Fed want to hike but held back by global environment; rate hike in US could trigger emerging market credit events; further easing from ECB and BoJ likely

By Ian Dobbs*:

The market is getting more and more confident that we will see further easing measures out of both Europe and Japan.

The soft growth and inflation outlook in both economies is likely to pressure their respective central banks to act again, potentially as early as later this month.

The US Fed on the other hand desperately wants to hike interest rates off the ‘zero bound’ but have been held back by the global environment and now potentially by domestic data.

In the wake of Friday’s US employment data the odds of a December interest rate hike have diminished.

When the Fed do eventually get around to hiking interest rates it could be easily be the start of another emerging market crisis.

The IMF recently warned it could trigger a wave of emerging market corporate defaults, setting off panic in financial markets as liquidity evaporates.

In this environment the markets will remain vulnerable to swings in risk sentiment and we can expect plenty of volatility over the foreseeable future.

Major Announcements last week:

  • NZ Business Confidence -18.9 from -29.1 prior

  • Australian Building Approvals -6.9% vs -1.8% expected

  • UK Current Account -16.8b vs -22.2b expected

  • Canadian GDP 0.3% vs 0.2% expected

  • Chinese Manufacturing PMI 49.8 vs 49.7 expected

  • UK Manufacturing PMI 51.5 vs 51.3 expected

  • US ISM manufacturing PMI 50.2 vs 50.8 expected

  • Australian Retail Sales 0.4% as expected

  • UK Construction PMI 59.9 vs 57.5 expected

  • US Non-Farm Payrolls Chance 142k vs 201k expected

  • US ISM Non-Manufacturing PMI 56.9 vs 58.0 expected

  • UK Services PMI 53.3 vs 56.4 expected

  • NZIER Business Confidence -14 from +5 prior.

NZD/USD

The New Zealand dollar has made some solid gains against the USD this past week. Although it took some time, Friday’s disappointing US employment report has started to weigh on the USD and this has helped the local currency break above 0.6450 resistance, with a high of 0.6529 trading last night. Positive expectations for another solid dairy auction result have also aided the NZD although today’s NZIER business survey, which saw the lowest reading since 2011, will have tempered enthusiasm a touch. The 0.6450 area should now provide some support and if the NZD can hold above that level a test toward 0.6600 may well unfold. Fonterra’s dairy auction is out tonight, after which attention will turn to US releases for the remainder of the week. The trade balance and the FOMC minutes will draw close attention and we also have a number of Fed officials set to speak.

DIRECT FX Current level Support Resistance Last wk range
NZD / USD 0.6490 0.6450 0.6600 0.6290 – 0.6529

NZD/AUD (AUD/NZD)

It has been an interesting week for this pair with the key 0.9160 resistance area (1.0917 support) broken last night. The New Zealand dollar has simply out performed its Australian cousin over recent days no doubt helped by positive expectations for another solid dairy action tonight. Caution ahead of today’s Reserve Bank of Australia rate statement will also have held the AUD back a touch and this release may well be key in determining near term direction for the pair. The break above 0.9160 (below 1.0917) is a positive signal as that level had capped the market for the past 3 months or so. If the pair can hold above there in the wake of today’s RBA statement, a broader move higher toward 0.9300 or even 0.9400 (1.0753 or 1.0638) may well unfold.

DIRECT FX Current level Support Resistance Last wk range
NZD / AUD 0.9165 0.9160 0.9300 0.9041 – 0.9199
AUD / NZD 1.0911 1.0753 1.0917 1.0871 – 1.1061

NZD/GBP (GBP/NZD)

The New Zealand dollar has been a strong performer this past week and against the UK Pound this resulted in a test of 0.4300 (2.3256) last night. Softer than expected UK service sector PMI has weighed on the GBP to a degree while the NZD has been supported by expectation of another positive dairy auction tonight. The 0.4220 (2.3697) area should now provide support on the downside and the pair may well try to extend gains toward 0.4400 (2.2727) over the coming week. I would expect the 0.4400 (2.2727) area to provide a significant barrier on the topside and those looking to purchase GBP should target levels just ahead of there. After tonight’s dairy action there is little else to get excited about on the NZ economic calendar, while from the UK we have a number of releases to draw focus including manufacturing and industrial production data, along with the Bank of England interest rate meeting.

