• Commodities rally, but not all commodity currencies The big move yesterday was in the commodities market, where many commodities from oil to copper rallied. There must have been some change in view towards the asset class as a whole, but it doesn’t seem to have been due to a change in the overall macro picture. Rather, there were individual stories for several commodities, which probably spilled over into other commodities as well. For example, oil rose after China’s crude oil imports rose to a record, easing fears that demand for energy – and other commodities -- there is slipping. Rains in Chile halted work at some of their copper mines, while excessive moisture is threatening US crops. However, don’t look for a long-lasting change in direction; all the precious metals and most of the energy futures are below their New York close now, while about half the agricultural commodities are lower too, after China revalued the CNY lower.
• Revaluation of CNY hits NZD and AUD The People’s Bank of China (PBOC) cut the central rate for USD/CNY by 1.86% to 6.2298, the largest devaluation in two decades. It said the move was a one-time adjustment because the currency’s effective exchange rate – that is, its exchange rate against all the country’s trading partners, not just the US – was stronger than other currencies. That certainly is true, although it’s probably due to a combination of A) weakness in other currencies and B) the PBOC pegging CNY largely against the dollar, which has been strong. Using the BIS’s measures of Real Effective Exchange Rates (REERs), China’s currency appreciated by 14%, the most of any major currency in the year to June (the latest data available).
• It’s quite likely that the larger-than-expected fall in exports in July that was announced over the weekend had something to do with the move. I’ve been saying for some time now that the slowdown in global trade, plus the deflationary pressures from falling commodity prices (which themselves may be just a symptom of falling demand, too) would be likely to restart the “currency wars.” Now we have the first shot fired. Although China said this was a one-off move, other countries are likely to be wary. Who will be first to react? South Korea has a Monetary Policy Committee meeting on Thursday. The country cut its policy rate back in June but kept it steady in July. All 16 economists polled on Bloomberg expect them to keep it unchanged at this week’s meeting, but following the Chinese move, for how long? We may also start to hear less from Japanese officials about how the weak yen may be hurting consumers and more about how it helps to spur exports, which are finally starting to revive there.
• China’s move is a big negative for the currencies of countries that sell to China and those that compete with it in third countries. This includes Australia, New Zealand, South Korea, Japan and the other Asian countries. Note that emerging Asia as a whole is doing no better than China in the export department, either. The weaker CNY may make life more difficult for the Eurozone as well. Total EU trade with China amounted to $638bn in 2014, only slightly less than trade with the US ($655bn). It also helps China to export deflation around the world. I doubt if it will derail the Fed’s plans to tighten, but it may well slow the pace of their tightening. It could have a bigger impact on the actions of the Bank of England, where the mandate is focused entirely on inflation.
• EUR/CHF hits post-floor high I mentioned yesterday morning that EUR/CHF had challenged the highs set since Switzerland dismantled the CHF floor back in January. The pair broke through that level in yesterday’s trading and moved higher. The weakening of this safe-haven currency may be due to Swiss investors moving funds out in search of higher yield – indeed, in search of some yield. There may also be a recovery of confidence now that Chinese stocks seem to have bottomed. CHF has been out of the spotlight recently but I think it could come back into fashion again as a funding currency, given how nicely investors are paid to borrow CHF (three-month CHF is around -0.73%.)
• Today’s highlights: During the European day, the highlight 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. Now however with the Greek crisis and Grexit risk having diminished, we could see an improvement in expectations towards the end of Q3. This may offset the recent soft data and will most likely keep alive the scenario that the Eurozone recovery could start to gather momentum again. EUR could strengthen a bit at these releases.
• In the US, only data of secondary importance are coming out. The NFIB small business optimism for July is expected to have increased a bit. While this indicator is not particularly market-affecting, it’s well worth watching because of the Fed’s emphasis on employment. Small businesses employ the majority of people in the US. We also get the preliminary unit labor costs and nonfarm productivity indices. This concept tracks the growth in employee compensation relative to real output in the nonfarm business sector. Taking into account that the employment cost index for Q2 rose by the least in the history of the report, the likelihood for another disappointment is high, in our view. Something like that could hurt the dollar a bit. Wholesale inventories for June are also coming out.
• From Canada, we get housing starts for July.