wasn’t resolved until the middle of the month. The figure should be slightly CAD-positive, especially in conjunction with signs that the US trade position – Canada’s biggest trading partner – isn’t improving.

Overnight, we get the first reading of Australia’s Q3 GDP. The qoq rate is forecast to slow a bit, but the yoy rate is forecast to accelerate because GDP shrank in the like year-earlier period. I think the market is likely to interpret the figure as showing that the economy is gaining momentum and will take it as positive for AUD, especially in light of the optimistic Reserve Bank of Australia report.

Bank of Japan Policy Board member Takako Masai will give a speech and hold a press conference. Nowadays the market is looking for any hints that the Board is thinking about an exit strategy or at least changing the inflation target so they can start reducing their JGB purchases or letting 10-year yields climb a bit.

There appears to be some disagreement among Board members about whether negative interest rates help or hurt the economy – they seem to be debating whether the concept of “reversal rate” is applicable to Japan; that is, a point where interest rates are so low that banks’ capital positions are impaired and the banks have to cut back on lending. Thus comments by Board members are getting a lot more scrutiny than in the past. The market will be waiting to see if Takako Masai makes any comments about the “reversal rate” and also any observations about the appropriate shape of the yield curve.

Finally, in the early hours of European trading, Germany announces its factory orders. The figures are expected to be rather poor, with orders falling slightly from the previous month. This would contradict the relatively high rate of the German manufacturing PMI, which was unchanged on the month at the quite high level of 60.5, and it rose to an even higher 62.5 in November 2017. The discrepancy could be the recent problem of the divergency between “soft” and “hard” data. In any case, I expect the market to disregard the factory orders figure as old data when the PMIs showed a further expansion in the next month.

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.