DIRECT FX Current level Support Resistance Last wk range
NZD / GBP 0.4285 0.4220 0.4400 0.4148 – 0.4301
GBP / NZD 2.3337 2.2727 2.3697 2.3253 – 2.4107

 NZD/CAD

The Canadian dollar is one of the few currencies to have outperformed the NZD in recent days. Last week better than forecast Canadian GDP data is definitely helping as are stronger oil prices. There is some support for the pair around 0.8450 and while above that level another test toward 0.8600 can’t be ruled out. We have a dairy auction from Fonterra to digest tonight and expectations are that it could be another positive result. This has certainly helped support the NZD to a degree in recent days. Once the dairy auction is out of the way attention will turn to the Canadian trade balance, Ivey PMI, building permits, the new house price index and employment change.

DIRECT FX Current level Support Resistance Last wk range
NZD / CAD 0.8500 0.8450 0.8600 0.8433 – 0.8581

NZD/EURO (EURO/NZD)

The New Zealand dollar has made solid gains against the Euro this past week trading to a high of 0.5830 (low of 1.7153) last night. NZ dollar out performance has been helped by expectation for another positive dairy auction tonight, but the Euro is also suffering as speculation mounts that the ECB will be forced to undertake additional easing measures over the coming months. Growth and inflation data in the Euro area are sagging and this is starting to weigh significantly on the Euro. With the NZD breaking above resistance around 0.5770 last night (below 1.7331), there is now potential for a broader recovery toward 0.5940 (1.6835) to develop. The pair would need to continue to hold above the 0.5770 level (1.7331), which now acts as support for a move higher to develop.

DIRECT FX Current level Support Resistance Last wk range
NZD / EUR 0.5800 0.5770 0.5940 0.5588 – 0.5830
EUR / NZD 1.7241 1.6835 1.7331 1.7153 – 1.7896

 NZD/YEN

We have seen strong gains for this pair over the past week helped by a return of positive risk sentiment. The New Zealand dollar has also been supported by the outlook for another decent dairy auction tonight, while the Japanese Yen is struggling on the back of growing expectation for further easing measures from the Bank of Japan. The break above 77.50 is a positive signal and that level will now provide support on the downside. The next key resistance area doesn’t come in until 80.50 and that level may well provide a good target for the pair over the coming week or two. After Fonterra’s dairy auction tonight the market will quickly turn its attention to tomorrow’s BOJ meeting.

DIRECT FX Current level Support Resistance Last wk range
NZD / YEN 78.20 77.50 80.50 75.22 – 78.53

AUD/USD

The Australian dollar has made gains against the USD over the past week, but there is some caution ahead of today’s Reserve Bank of Australia rate statement that is holding the currency back to a degree. Without a shadow of a doubt, Friday’s US employment data was a big disappointment and although it took some time, it eventually started to weigh on the USD. This has helped the AUD trade up over 0.7100 in the past 24 hours, but direction from here will likely be determined by the tone of the RBA’s statement this afternoon. The AUD will see increased support if the central bank continues to maintain its very neutral stance. Any signal of a move toward an easing bias will weigh on the currency however. Releases from the US this week that will draw attention include the trade balance and the FOMC minutes along with a number of Fed officials who are set to speak. If the AUD can sustain a break above initial resistance around 0.7100 then a move toward 0.7250 may well develop.

DIRECT FX Current level Support Resistance Last wk range
AUD / USD 0.7085 0.6900 0.7100 0.6939 – 0.7109

AUD/GBP (GBP/AUD)                            

The Australian dollar has had a positive week against the UK Pound with gains to 0.4685 (down to 2.1345) in the past 12 hours. This is a critical area for the pair and if it can hold above 0.4670 (below 2.1413) a move higher toward 0.4800 (lower toward 2.0833) may well develop. The UK pound has been hurt by soft service sector PMI data which has served to undo the positive impact of last week’s construction PMI. The immediate attention however is now on this afternoon’s Reserve Bank of Australia rate statement. The AUD will see increased support if the central bank continues to maintain its very neutral stance. Any signal of a move toward an easing bias will weigh on the currency however. From the UK this week we have a number of releases to draw focus including manufacturing and industrial production data along with the Bank of England interest rate meeting.

DIRECT FX Current level Support Resistance Last wk range
AUD / GBP 0.4675 0.4600 0.4800 0.4574 – 0.4685
GBP / AUD 2.1390 2.0833 2.1739 2.1344 – 2.1862

AUD/EURO (EURO/AUD)

It has been a volatile week for this pairing with some real action seen in the wake of Friday’s US employment data. That release caused a quick drop to just below 0.6200 (above 1.6129), but it was short lived and the cross has managed to recover back toward the weeks highs in the past 12 hours. Gains in the Australian dollar have been limited to a degree by uncertainty around today’s Reserve Bank of Australia rate statement. This release will likely provide the near term direction for the pair. If the central bank fails to signal a move toward a more explicit easing bias, the AUD should find support. The Euro itself is being weighed on by expectation that the ECB will be forced to ease policy further over the coming months. That expectation should continue to see support on any dips toward 0.6200 (resistance 1.6129). Topside resistance comes in around 0.6400 (support 1.5625) and if we were to see a break above there the target would then be a test of 0.6530 (1.5314).

