The FX market is again turning its attention to global equity space for inspiration, as investor moods darken quickly and everyday bourses test key levels. Again, risk aversion is maintaining a foothold on sentiment as concerns that the global economic outlook is worsening.
So far in today’s opening Euro session, equity markets have opened lower following the sharp losses seen stateside on Tuesday and ahead of FOMC minutes this afternoon. The DAX is underperforming as it again trades -10% below its previous record high, mostly on the back of German corporate earnings worries and various airline profit warning from Ebola concerns throughout the leisure and travel industry.
European misfortunes seem to be only getting worse, as yesterday’s weak Germany August industrial production data has been able to mirror the horrid factory orders print. So far this week, Euro-indices are contemplating taking a good run at closing at or near their recent lows, while gold, bonds/bunds and the JPY (107.89) remain better bid overall. The 10-year UST yield has dropped to +2.34%, bunds to +0.90% – their lowest levels in a number of weeks – and spot gold is firmly back above the psychological $1,200 (at $1,218) as investors appetite for risk has again taken a huge hit.
IMF comes forewarning
Yesterday, the IMF cuts its 2014 global growth forecast from +3.4% to +3.3% and its 2015 forecast from +4.0% to +3.8%, citing eurozone recession risks and emerging market slowdown. The outlook for the global economy has blackened and the IMF sees a “four-in-10″ chance that the eurozone will slide into its third recession since the financial crisis. Despite the softer data touch of late, the IMF is maintaining its Chinese 2014 GDP forecast at +7.4% (somewhat piggybacking Chinese officials official forecasted +7.5%). It seems only natural that Ms. Lagarde and co raised the US 2014 forecast from +1.7% to +2.2% on the back of much stronger data being revealed.
U.S jobs climate paves the way
An example of firmer US data was yesterday’s job opening and labor turnover headlines (the JOLTS report). It’s one of Fed Chair Yellen’s favorite gauges of labor market health in the US. The month of August happened to be mixed, nevertheless, the number of job openings rose +5%, to the highest level in a “bakers” dozen years, while the labor market turnover “slowed” and the number of “quits” declined nearly 3%. The latter decline reflected a reversal of the July increase, leaving the level of quits roughly equal to its average over the first six-months of the year (but still up +5%, y/y). Worker mobility is a close indicator of possible wage growth. Last Friday’s NFP report would suggest that the US economy is again on firmer footing, certainly in stark contrast to some of the other major developed economies who seem to require further monetary stimulation, much sooner rather than later. It’s no wonder that equity markets continue to signal their disappointment with a perceived lack of urgency by both the ECB and to a lesser extent the BoJ.
ECB and BoJ need to open “toolbox”
So far, the weapons of choice for developed economies to combat low inflation or heightened deflation are to limit domestic currency strength – RBA, RBNZ, BoJ and ECB in particular.
Thus far, the antipodean central banks favor “verbal” intervention to adjust currency levels that are “fundamentally” unjustified. Overnight, Aussie intraday volatility action was driven by the big downward revision to Aussie’s August job numbers that had been aggressively overstated (now +32k from +121k). The AUD initially fell to $0.8752, where outright short AUD positions have been able to provide some support. Investors will be looking to September’s jobs data out Thursday for confirmation.
The BoJ and ECB are using “zero” (ZIRP) and “negative” (NIRP) policies, and are actively looking to expand their balance sheets. Despite the mighty U.S dollars strength having a massive FX impact, especially since July, it’s the ECB and the BoJ respectively, who are having the greatest impact on their own currency values, as investors play on the central banks “diverging” interest rate outlook. Many suspect that the ECB will be unable to get to their desired ABS and covered bond program amounts, approximately €1billion for various administrative reason. The ECB’s “whatever it takes attitude” would probably require Euro policy makers to consider opening full-blown QE in H1 2015.
Abenomics under pressure
Japan’s ruling party overnight suggested that USD/JPY trading 110-120 is positive for their economy and that further weakening would probably do more harm. The market believes that the BoJ needs to ease policy again to meet its +2% inflation target in 2015/16. Due to the economic fallout of the initial consumption sales tax implemented in April, many analysts are suggesting that PM Abe is required to postpone the new sales tax hike until April 2017 – proceeding as planned would ruin “Abenomics.”
The BoJ, as expected, kept monetary policy unchanged overnight, with their assessment on industrial production revised lower. Governor Kuroda suggests that the “virtuous cycle of economic activity continues to operate firmly, IP is weak now, but forecasts show growth. CPI is likely to hit the +2% between the periods of 2014 and 2016″ – if the goal can be met then there is no need to adjust policy any time soon.
Weakening currencies are inclined to dampen inflation externally, even at a time when global inflation risks are now weak. Already, the Fed is signaling that U.S inflation is running below the FOMC’s longer-term objective and this despite the improving U.S labor markets. If the dollar’s continued strength begins to weigh on import prices and inflation, it will probably prevent the Fed from communicating a “normalization of monetary policy” – in other words; U.S policy makers will eventually begin to mouth off their concerns surrounding rapid USD appreciation. This is a part of any sustainable currency strength cycle.
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