FX Traders Cautious Despite Positive US Data

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FX Traders Cautious Despite Positive US Data
EUR: Still Waiting on Moody’s
GBP: Hit By Weaker Manufacturing and Lending Data
AUD: Will the RBA Ease?
CAD: Mixed Inflationary Indicators
NZD: Gold and Oil Up Marginally

FX Traders Cautious Despite Positive US Data

Better than expected U.S. economic data failed to lift risk appetite as currencies treaded water throughout the North American trading session. The jump in manufacturing activity provided a jolt of excitement for investors but the enthusiasm didn’t last for long. After contracting for 3 consecutive months, manufacturing activity expanded in September thanks to a surprisingly large increase in new orders. The Institute of Supply Manager’s factory index rose from 49.6 to 51.5 last month. Investors were caught off guard because regional reports have not been as positive as the national reading. While the road to recovery for the U.S. economy is still very long, these small wins are encouraging. Unfortunately the U.S. is a service-based economy and this means stronger manufacturing activity is not enough to get everyone excited. We are far more interested in the non-manufacturing ISM report due later this week and non-farm payrolls. For currency investors, this first trading day of the third quarter is fraught with uncertainty because investors are still waiting for updates on Spain.

In the meantime, Federal Reserve officials were out in force defending Quantitative Easing. Fed Chairman Ben Bernanke hit back at the critics in a speech to the Economic Club of Indiana this morning. He explained that the Fed needed to increase stimulus last month because the economy wasn’t growing fast enough to reduce unemployment. By boosting their asset purchase program, the Federal Reserve is actively driving yields lower which should promote growth by supporting the prices of stocks, homes and other assets. The Fed hopes this will translate into stronger business and consumer spending. There have been a lot of critics of QE inside and outside of the Fed but the central bank Chairman is unwavering in his belief that this is the right path to stronger growth. Bernanke pledged to keep monetary policy highly accommodative after the economy strengthens but clarified that this does not mean the central bank expects the economy to be weak through 2015. He tackled the main issues of concern one by one including the damage that QE will have on savers by arguing that they will benefit from stronger growth. In doing so, it is clear that Bernanke is more committed than he has ever been to ultra easy monetary policy. Fed President Evans also spoke this morning and while he is not a voting member of the FOMC this year, his view that there’s scope for the Fed to do more has some investors thinking that they could get more out of the central bank. No major U.S. economic reports are scheduled for release tomorrow, which means it could be another quiet trading day. Volatility should pick up on Wednesday and we are still on watch for a decision from Moody’s on Spain’s debt rating.

EUR: Still Waiting on Moody’s

The euro traded slightly higher against the U.S. dollar following a small upward revision in manufacturing activity. Thanks to stronger growth in France and Germany, the Eurozone PMI manufacturing index was revised up from 46.0 to 46.1. Despite the Swiss National Bank’s intervention efforts, manufacturing activity contracted for the sixth consecutive month with the PMI index dropping to its lowest level in more than 3 years. Thankfully the Franc still managed to rise against the U.S. dollar because retail sales rose a whopping 5.9% in the month of August. Despite quiet trading in the EUR/USD, there is an overall sense of nervousness in the market that makes us worried about how the currency pair will react to any bad news. We are still waiting for Moody’s to make a decision on whether Spain should be downgraded. Last night, the rating agency said Spain’s plan to recapitalize their banks is credit positive, but maybe not enough. In doing so, they teased the possibility of a downgrade but stopped short of making a definitive decision. For investors, this means continued uncertainty that won’t be lifted until Spain asks for bailout. Even if Moody’s spares Spain a downgrade, the financial community won’t be satisfied until the country asks for help and we think Spain will cave within the next 20 trading days. More than EUR20 billion worth of Spanish bonds are scheduled to mature this month – the single largest month of bond redemptions this year. If Spain fails to convince investors to reinvest their proceeds, they will need to procure enough cash to pay them out. Last week, the Spanish government outlined 43 new measures to boost growth and rein in the deficit. It is widely believed that their decision to go above and beyond in terms of laying out a detailed timetable for economic reforms is their way of paving the foundation for a bailout in the next few weeks. The hope is that if they outline new reform measures now, the European Union won’t ask for more cuts when Spain comes knocking on their door. Part of the reason why the Prime Minister has been holding off is because of regional elections on October 21st. A bailout would represent a major failure that could affect his party’s stronghold in key regions. Once the regional polls are out of the way however, the government must repay a EUR5.3 billion note maturing on October 29 and a EUR15 billion bond that matures on October 31st. Therefore the perfect window for Spain to ask for a bailout is between October 22nd and October 26th. If borrowing costs rise materially before then, due to a downgrade from Moody’s or pure risk aversion, they could cave even sooner.

GBP: Hit By Weaker Manufacturing and Lending Data

Weaker economic data out of the U.K. drove the British pound lower against the U.S. dollar and euro. According to the PMI report, manufacturing activity in the U.K. contracted more deeply in the month of September. The index dropped from 49.6 to 48.4, marking the fifth straight month of contraction. While new orders edged higher, output and exports declined materially which indicates that slower growth in the Eurozone and Asia is taking a big toll on the U.K. economy. The employment component also fell to its lowest level since November, which is a sign that labor market conditions this month weakened. Consumer credit and net lending securities on dwellings also dropped in August, which represents a disappointing start for the Funding for Lending Scheme. The goal of FLS was to get banks to increase lending and based on the August numbers, there was very little uptake. However it is unfair to draw a conclusion so quickly on the Bank of England’s program. It was recently announced that 13 lenders including 4 out of the country’s 5 largest banks are participating in the scheme. This suggests that the next few reports should show significant improvement and if they don’t, then the U.K. economy is in big trouble. Nationwide house prices and PMI Construction are scheduled for release on Tuesday.

AUD: Will the RBA Ease?

Weaker Chinese manufacturing activity drove the Australian and New Zealand dollars lower against the greenback. The greatest fear in Asia is that slower growth in China will mean slower growth for the region as a whole. Tonight, we will learn if the Reserve Bank of Australia will be pushed over the edge by weakness in the country’s most important trade partner. Economists are not looking for the RBA to change interest rates but futures traders are pricing in a 70% chance of a rate cut. Slower growth in China is certainly a worry for the central bank and we have already seen manufacturing activity weaken in August. However job vacancies increased, leading indicators steadied, business and consumer confidence increased and the unemployment rate dropped to 5.1%. Having already cut interest rates by 75bp the RBA has done a lot this year. Based on the minutes from the last monetary policy meeting, the central bank is comfortably on hold. At the time, they wanted to give the May and June rate cuts more time to work their way into the economy. Since then, there has not been a tremendous amount of economic data and at the same time, Europe’s uncertainties remain unresolved. A smart central bank would wait to see whether Spain gets downgraded by Moody’s and accepts a bailout and that is exactly what we think the RBA will do. Nonetheless, the differing views between economists and traders mean that someone is bound to be surprised and for the Australian dollar this means volatility. If the Reserve Bank moves forward with a rate cut this week, the AUD/USD could revisit its 2 month low of 1.0167. If the RBA leaves rates unchanged, the AUD/USD could rise back towards 1.05. In Canada, industrial product prices continued to fall in August but raw material prices jumped 3.4%, which helped the Canadian dollar hold steady against the greenback.

Kathy Lien
Managing Director

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