DIRECT FX Current level Support Resistance Last wk range
AUD / EUR 0.6330 0.6200 0.6400 0.6156 – 0.6352
EUR / AUD 1.5798 1.5625 1.6129 1.5743 – 1.6243

AUD/YEN

The Australian dollar has managed to outperform the Japanese Yen this week despite a sharp drop in the pair after US employment data on Friday. That dip was short lived and in the past the past 12 hours the cross has managed to break above initial resistance around 85.00. If the AUD can hold above 85.00 a broader move higher toward 87.00 should develop. The Japanese Yen is being weighed on by expectation of further easing action from the BOJ in the coming months. We have the Reserve Bank of Australia rate statement to digest this afternoon and if they maintain their neutral stance the AUD may well benefit. If however they signal a move toward an easing bias, the AUD will suffer. We also have the BOJ meeting to digest tomorrow although any potential easing from them is more likely at their 30th October meeting.

DIRECT FX Current level Support Resistance Last wk range
AUD / YEN 85.35 85.00 87.00 82.85 – 85.50

AUD/CAD

The Canadian dollar has outperformed the Australian dollar this past week. Last week’s better than expected Canadian GDP data has underpinned the CAD along with an improvement in oil prices recently. The Australian dollar on the other hand is being held back by uncertainty around today’s RBA rate statement. Many expect the Reserve Bank will be forced to cut interest rates again over the coming months and if they move to an easing bias at this meeting the AUD will suffer. If however they maintain their current neutral stance the AUD will likely see some appreciation. On the downside there is support around 0.9150 while topside resistance comes in around 0.9400.

DIRECT FX Current level Support Resistance Last wk range
AUD / CAD 0.9270 0.9150 0.9400 0.9259 – 0.9433

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Market commentary:

The market is getting more and more confident that we will see further easing measures out of both Europe and Japan. The soft growth and inflation outlook in both economies is likely to pressure their respective central banks to act again, potentially as early as later this month. The US Fed on the other hand desperately wants to hike interest rates off the ‘zero bound’ but have been held back by the global environment and now potentially by domestic data. In the wake of Friday’s US employment data the odds of a December interest rate hike have diminished. When the Fed do eventually get around to hiking interest rates it could be easily be the start of another emerging market crisis. The IMF recently warned it could trigger a wave of emerging market corporate defaults, setting off panic in financial markets as liquidity evaporates. In this environment the markets will remain vulnerable to swings in risk sentiment and we can expect plenty of volatility over the foreseeable future.

Australia

At the end of last week we got the latest reading of retail sales from Australia. Retail sales grew 0.4% in August which was right on expectation. With all the negative sentiment around the outlook for the Australian economy at the moment there was probably some relief it didn’t print weaker than forecast. Attention now turns to this afternoon’s RBA meeting outcome. There is no expectation for any action from the RBA today, but many forecasters are suggesting we could see further easing late this year or sometime in 2016. So the market will be closely analysing the statement to see if the central bank is shifting to a more ‘dovish’ stance from their current neutral policy setting. The market may be starting to get ahead of itself with expectation for further easing’s from the RBA. Governor Stevens has previously made it clear that the bar for further interest rate cuts is set quite high, and he’s not convinced there would be all that much benefit to the economy. They certainly have room to move if the global, and domestic, situation declines further, but I suspect we’re not close to that threshold just yet. The economy is transitioning away from mining led investment and growth, it’s just happening slower than everyone would like and the global environment isn’t helping much. If we do get another very neutral statement from the RBA the Australian dollar may well react positively.

New Zealand

The only data of note from NZ last week was ANZ business confidence which saw an improvement from the six year lows that printed prior. In the past couple of hours we have seen the latest reading from the NZIER’s quarterly survey of business opinion. It has declined from a prior reading of +5 in Q2 to -14 in Q3. That is its lowest reading since 2011. The drop in confidence is however in contrast to firms own activity with a net 12% reporting an improvement in trading activity over the past quarter and a net 17 percent expecting a further improvement over the coming quarter. The only other data that will draw attention this week is tonight’s dairy auction. Expectation is for another positive result which would be very encouraging considering the past three auctions have delivered double digit growth.

