- Markets doubting the possibility of a December Fed move, especially if US data continues to come in on the soft side
- The JPY may further strengthen in response to fading rate hike expectations in the US. The only thing that could prevent the yen from strengthening further is the possibility of the Fed pushing the button before the end of the year
- Emerging market currencies likely to be the best performers should investors continue returning to carry trade strategies
- We are very concerned about the state of the German economy as the Eurozone’s main economic driver
- We believe that Draghi is likely to announce the extension of the ECB QE program despite the fact that we believe that an 18-month program won't be sufficient to stimulate growth and inflation.
- It could be a good idea to reload dollar positions as expectations for a year-end Fed rate hike should soon improve again and then to sell dollar positions before the markets has a chance to price in a no rate hike scenario
- We expect the 2017 growth forecast to be lowered to 1,5% from 1,7%
After Tuesday’s broad sell-off in the USD dollar, FX markets stabilised on Wednesday with the exception of the Japanese yen, which continued to appreciate. The dollar index fell almost 1% to 94.78 yesterday after the ISM non-manufacturing index moved closer to the 50 threshold that separates contraction from expansion, printing at 51.4 in August versus 54.9 median forecast and 55.5 in July. This is the lowest read since January 2010. The summer months were definitely not kind to the US economy: The NFP report disappointed, the ISM manufacturing gauge moved below 50 and now the non-manufacturing index has hit a 6-year low. We are already dovish about the next FOMC meeting in late September and rule out any tightening move from the Federal Reserve. The market has even come to doubt the possibility of a December move, especially if US data continues to come in on the soft side.
The Japanese yen strengthened in overnight trading in response to fading rate hike expectations in the US. After falling 1.40% yesterday, USD/JPY slid another 0.90% in Tokyo to reach 101.21, the lowest level since August 26th. The only thing that could prevent the yen from strengthening further is the possibility of the Fed pushing the button before the end of the year.
Emerging markets currencies were the best performers yesterday as investors returned to carry trade strategies. Since Tuesday morning, the South African rand rose almost 3% against the greenback, the Brazilian real surged 2.70%, while in Asia, the South Korean won was up 1.26%.
Equity markets across the globe also welcomed the news and continued to rally strongly. On Tuesday, US equity indices extended gains with the S&P 500 rising 0.30% and the Nasdaq Composite climbing 0.50%. In Asia, regional markets were mostly up with the exception of Japanese equities, which were dragged down by a strengthening yen. In mainland China, the Shanghai and Shenzhen Composites were up 0.14% and 0.04% respectively. In Taiwan, the Taiex index was up 0.84%, while in India the Sensex rose 0.16%. In Europe, equity futures continue to climb as investors join the rally.
Peter Rosenstreich, head of market strategy: "Weak USD will influence ECB and BoJ: US data continues to print on the weaker side as ISM non-manufacturing fell to its lowest levels since 2010. The ISM non-manufacturing index slid to 51.4 in August from 55.5 against expectations of 54.5. A sharp decline in business activity was the primary reason for the fall, collapsing to 51.8 following a strong 59.3 read in July. While the data remains above recessionary levels, the fall and downward trend should raise red flags, especially for voting FOMC members. OIS markets are now pricing in only a 13% probability of a 25bp Fed Sept rate hike (Dec hike is around 50%). Lingering USD longs built up on Fed rate hike expectations were quickly cut. In the short term, the reversal of bullish sentiment should have a meaningful effect on central bank strategy.
What concerns central banks most about the sudden USD weakness is that it in turn makes other currencies stronger and their financial conditions tighter. Most central banks, including the BoJ and ECB were praying for a Fed hike, which would have sent capital into the USD, weakening the JPY and EUR. Basically, this would have had the Fed doing the central bank’s dirty work of debasing their currencies and retaining their competitive advantage. When you clear the policy rhetoric away, currently the most important factor to economic recovery is a weak currency. Without the help of the Fed to weaken their respective currencies, the ECB and BoJ will have to move forward with additional policy easing to sustain their competitive currency advantages. The weaker USD increases the likelihood of the ECB and the BoJ moving forward with currency debasing policies in the near term. Remember, while it doesn’t make the headlines, the fact remains that the world is still in the throes of a currency war and in the end the national loser will be the one with the strongest currency.” ---
Yann Quelenn, market analyst: “Continued decline of German economic data: Early this morning, July German industrial production came in very weak. The data was expected to print quasi flat at 0.1% m/m but it came in largely in negative territory at -1.5% m/m. As stated yesterday, Germany's economic data is very troubling, especially when we consider that the country is the main driver of the Eurozone.
In terms of currency, markets have priced in a long QE program from the ECB so there is no more massive downside pressures for the time being. The Fed is the main EUR/USD driver at the moment. Indeed, yesterday’s US economic data printed lower (ISM non-manufacturing) triggering an important dollar sell-off, which has sent the euro higher. Markets was repricing a reduced likelihood of a rate increase for the September Fed meeting. Now, is a good time to reload dollar positions as expectations for a year-end Fed rate hike should improve again. The key is clearly to sell these dollar positions before markets have the chance to price in a no rate hike scenerio. This strategy has played out well over the past year.
At tomorrow’s ECB meeting, markets have largely priced in that rates will be kept unchanged. Initially, QE was set to take place until this month but we believe that ECB president Mario Draghi is likely to announce the extension of the program. When looking to QE in Japan or in the US, it is obvious that an 18-month program would never have been sufficient to stimulate growth and inflation. On top of that, we will closely watch growth and inflation projections for this year up to 2018. We expect growth forecasts to be lowered to 1.5% for 2017 from 1.7%. What is ironic is that extending the QE program is actually revealing much about its inefficiency. And as a result, the free money party is set to continue for stocks and bonds investors.” ---
Today traders will be watching FX reserves from Switzerland; Halifax house prices from the UK; interest rate decision from Sweden and Canada (no change expected); industrial production from Norway and UK; the release of the Beige Book from the US.