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IronFX Daily Commentary | 10/08/15

10.08.2015, 10am

NFP in line with expectations, impact lasts two hours Friday’s US nonfarm payrolls were pretty much in line with expectations. EUR/USD fell about one cent on the news, which pretty much confirmed that a rate hike is coming this year (December if not September). But the impact on market thinking was hardly straightforward: Fed funds rate expectations out to October 2016 gained up to 2 bps, but dates after that gained less and expectations for November 2017 and out actually declined. The 215,000 gain in payrolls, steady 2.1% yoy growth in average hourly earnings, and the unemployment rate remaining at 5.3% will certainly be enough for Atlanta Fed President Lockhart, who said last week that only a “significant deterioration” in the data could change his mind. On top of that, hours worked surged in July, which could indicate that the economy is gaining momentum. The question is whether the data were good enough to convince people like Fed Gov. Powell, who put forward a less certain outlook last week.

• In that case, why did the dollar reverse two hours later and why is it opening mostly lower this morning, particularly against the EM currencies? Several reasons. First off, position-cutting ahead of vacations. People may well have taken advantage of the stronger dollar to sell out in preparation for their holidays. Secondly, oil prices fell further. The Fed may want to start raising rates in September, but if commodity prices continue to weaken, the ultimate level that the Fed hikes to – the “terminal rate” – is likely to be lower than otherwise expected. That would explain why short-term expectations could rise but long-term expectations fall.

• Finally, the NFP data shows that the US labor force is barely growing. Indeed, the drop in the unemployment rate from 5.5% in May to 5.3% in June and July was entirely accounted for by a fall in the participation rate, not from higher job growth. There are some 9mn “missing” workers in the US, if we look at the trend growth in the labor force that existed for many years before the 2008 financial crisis. The Fed doesn’t expect these people to come back to work. Slower growth in the labor force plus little growth in productivity – look for the revised US productivity figures tomorrow – mean slower long-term growth in the US. That again would indicate a lower terminal Fed funds rate and hence less appreciation for USD over the long term.

UK rate expectations no longer following US One notable point from the NFP aftermath: normally, UK rate expectations rise when Fed rate expectations rise, based on the idea that a) a Fed move would provide political cover for the Bank of England to move, and b) both countries are affected similarly by global inflationary trends. This time however it was notable that UK rate expectations didn’t budge, and in fact GBP weakened against USD. This reinforces my view that GBP may well be weak until investors regain confidence that the BoE is likely to raise rates in the foreseeable future. That could be the next BoE meeting, scheduled for Sep. 10th. The near-term technical picture too looks good for EUR/GBP (i.e., bad for GBP). See technical section for more details.

EUR/CHF hits post-float high EUR/CHF hit 1.07892 during trading Friday. This was about the same as the highest European close (1.07894 on 19 Feb) since the pair was allowed to float again in January. Swiss National Bank (SNB) Vice President Fritz Zurbruegg was interviewed in a local paper and made some hawkish statements, such as “the franc still is strongly overvalued.” He said the SNB hasn’t seen any increase in demand for cash, which means that there’s still room for them to lower interest rates further, something they are “of course contemplating.” He added that rates are likely to remain low for longer than people may have expected, because “the global recovery is so slow.” And if that doesn’t work, they’re ready to intervene. All told, it looks to me like CHF is headed lower. It may gain vs some currencies that still have room to cut rates further, such as AUD and NZD, but it’s likely to depreciate vs EUR and USD as domestic investors move money abroad in search of not just higher yield, but indeed any yield at all, as Swiss bond yields are negative out to and including 10 years.

