Data, Earnings, Central Banks and Virus Cases In Focus

Risk appetite took a turn for the better at the end of last week despite an array of the usual suspect risk factors (accelerating Covid-19 cases, US-China tensions, rich valuations). This kept the US dollar under pressure given the inverse relationship between equities and the USD over recent weeks.  Market positioning continues to show sentiment for the USD remaining negative (CFTC IMM data revealed that aggregate USD speculative positions have been net short for 15 out of the last 17 weeks, including the last 5).  Increasingly risks of a US fiscal cliff as stimulus programs run out, with Republicans and Democrats wrangling over more stimulus and US Presidential elections will be added to the list of factors testing market resilience in the days and weeks ahead.

This week there are several key data and events including China June trade data (Tue), China Q2 GDP (Thu), US June  CPI (Tue), US June retail sales (Thu), Australia June employment data and several central bank decisions including Bank of Japan (Wed), European Central Bank (Thu), Bank of Canada (Wed), Bank Indonesia (Thu), Bank of Korea (Thu), and National Bank of Poland (Tue).  Aside from economic data and events the path of virus infections will be closely watched, especially in the US given risks of a reversal of opening up measures.  Last but not least the Q2 earnings season kicks off this week, with financials in particular in focus this week.  Low real yields continue to prove supportive for equities and gold, but very weak earnings could prove to be a major test for equity markets.

On the data front, Chinese exports and imports likely fell in June, but at a slower pace than in the previous month, China’s Q2 GDP is likely to bounce, while US CPI likely got a boost from gasoline prices, and US retail sales likely recorded a sharp jump in June. Almost all of the central bank decisions this week are likely to be dull affairs, with unchanged policy decisions amid subdued inflation, although there is a high risk that Bank Indonesia eases.  The EU Leaders Summit at the end of the week will garner attention too, with any progress on thrashing out agreement on the recovery package in focus.  Watch tech stocks this week too; FANGS look overbought on technical including Relative Strength Index (RSIs) and more significantly breaching 100% Fibonacci retracement levels as does the Nasdaq index, but arguably they have looked rich in absolute terms for a while.

There has been plenty of focus on the rally in Chinese equities over recent weeks and that will continue this week.  Last week Chinese stocks had their best week in 5 years and the CSI 300 is up close to 19% year to date.  Stocks have been helped by state media stories highlighting a “healthy” bull market, but the rally is being compared to the bubble in Chinese stocks in 2014/15, with turnover and margin debt rising.  At that time stock prices rallied sharply only to collapse.   However, Chinese equity valuations are cheaper this time and many analysts still look for equities to continue to rally in the weeks ahead.  China’s authorities are also likely to be more careful about any potential bubble developing.

Interest Rate Decisions Galore

The Reserve Bank of New Zealand (RBNZ) decision to cut policy rates by a bigger than expected 50bps does not necessarily mark the onset of a new wave of NZD selling. Indeed, whilst the NZD was hit by the rate cut it recovered quickly.

The NZD was aided by comments from the RBNZ Governor Bollard that short term inflation may spike due to the earthquake but this tempered by another RBNZ official who stated that the central bank may hold rates at 2.5% at least until January 2012. The post meeting statement indicated that the RBNZ will not embark on a series of rate cuts, a fact that will provide some relief to the Kiwi. Moreover, the currency looks increasingly oversold especially relative to the AUD as indicated by relative positioning.

Weaker than expected employment data in Australia will also help to stem AUD strength versus NZD. After many months of positive surprises the labour market is showing signs of cracking. Admittedly full time employment rose but this was outweighed by an even bigger drop in part time employment, resulting in a 10.1k fall in overall employment.

Although the AUD is unlikely to face too much downside markets the data will likely dampen expectations of possible rate hikes in the months ahead. My preferred way of playing possible AUD underperformance is via the NZD. AUD/NZD is likely to face plenty of resistance around the 1.3800 level and eventually as indicated by our quantitative models the currency pair is likely to move lower over coming weeks.

In sharp contrast to the RBNZ, the Bank of Korea hiked interest rates by 25bps in a further move to normalize policy. The decision was not much of a surprise and the statement indicated that more rate hikes should be expected. The KRW remains rangebound but the currency remains on path for further appreciation over coming months. The surprise trade deficit in China has weighed on Asian currencies in general but weakness is likely to be limited.

The Bank of England is the next central bank on tap today but is unlikely to hike rates despite the hawkish shift within the Monetary Policy Committee. A rate hike is moving closer but the Bank will likely wait until at least May before moving. Further details about today’s decision will as usual wait for the minutes in two weeks time. GBP looks vulnerable and whilst a rate move today is not expected the currency may lose ground over coming days against the background of a firmer USD.

Where will interest rates go up next?

Following the decision by the Reserve Bank of Australia to raise interest rates attention has swiftly turned to which central bank will move next. Indeed, there has been a reassessment of global interest rate decisions following Australia’s move. The hike in Australia is unlikely, however, to be quickly followed by the US, Japan, Europe or UK where policy is set to remain highly accommodative for long while.

Attention will however, turn to the Bank of Korea as well as the RBNZ and Norges Bank. In particular, the Norges Bank may be the next to hike when it meets on October 28. Norway has already appears to be priming markets for a rate hike. The RBNZ is likely to be slower to hike given the still slow pace of recovery in New Zealand and comfortable inflation backdrop.

The impact on currencies is not straightforward as the bigger influence on currency markets throughout the crisis has been risk appetite rather than interest rates. However, the influence of risk on currencies is beginning to wane and although interest rates have not been a major driver of currencies over recent months the move by the RBA likely accelerates the process of yield re-emerging as a key currency driver.

This is a big problem for the US dollar given that the Fed is unlikely to be quick to raise interest rates even if quantitative easing is withdrawn sooner. This means that the dollar will suffer from a growing yield disadvantage as interest rate hikes are priced in elsewhere. Taken together with improving risk appetite as reflected in the resilience of global equity markets, the main casualty will be the dollar, hit both from a yield and risk appetite perspective.

Risk currencies and those currencies with the greater prospect of higher rates will do well meaning further upside for the Australian dollar and New Zealand dollar as well as the Norwegian krone. Asian currencies look to continue to strengthen with the Korean won remaining an outperformer despite intervention threats by the Korean central bank. The euro will benefit from dollar weakness but is unlikely to benefit from anything euro specific given the likely slower pace of recovery in the eurozone. Meanwhile sterling is likely to remain under pressure, not helped by yield or risk appetite, and sentiment hit afresh by weak data.

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