United States

Data from the United States last week was less than inspiring and Friday’s release of key employment data was even worse. The market was keenly anticipating Friday’s data in the hope it would largely confirm a December interest rate hike from the Fed was likely. On that level it has fallen well short. In fact it’s now started to raise serious doubts about the chance of a Fed interest rate hike this year. The non-farm payrolls figures were universally disappointing. The headline figure was much softer than expected at just 142k. Forecasts had been for 200k+. On top of that there were significant negative revisions to prior numbers and wage growth was flat, against expectations of a 0.2% gain. The only positive thing you can say is that the unemployment rate stayed steady at 5.1%. But even then it was only because the participation rate declined to levels not seen in nearly 40 years. There are now 95 million working age Americans not included in the labour force. This was only one month’s data and it can be volatile, so we must be cautious about reading too much into one print, but barring a sharp rebound next month, it’s going to be very hard for the Fed to hike into weakening employment growth figures. The US dollar initially saw pressure on the back of the release, but much like after the last Fed meeting, it rebounded sharply back close to unchanged by the end of the session. It is however getting harder and harder to justify why the USD continues to find so much support. Last night’s release of non-manufacturing PMI data was also a little disappointing falling to 56.9 from 59.0 prior. The overall level of the index is still healthy and the employment component actually improved, but the declining headline reading has only added further doubt to potential Fed action in December. Still to come this week we have the trade balance, the Fed minutes and a number of speeches from officials to digest.

Europe

European Central Bank President Mario Draghi made it very clear recently that the bank is more than willing to ease policy further if economic conditions warrant it. The market currently expects further action from the ECB and data over the past week is certainly heading in the right direction to prompt it. Last week we saw inflation data dip back into negative territory and on Friday we got another soft reading from producer prices. The PPI printed at -0.8% against expectations of -0.6%. Energy prices were obviously a big part of that decline, but even the PPI ex-energy reading fell to -0.2% from 0.0% prior. It seems there may well be further downside pressure on inflation in the pipeline. Euro area PMI’s also mostly declined in September with the composite reading falling to 53.6 driven by weakness in the service sector. Over the coming days we get data on German factory orders and industrial production along with the ECB meeting minutes. These will be closely analysed to get a better feeling of just how far away the central bank is from announcing further easing’s. The ECB will probably be forced to act again at some stage late this year or early next, but with negative interest rates and quantitative easing already in place, what more can they really be expected to do, and is it likely to make any real impact? Draghi has said many times there is a limit to what central bank can do. The world tends to look toward central banks these days to underwrite growth, but they only have a few blunt instruments to work with. Governments are the ones who can really stimulate growth and put policies in place for the long term benefit of the economy. We’re just not seeing this in Europe at the moment.

United Kingdom

Over the past few trading days we have seen PMI data from the manufacturing, construction and services sectors of the UK economy. Manufacturing PMI was largely unchanged and very close to expectation at 51.5, while the construction reading made solid gains to print at 59.9. This suggests construction firms would have enjoyed a very strong finish to the third quarter. Residential construction grew at the highest rate for a year and the employment component of the PMI was also very strong. Countering all this however was the release last night of service sector PMI which accounts for three quarters of the UK economy. It fell to 53.3 from 55.6 prior. The market was expecting a gain to 56.4. This is the lowest print since April 2013 and it seems uncertainty about the global situation has impacted activity to a degree. A reading like this would be consistent with GDP slowing at touch toward 0.5% from 0.7%. Still to come this week we have manufacturing and industrial production data, along with the Bank of England interest rate meeting. The BOE are not expected to adjust policy settings at all and after the Fed decided to hold off hiking rates a couple of weeks ago we may well find the BOE are sitting on their hands for some time yet as well.

Japan

The Japanese economy is struggling to gain traction and continued soft inflation is keeping speculation over more quantitative easing alive and well. Tomorrow we have the latest Bank of Japan interest rate meeting and it’s going to be an interesting affair. There isn’t much expectation for further action from this meeting, but it’s fair to say there is growing expectation for more QE over the coming months. Last week’s Tankan survey result will have done nothing to ease fears that the Japanese economy could well slip back into recession over the coming months. Retail sales and industrial production figures last week also undershot expectation as did wage data released yesterday. All this will leave the BOJ very concerned about the outlook for growth and inflation. Governor Kuroda may well continue to put on a brave face at tomorrow’s meeting, but there is real pressure, and expectation, for them to act at their next meeting on October 30th. The Japanese Yen should remain vulnerable in this environment.

Canada

There has been little of note released from Canada since last week’s better than forecast GDP result. A slightly better commodity picture, particularly for oil, has helped to support the Canadian dollar in recent sessions and we now look forward to a number of key releases over the coming days. The trade balance, Ivey PMI, building permits, the new house price index and employment change are all set to hit the wires before the weekend.

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Ian Dobbs is a currency analyst with Direct FX You can contact him here »