China trade far below estimates, CPI accelerates China’s trade figures for July, announced on Saturday, corroborate the story of slowing global trade. Exports collapsed 8.3% yoy, far more than expected, while imports were also down 8.1% yoy, an acceleration from -6.1% yoy in June. These figures are by value, not volume, so the import side is likely to be depressed by the fall in commodity prices, but the export side relies more on manufactured goods and therefore probably is not distorted as much. (The volume figures aren’t available yet.) The data show that China can no longer rely on exports for growth. This is in fact the government’s aim, to diversify the economy away from export-led investment and towards domestic growth, so it actually shows some success. Nonetheless, there are always winners and losers from every change in the business model, and there are likely to be a lot of export firms that are losing. Weaker exports may encourage the authorities to allow CNY to weaken, which could help to trigger another round of “currency wars” in Asia. No surprise then that AUD and NZD opened lower this morning, although still higher vs USD than they were Friday morning. I expect them to continue to weaken over the medium term as the terms of trade move against them.

• China also released on Sunday its CPI and PPI for July. The longstanding trends continued: CPI growth accelerated more than expected, while PPI deflation also beat expectations. Nonetheless CPI inflation at 1.6% still remains about half the central bank’s target of 3%, so it means there’s plenty of room – make that need – for further stimulus. That may explain why stocks were up sharply this morning: falling exports and deepening deflation at the factory gate level are likely to elicit more of a policy response, the “QE with Chinese characteristics” that we are seeing now with such measures as increased funds going to the policy banks, a government fund to stabilize stock prices, and accepting municipal bonds as collateral.

Today’s highlights: On Monday the calendar is relatively light, with only data of secondary importance due to be released.

• During the European day, Norway’s CPI for July is expected to decelerate a bit. Last month, NOK surged after the country’s core inflation rate beat estimates and the headline figure accelerated to 2.6% yoy from 2.1% yoy previously, a touch above the 2.5% target. Even though the strong data are likely to take some pressure off the Norges Bank to ease further at its September meeting, I would prefer to see the actual figure before getting confident about this idea. If indeed the July CPI is still above target, NOK could strengthen somewhat, at least temporarily.

• In the US, we get the labor market conditions index for July. This is a monthly index that draws on a range of data to produce a single measure to gauge whether the labor market is improving overall. Although not major market mover, the LMCI index will show the broader US labor conditions following Friday’s US employment report for July.

• As for the speakers, Atlanta Fed President Dennis Lockhart speaks. His comments last week touched off a firestorm after he said it would be appropriate to start hiking rates in September. It will be interesting to hear his comments on Friday’s labor market report as well as any riposte he might make to Fed Gov. Powell, who said following Lockhart’s comments last week that “nothing has been decided.”

As for the rest of the week, on Tuesday, the main event will be the German ZEW survey for August. The survey for July added to the weak data coming out from the country, with the expectations index declining and only a modest increase in the current situation index. With the Greek crisis and Grexit risk having diminished however, we could see an improvement in expectations towards the end of the Q2. This will most likely keep alive the scenario that the Eurozone recovery could start to gather momentum again and strengthen EUR a bit.

On Wednesday, China releases its retail sales, industrial production and fixed assets investment for July. It is expected to be a mixed report, which could boost hopes for further stimulus. It remains to be seen though whether AUD and NZD can benefit; in theory they should, but as we saw today, the local stock market rose on such hopes but the currencies didn’t.

• In the UK, we get the unemployment rate for June. Another decline in the rate and acceleration in the growth of average weekly earnings is likely to strengthen GBP.

On Thursday, the highlight will be the US retail sales for July. Retail sales unexpectedly declined in June and the May increase was revised down. This frustrated investors who have being looking for signs that the soft Q1 data was coming to an end. Nevertheless, given the strong 1st estimate of US GDP and expectations for a rebound in July’s retail sales figure, we would expect USD bulls to gain confidence again and strengthen the greenback on the news.

Finally on Friday, in Europe, the main data will be the preliminary Q2 GDP figures for France, Italy, Germany and the Eurozone as a whole. Eurozone’s preliminary GDP rate for Q2 is expected to have risen at the same pace as in Q1, while figures released from Germany, Europe’s growth engine, is likely to show that the economy expanded moderately from Q1. Investors will most likely watch the French, Italian and German data released earlier in the day for the overall growth outlook of the bloc and EUR will react accordingly.


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