Fundamental Analysis 16.10.2017 - Market Outlook

EUR was the biggest loser since last Friday 13th October 2017, although the movement wasn’t that great. The drop could be just a reaction to USD strength after Fed Chair Janet Yellen on Sunday 15th October 2017 reiterated her long-standing view that inflation will eventually accelerate and the Fed intends to keep raising rates gradually. (Just FYI, ECB’s Draghi and Bank of England’s Carney agreed with her on inflation.) Why anyone would think she would say anything different is beyond me; perhaps they were worried that Friday 13th October 2017’s slightly lower-than-expected US CPI might have changed her view.

I wonder though if the EUR weakness also reflects the return of political concerns to Europe. There were two significant elections in Europe on Sunday 15th October 2017, and both didn’t go the way the markets would have preferred.

The Austrian center-right People’s Party came in first in the election for the Austrian National Council, with the far-right Freedom Party coming in second. The ruling Social Democrats came in third. The two right-wing parties will now form a government. Austria is now likely to align itself more with the eastern European countries that have clashed with Brussels over some EU policies, notably migration. Secondly, in Germany, PM Merkel’s CDU party posted its worst result in the state of Lower Saxony since 1959. The result may weaken Merkel’s hand in talks that begin on Wednesday 18th October to form a national coalition.

Political uncertainty has faded recently in Europe, especially since the CDU won the national ballot three weeks ago, but these elections together with the tensions in Spain (see below) may bring back a political risk premium to the euro.

Speaking of political risk premium, NZD was the biggest gainer even though the politicians failed to achieve a breakthrough over the weekend. Acting PM English said it could take until the end of the week to confirm the country’s next government. Nonetheless NZD and AUD both held onto much of their gains from Friday 13th October, when the disappointing US CPI came out.

Today’s market

The main indicators for the day are over already – China’s CPI came out as expected at 1.6% yoy (down from 1.8%), while PPI rose more than expected to 6.9% yoy from 6.3%. The PPI is what’s important for global inflation, since China exports so much. The jump in Chinese PPI inflation does make it marginally more likely that Western countries will hit their inflation targets.

We’re now waiting to see how Catalonia clarifies its declaration of suspended independence from last week – when Catalan President Puigdemont said the vote gave the region the right to be “an independent state,” but that the state had been “suspended” for a few weeks pending talks.

Spanish PM Rajoy has given Puigdemont until 10 AM local time today to state whether they actually declared independence. If he says they didn’t, then fine. If he says they did, then he will have three days to reconsider, after which Rajoy will seek official approval to defenestrate the Catalan government and govern the region from Madrid. That would be almost sure to involve huge demonstrations, which could rebound against the euro.

The developments in Catalan haven’t had that much of an impact on the Euro yet, as the EU authorities have stayed totally out of the picture. The graph shows that as the spread of 10yr Spanish bonds widened out relative to German bonds, the green line, EUR/USD, the purple line, was pretty steady. That may be because the EU and other regional authorities have been careful to stay out of the crisis. But if the situation worsens, I think we can expect some contagion and a knock-on effect on the euro.

In the US, the Empire State manufacturing index is expected to fall slightly, as is the Philadelphia index, which will be released on Thursday. The decline in the Empire State index is nothing to be concerned about, seeing as it was recently at the highest level in three years anyway (and second highest since 2010). It stands to reason given the diminishing prospects for tax reform or any kind of fiscal stimulus. USD-neutral.

While it’s not usually given on most FX calendars, the sub-index for new orders is closely watched by economists as a leading index of manufacturing strength. In September it hit the highest level since Oct. 2009. Even if the headline number falls more than expected, we could see USD gain if the new orders figure rises further.

After that, it’s all quiet until Tuesday morning in New Zealand, when the Q3 CPI will be released. The market expects it to hit 1.9% yoy, above the Reserve Bank of New Zealand’s forecast for the quarter and close to their 2% target.

Faster NZ inflation could be positive for NZD and see AUD/NZD fall further. Right now there’s slightly less tightening priced into NZD (the green line below) than AUD (the purple line). An acceleration in NZ inflation could narrow that gap and push AUD/NZD down.

The minutes of the 3 October meeting of the Reserve Bank of Australia (RBA) will be released. We should get more clarity on their views about such key issues as housing, consumers and the labor market. However, the statement and the decision didn’t have a lasting impact when they were released – AUD/USD fell 30 pips immediately following the announcement, but had regained it all four hours later and was higher by the end of the (European) day. Thus it’s unlikely that the minutes will reveal anything to dramatically change people’s view of the RBA, particularly since the twice-yearly Financial Stability Review was recently published. AUD-neutral.

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

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