Dollar rally takes a breather against G10 currencies; emerging markets, equities, and oil continue to fall
15/Dec/2014 • Currency Updates•
Financial markets moved in a somewhat disjointed manner last week. While the US Dollar fell against most other G10 currencies, particularly the Euro, most risk assets performed quite badly, which is typically associated with a flight to safety and a stronger Dollar. The most likely explanation is that investors are squaring their positions into year-end; the best performing trades of 2014 (long on the Dollar, long on equities) are being unwound at the same time as liquidity is drained from the markets.
Commodity prices deserve a special mention. Most key crude indices fell another 8-10% for the week. Commodity indices are down over 20% so far this year, and oil has fallen almost by half. We regard this drop as similar in effect to a tax cut on most G10 consumers, although the resulting drop in headline inflation may have the perverse effect of helping entrench deflationary expectations in the Eurozone.
Macroeconomic releases in the UK were uniformly disappointing last week. Industrial production and construction both posted decreases in October, at -0.1% and -2.2% MoM SAAR respectively. The November RICS report on the housing market was also consistent with dropping sales and stabilising prices. Overall, the reports last week mean there is downside risk to our expectations for 3% GDP growth in the fourth quarter of 2014.
There were also some important changes in the Bank of England’s communication policies, although these will not start to be implemented until well into 2015. First of all, starting in August of next year, the minutes of the BoE meetings will be published concurrently with the announcement of the rate decision, rather than three weeks later. Second, in 2016 the number of meetings will be lowered from 12 to 8 a year. Although these are clearly important changes, neither of them is expected to have an impact on the timing of interest rate hikes next year.
The main news of the week was the disappointing take up of the second tranche of TLTRO ultra-cheap funding by Eurozone banks. Contrary to our expectations of an upward surprise, 306 banks took up just under 130 billion Euros in total, considerably below consensus of 150 billion Euros. There were further negative developments, in both the economic and policy fronts. Industrial production disappointed again, increasing just 0.1% MoM. The Eurozone discussion of the 2015 budget plans for individual countries left little doubt that Brussels continues to insist on fiscal retrenchment and further budget cuts and tax increases, in particular in France, Spain, Italy and Portugal. Those looking to fiscal policy to provide a tail wind to the Eurozone economy in 2015 were disappointed yet again.
The upshot of this string of negative developments is that the ECB cannot afford to delay any more the launch of further quantitative easing measures, in particular the outright purchase of Eurozone sovereign bonds. We simply do not see how else the ECB can achieve its intended target of a 3 trillion Euros balance sheet – the banks’ disappointing take up of the TLTRO offer has made it clear that they have no interest in helping the ECB achieve this goal. Therefore, we now expect the ECB to announce the start of quantitative easing at its January meeting.
Economic data from the US supported the view that the economic gap across the Atlantic is widening. November retail sales came out much stronger than expected at +0.7% MoM. The combination of an improved labour market and lower energy prices is already being felt both in consumer spending and consumer confidence; the Michigan consumer confidence survey soared to a new cycle high. All eyes are now on next week’s FOMC meeting, which will be followed by a press conference, new economic forecasts and the all-important “points” forecast where each FOMC member is expected to record its expectations for the level of rates at year end of 2015, 2016, and 2017.