Fundamental Analysis 2017.09.28 – Interest Rates and Major Currencies

Market Recap
It’s all about interest rates these days. As the graph below shows, the change in a currency’s value vs USD over the last two weeks has been 61% determined by the movement of that country’s 10-year yields. For USD, thoughts of faster-than-expected tightening by the Fed and hopes of faster economic growth brought about by the Trump administration’s proposed tax cuts have been pushing up bond yields and thereby supporting the dollar.

The Reserve Bank of New Zealand kept policy unchanged, as expected. The forward-looking last paragraph was unchanged, leaving the possibilitiy of a further cut in rates if necessary. Concerning FX, the main change was that since the NZD had weakened a bit since the August statement, they said a weaker currency “would help” rather than “is needed” “to increase tradables inflation and help deliver more balanced growth.” NZD had weakened in the days ahead of the meeting and was little changed when the statement actually came out. Given that New Zealand is one of the few countries around that is still holding out the possibility of easing policy, I would expect the currency to decline further.

Today’s market
The focus during the European day will be on the German inflation data. It starts off as usual with the consumer price index (CPI) for Saxony early in the morning. Although this isn’t usually forecast, the market does pay attention to it, because as Saxony goes, the country often goes too (even though Saxony is only the sixth most populous state out of the country’s 16).
Later in the day, the pace of national inflation is expected to accelerate a bit to 1.9%, exactly at the ECB’s “close to, but below, 2%” target. Alas Germany is not the EU as a whole, but still, reaching that point could be positive for the euro.

Another focus Thursday will be a conference on “Independence 20 Years On” at the Bank of England, in commemoration of the 20 years since the BoE was granted operational independence over monetary policy. Before then, the Chancellor of the Exchequer (the British equivalent of the Treasury Secretary) decided monetary policy. “The 20th anniversary is an appropriate time for us to reflect on the theory of central bank independence, its practical application and its future,” according to the BoE’s web site. Speakers include BoE Gov. Carney, BoE Deputy Gov. Broadbent, Fed Vice Chair Fischer, RBA Deputy Gov. Debelle, IMF MD Lagarde, and former US Treasury Secretary Summers. The discussions may be largely theoretical, but of course with so many policy makers speaking, something of note to the markets may also come out.

ECB Chief Economist Peter Praet gives the keynote speech at a financial industry conference. His topic will be “The Effects of Quantitative Easing on the European Financial Markets.”
The third estimate of US 2Q GDP is expected to be unchanged from the second estimate at 3.0% qoq SAAR. That would be somewhat disappointing, since the figure has been revised up on the third revision for the last six quarters. The lack of any upward revision could be negative for the dollar, but even so, the effect is likely to be minor at this point, in my view. The Trump administration’s tax plans and their expected impact on the economy and interest rates in the future will probably be more important.

US wholesale inventories are expected to be up 0.4% mom, below the 0.6% mom rate we’ve seen for the last three months. Although this may be considered a deceleration, it’s still slightly above trend and so should be dollar-positive.

Meanwhile, the US advance trade balance is expected to be in deficit by $65.1bn, a notable widening from $63.9bn in the previous two months. Nonetheless, this would be exactly at the 6-month moving average. That could be taken as a sign that the deficit has stabilized (dollar-positive), or it could be taken as a sign that the deficit has stopped narrowing (dollar-negative). Given the current “buy dollar” sentiment, I expect the market would interpret an ambiguous indicator like this favorably if it comes in as forecast. Otherwise, of course the impact depends on whether it misses or exceeds expectations.

Overnight, we get the usual end-of-month slew of Japanese economic indicators. The most important one of these for the FX market is probably the Japan CPI, as that has the most direct impact on Bank of Japan policy. If so, then the impact is likely to be positive for the yen – all the major gauges of CPI are expected to show some measure of acceleration.

Japan’s industrial production is also expected to accelerate, which could be another JPY-positive development.

Australia’s private sector credit growth is expected to maintain the healthy month-on-month pace of growth of the previous month, which would mean an acceleration on a year-on-year basis. That could be positive for AUD.

But 15 minutes later, the Caixin/Markit manufacturing PMI for China comes out and that could be even more important. The index is expected to fall slightly to 51.5 (the same as the official manufacturing PMI, due out Friday, which is why there is only one dot for the forecasts in this graph). A slowdown in Chinese manufacturing might be considered more significant for Australia than a rise in domestic borrowing and therefore be negative for AUD.

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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