AUD/JPY down on trade fears; Bank of England meeting

Rates as of 05:00 GMT


  • BUY AUD/JPY: I think the FX market overreacted to the news about the timing of a US-China trade agreement. I expect some mean reversion today.
  • BUY AUD/NZD: The market is going to start discounting the possibility of a rate cut at next week’s RBNZ meeting.
  • SELL EUR/USD: I expect the dollar to keep gaining on the euro. One caveat: if yesterday’s EUR/USD decline was due to fears of the impact on trade on Germany, EUR could also recover today.

Market Recap

The stock markets are once again showing neither a strong “risk on” nor “risk off” bias, but the FX market certainly is – AUD/JPY is down sharply after a US official said a meeting between Trump and China President Xi to sign the “phase one” trade agreement could be delayed until December. That doesn’t seem to me to warrrant such a big move. I think the equities market’s response – a shrug of the virtual shoulders – is more appropriate, especially as the aforementioned official did say that a deal is more likely than not. Apparently China thinks they’ll be able to get good terms now, before Trump gets wrapped up in the impeachment trial and re-election campaign, and so wants to sign something quickly.

The fact that AUD was the biggest loser today is a good example of how global factors are dominating the FX market nowadays. Australia’s trade balance for September beat estimates dramatically at a near-record AUD 7.18bn vs estimates of AUD 5.05bn. This was higher than the highest estimate on Bloomberg (AUD 6.15bn), plus the previous month was revised up substantially. But aside from a brief spike when the news came out, that did nothing to stop the decline in the currency.

NZD was hit by the US-China trade news too, and then by a higher-than-expected unemployment rate for Q3 (4.2% vs 4.1% expected, 3.9% previously). Maybe I should amend my previous paragraph to say that the market ignores domestic news that goes against the trend but pays attention to news that confirms what’s happening already – confirmation bias, I think it’s called. Having said that, the news did make a material difference in investors’ expectations about the possibility of a cut in the Official Cash Rate at next Wednesday’s Reserve Bank of New Zealand meeting, so perhaps it is logical to pay more attention to this figure than to the Australia’s trade data.

The small fall in EUR/USD told a story much bigger than the movement would imply. It came despite much better-than-expected news for Europe: the final service-sector PMI for the Eurozone was revised up 0.4 ppt, with Germany being revised up and a better-than-expected reading for Italy, and German factory orders surprised on the upside. All this suggests that perhaps Europe’s slump is bottoming out. But that good news did nothing for the euro – perhaps again it was outweighed by the negative news on trade, which has implications for Germany (in which case we might expect to see the euro rebound today), or perhaps people are just negative on Europe. We’ll get some clarification on this point today after we see what happens.

Today’s market

The big thing today is the Bank of England meeting.

The market’s view on UK interest rates has been largely predicated on its view on Brexit. As the likelihood of Britain leaving the EU in October receded, the likelihood of a near-term interest rate cut receded as well. In fact, it looks like the market thinks there’s only a 50-50 chance of Brexit within the next year or so.

The Bank of England’s view of Brexit has been relatively rosy. It’s kept an underlying tightening bias, as expressed in their statement that

In the event of greater clarity that the economy was on a path to a smooth Brexit, and assuming some recovery in global growth, a significant margin of excess demand was likely to build in the medium term. Were that to occur, the Committee judged that increases in interest rates, at a gradual pace and to a limited extent, would be appropriate to return inflation sustainably to the 2% target.

However, the BoE may be the only institution in Britain that’s talking about “a smooth Brexit,” and even they’ve started to have their doubts. In September they said that “Recently, however, entrenched Brexit uncertainties and slower global growth had led to the re-emergence of a margin of excess supply.”

I think at this meeting they could drop their tightening bias, or at least downgrade that possibility and place more emphasis on the “entrenched Brexit uncertainties.” For example, MPC member Gertjan Vlieghe said recently that prolonged uncertainty would “likely represent greater headwinds to the economy, and require a lower path of interest rates, than in a “smooth Brexit” scenario.” With Brexit extended to end-January and dependent on the results of uncertain election, the uncertainty has indeed been prolonged. The Monetary Policy Committee (MPC) has voted unanimously to keep rates on hold since September last year, but we might see a dissenting vote at this meeting as Brexit drags on, uncertainty weighs on investment, and economic activity slows. The manufacturing purchasing managers’ index (PMI) for example is at levels that have been consistent with a rate cut in the past.

Crucially, it looks as if progress in the labor market may have stalled: the unemployment rate has stopped declining and wage growth may have peaked. This change would eliminate what was probably the one inflationary concern that the MPC had.

If the BoE does shift to a loosening bias, it would eliminate the one support that the pound has left. I think it would be negative for sterling.

Today’s indicators

German industrial production is the first item out today. It’s alread out though – it was worse than expected at -0.6% mom vs -0.4% expected. But after yesterday’s better-than-expected factory orders, which are more about the future, this backward-looking indicator might not have that much impact.

Overnight Japan releases the labor cash earnings. This should be a major indicator, as it is in the US and UK, but it’s not. Maybe it would be if earnings were growing and feeding through to higher prices, but they’re not and they’re not. JPY neutral

Australia’s quarterly Statement on Monetary Policy (SMP) will include updated of forecasts, although the highlights were outlined in the statement following the RBA meeting Tuesday. Then they said that “the outlook for the Australian economy is little changed from three months ago”, “the central scenario remains for inflation to pick up, but to do so only gradually”, and “The unemployment rate…is expected to remain around (5 ¼%) for some time, before gradually declining to a little below 5 per cent in 2021.” The key will be the outlook for core inflation. In the last SMP (August), the RBA expected core inflation to start accelerating in the middle of next year. Any change to that forecast will have a significant impact on the outlook for monetary policy.

At some point during the Asian day Friday China will release its trade data. The trade surplus is expected to rise, but for not a great reason: both imports and exports are expected to fall, with imports expected to fall more than exports (as has been happening for most of this year). Together with the weak China official PMIs, this news could create doubts about how much support Australia and New Zealand can expect from Chinese demand going forward. AUD and NZD negative


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