Thursday’s currency trading looks like a contest for which currency has the worst economic fundamentals; the euro, sterling and kiwi are all falling against the U.S. dollar and the Japanese yen due to fresh evidence of deteriorating economic data. Germany’s IFO survey tumbled to a three-year low in July, showing the fastest percentage decline since September 2001. UK retail sales tumbled by the most in 22 years in June. The high yielding kiwi tumbled across the board as the Reserve Bank of New Zealand made its first interest rate cut in five years, slashing rates by 25 basis points (bps) to 8.00%.
The United States is not unscathed as weekly jobless claims rose by 34,000 to 406,000 last week vs. 375,000 expected. Department of Labor (DoL) analysts continue to cite the July 4 holiday and auto plant shutdowns as a reason to the jump. Continued claims fell by 9,000 to 3.107 million. The number means more declines in yen crosses, especially in GBP/JPY, EUR/JPY and NZD/JPY.
Nonetheless, the dollar continues to benefit from the economic woes of other currencies as the lack of major U.S. data releases so far this week has been replaced by reassuring words from the U.S. Treasury Secretary and the passing of bills supporting Fannie Mae and Freddie Mac. Markets have largely ignored yesterday’s Beige Book survey, which echoed the Federal Open Market Committee’s (FOMC) concerns with prolonged upside inflation risks and downside growth pressures.
Markets await the 10 a.m. release of U.S. existing home sales, which are expected to drop to 4.95 million in June from 4.99 million.
German IFO disappointment rises to the occasion
Germany’s much anticipated release of the IFO business sentiment survey did not disappoint in undershooting expectations, as all three components of the survey tumbled to three-year lows, falling by the fastest pace since September 2001. The July current assessment index fell to 105.7 (exp: 106.0) from 108.3, while the business expectations index fell to 90.0 (exp: 93.0) from 94.7. In other data, Euro zone July flash services PMI fell to 48.3 from 48.8, while July flash manufacturing PMI dropped to 47.5 from June’s 48.7. Germany’s flash services PMI unexpectedly rose to 53.3 from 52.1, while its flash manufacturing PMI dropped to 50.9 from 52.6. French flash PMIs further deepened their gloom below the 50 level.
Yesterday we warned that the “combination of prolonged IFO and PMI weakness could further punish the single currency, to as low as $1.5660.” Today, EUR/USD dropped to $1.5639 from $1.5710. The onset of a better than expected showing in U.S. existing home sales at 10 a.m. EST may further push the single currency back towards 1.5610-15, which is just below the 50- and 100-day moving averages. Key support stands at 1.5580. The euro appears too weak to make any convincing recovery above $1.5780 in the incoming week.
We warned yesterday about the onset of a reversal in EUR/JPY towards the 168 yen target from 169.95 high, but the pair has limited its losses to 168.53. We expect declines towards 168.20 and 167.50.
Sterling fundamentals catch up
The sterling dropped across the board after U.K. retail sales fell by the most in 22 years in June, dropping 3.9% following a 3.6% increase in May, and overshooting expectations of a 2.6% decline. While the data are viewed an obstacle to a Bank of England (BoE) rate hike, we view them amid the increasing evidence of a looming interest rate cut. Although the retail sales report showed rising price pressures, the downside risks to the economy are unlikely to maintain interest rates at 5.00% when GDP growth is expected to slow to 1.0%. We continue to expect the next interest rate change to be an increase, with 50 bps of easing seen by year end. GBP/USD chart below shows increasing bearish divergence in the stochastics, which pave the way for a crossover that will likely call up $1.9650 and $1.9580. GBPJPY dropped from 215.50 to 214, signaling further pullback to as low as 211.50.
What does the Kiwi rate cut mean?
The 25 bps rate cut from the Reserve Bank of New Zealand is the first rate cut from a top central bank since the April rate cuts from the Fed, BoE and Bank of Canada. While New Zealand’s fundamentals suffered from excessively high rates of 8.25%, which were aimed at stemming dairy product inflation, the RBNZ rate cut could portend similar actions by other central banks as downside growth pressures escalate further relative to inflationary pressures. The rate cut suggests further easing to come, likely triggering prolonged NZD declines against USD (0.7370), JPY (76.7), EUR (0.4660) and AUD (1.3030).
The RBNZ rate cycle may appear similar to that of the Reserve Bank of Australia, but as the chart indicates, the RBNZ cycle is more volatile and is not necessarily indicative of future RBA moves. This is especially the case as the prospects for Aussie commodities diverge from dairy products, which are the sole commodities comprising Kiwi earnings. We may see Aussie rates remaining at 7.25% into the end of the year as the same time as the RBNZ eases interest rates by another 50bps.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
