Fed Speak Affects USD
One key theme dominating markets recently has been a reaction to commentary from central banks with Fed Vice-Chair Fischer the latest to speak over the weekend. Despite relatively hawkish comments, USD seems to have limited scope for upside moves given the current climate of weakness in leading economic indicators which suggests that a rate hike over the remainder of the year is not a foregone conclusion.
However, any uptick in data prints and or accompanying hawkish signals from Fed members does threaten more vulnerable currencies, e.g currencies like the Australian Dollar which have high positioning and as such are at risk of a squeeze. The Australian Dollar has further downside risk stemming from a deflationary environment which places greater emphasis on further RBA easing, though for now, the current yield hunt keeps AUD supported.
Comments by Fed’s Fischer, purporting that the Fed is near to target as further widened the range of Fed views expressed over recent weeks. Essentially at this stage, traders will be waiting for Fed Chair Yellen on Friday to provide some clarity in her speech, titled “The Federal Reserve’s Monetary Policy Toolkit”. Given the current context of discussions surrounding the departure from using monetary policy to stimulate the economy and instead placing more of an emphasis on using Fiscal policy, is interesting, knowing that Fischer himself touched on this subject. Fischer noted that a main flaw in the US economy was low productivity which could be boosted by fiscal and regulatory policies.
Whilst fiscal policy will likely to continue to feature in the peripheral academic discussions, for now, central bank commentary is likely to remain orientated around what other measures banks can take in the face of growing recessionary pressures. Market consensus is looking for Yellen to essentially provide commentary with a Dovish slant on Friday, further fuelling USD weakness.
The issue with the Fed sounding Hawkish at this stage is that it threatens to push down already weak inflation expectations. The implication of these low inflation expectations is that the market is currently discounting recent comments by Fed’s Williams on adopting a higher inflation target as purely theoretical at this stage. Though if the subject is raised again on Friday we could expect further weakness.
USD and EM
The issue of USD weakness is important once current with the BIS once again highlighting the sizeable levels of USD debt among corporates in emerging markets which at current levels means these debtors will have to pay back $340bln between now and 2018, more than 40% more than during the last three years. If US real yields start to move higher, approaching levels seen last autumn, then Emerging market asset classes will be in significant trouble. With this in mind it seems as though even if the Fed were to raise rates at this stage, they would be forced to apply a very long pause on the back end which again limits the US Dollar’s upside potential.
BOJ To Review Policy
The BOJ then similar to the Fed is going to be reviewing its monetary policy at its September meeting. A leading Japanese newspaper cited Kuroda as noting the BOJ stand ready to take further action if need be, which is expected to refer to further asset purchases. The BOJ Governor also announced that the bank would seek to use “fintech” in all future operations to reflect the growing importance on global payments, settlements, and financial services. The benefits of these comments, which have seen the Nikkei supported, are probably best explored via EURJPY with the ECB currently providing very little in the way of opposing commentary regarding current Euro strength.
A raft of August PMI data was released for the EuroZone this morning with the EuroZone Composite flash estimate coming at 53.3 vs. 53 expected. EuroZone Manufacturing flash estimate was 51.8 vs. 51.9 expected whilst EuroZone Services PMI was 53.1 vs. 52.7 expected. The data, which fell broadly in line, once again highlights the absence of any material damage to the EuroZone economy in the wake of Brexit.
Euro Area Composite PMI