A volatile week ends with Euro and Sterling largely unchanged
01/Sep/2015 • Currency Updates•
Financial markets saw an extraordinarily volatile week. The nervousness started late Sunday 23rd when further negative news out of the Chinese economy, together with signs that the authorities there were (sensibly) backing away from propping up stock price levels, hit Chinese equities hard.
What followed was, in our view, a classic case of deleveraging. Popular investment positions and trades were forcibly unwound into typically illiquid August markets, magnifying the size of the market moves. In terms of currencies, we saw the Euro rally sharply and emerging market currencies crash early in the week, with the single currency gaining on so called “carry trades”. This occurred as previously ultra-low rates prompted investors to borrow the Euro to purchase currencies with higher returns. Then in times of financial stress, such as last week, investors flocked back to the Euro.
However, by mid-week the selling was exhausted, and we saw a strong rally in risk assets across the board, which meant equities actually ended the week up in most exchanges, and the Euro back below its starting point for the week. Strong US GDP data and further cuts in rates from China strengthened the bulls’ hands, and it seems possible that last week moves were nothing more than a summer squall – though the Chinese slowdown will continue to be a drag on global growth into 2016.
This most eventful week ended with the annual gathering of central bankers in Jacksonhole, Wyoming. The message there, particularly from the Fed and the Bank of England, is that monetary authorities are mostly looking past the market volatility and the drops in equity prices will not stay the central banks’ hands when it comes to raising interest rates.
A quiet week on the data front, though far from that in terms of market action. The first revision to second-quarter GDP numbers left the number unchanged at a healthy 2.8% annualised. We now look forward to next week’s PMI numbers, for an indication of how the third quarter is shaping up.
More important for future developments in Sterling was Governor Carney’s declarations at the central bankers confabulation in Jacksonhole, Wyoming. Carney sounded distinctly unfazed by the wild market moves. He stated that “developments in China are unlikely to change the process of rate increases”.
This provides strong support for our view that interest rates in the UK will start going up in February 2016, and therefore Sterling is likely to be well supported against the Euro, as Eurozone policy is moving in the opposite direction.
Second-tiers indicators out of the Eurozone last week were consistent with a continuation of growth in the modest 1.5%-2% range, which has been the recent norm.
The most hopeful news was the sharp acceleration of bank lending in July, which rose at its fastest pace in four years. All in all, the Eurozone economy is yet to show any effects from either the Chinese slowdown or market volatility – though of course all these indicators are lagging, and we will have to wait for the PMI confidence indices to confirm this resiliency.
The common currency was mostly driven by a lack of liquidity and the liquidation of stale trader positions, which had taken advantage of the extremely low Eurozone yields to establish “carry trades” against other higher yielding currencies, particularly those of emerging markets. Now that this positioning has been largely unwound, we expect the common currency to resume its downward trend against the US Dollar.
The US provided a slate of significantly better than expected news last week.
Second-quarter GDP was revised sharply up to 3.7% from 2.3%. Recent data from durable goods orders in July was also consistent with a modest acceleration of US growth. With financial volatility and actual economic data pulling in different directions, the Fed September interest rate hike remains a close call.
This was underlined by New York Fed President Dudley and Vice Chair Fischer, who gave fairly divergent speeches. The former mentioned that the case for an increase was now “less compelling”, while the latter suggested he expects inflation to rebound to the Fed’s target relatively quickly.
Although uncertainty has increased, and the vote will not be unanimous either way, we remain of the opinion that rates will go up later this month in the US.