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IronFX Daily Commentary | 05/08/15

05.08.2015, 10am

• Lockhart changes the way of looking at Fed rate decision Will they raise rates this year? Will the data be good enough to support a rate hike? These have been the major questions for financial markets his year. Overnight the debate turned around and raising rates became the default position after Atlanta Fed President Lockhart said “the economy is ready and it is an appropriate time to make a change.” Rather than looking for an improvement in the economy to convince him to tighten in September, he said there would have to be “a significant deterioration in the economic picture” to convince him not to move. In other words, the calculus is reversed. This is important because Lockhart tends to be a centrist among the FOMC members, neither a noted dove nor hawk. For example, back in May he said, “I am more prepared to take the risks of waiting than the risks of being too early, particularly in light of what we saw in Q1.” Following St. Louis Fed President Bullard’s comments Friday that the economy is “in good shape,” his comments indicate a growing view among the Committee, albeit not yet a majority.

• Following his comments, Fed funds futures were predicting 0.185% for September and were back above 1% for December 2016, although just barely (1.03%). This strengthened the dollar against almost all currencies. I would expect the dollar to remain strong, at least this week, as the labor market data is likely to show continued gains towards the Fed’s policy goals. Unfortunately there are few Fed officials speaking in the near future to give further clarification – Lockhart gives a speech on Aug. 10th and noted dove Minneapolis Fed President Kocherlakota on Aug. 20th. We may have to wait until the annual Jackson Hole symposium on Aug. 27th to get detailed views from more Fed officials.

• Commodities rebound a little Commodities rebounded slightly on Tuesday, perhaps because of some stabilization in the Chinese stock market (which has resumed falling today). Oil gained after the API inventory report showing a bigger drawdown than expected. That helped the commodity currencies somewhat, although they were still generally lower vs USD – CAD for example was down only slightly despite the disappointing decline in the Canadian manufacturing PMI in July, reversing several months of recovery.

• AUD has been gradually moving lower but is still well above its level of before the RBA meeting as the market digests the change in its view on the currency. NZD however fell as the average winning price at the biweekly dairy auction declined once again, the ninth consecutive decline. The price is now down 38% from its peak in March, which is a dramatic fall in just a few months. Moreover the unemployment rate rose to 5.9% from 5.8%, as expected, making further loosening all the more likely.

• I believe that just as investors were talking about a “commodity supercycle” a few years ago, we are now in a chronic situation of oversupply and prices are likely to continue to decline. Against that background, we can expect the commodity currencies to weaken further.

• China’s service sector doing OK: China’s Caixin service-sector PMI for July rose to 53.8 from 51.8, as the service sector in China – as in much of the world – is doing better than manufacturing. This is particularly important for China, where the government is trying to rebalance the economy away from investment and towards domestic demand. The overall PMI however declined to 50.2 from 50.6, meaning the economy as a whole is perilously close to contraction.

• Today’s highlights: During the European day, we get the final service-sector PMIs for July from the countries we got the manufacturing data for on Monday. As usual, the final forecasts for France, Germany and Eurozone are the same as the initial estimates, therefore the market reaction is usually limited at these releases. Eurozone’s retail sales for June are coming out as well.

• The UK service-sector PMI is forecast to have slid to 58.0 in July from 58.5 in June. After the mixed manufacturing and construction PMIs for July, a slide in the service-sector PMI could prove GBP-negative.

• The main indicator for the day is the US ADP employment change for July coming out two days ahead of the nonfarm payroll release. The ADP report is expected to show that the private sector gained fewer jobs in July than it did in the previous month. Although there is a lot of variation between the ADP and the NFP reports, if the ADP report comes strong and prints another solid above 200k reading, the market is likely to assume that the nonfarm payroll figure may come in strong as well and boost the dollar. Further improvement in the labor market is likely to keep confidence up that the Fed is on track to raise rates.

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