August Market Summary
Summer has finally arrived and with it a new heir to the throne. The Queen can now breathe a sigh of relief. "It’s a boy", came the screams from St Mary’s Hospital London, so no need to be dragged into dull debates or to draw up new constitutional laws, for now. OK, slightly deviating from currency matters, although as with the Olympics last year, the UK should benefit from the inevitable tourism derived from Prince George of Cambridge. However, don’t be fooled and get caught up in the feel good factor; if you have budgets, stick to them. When the dust settled after the Olympics last year, reality gripped and the pound fell for six months consecutively.
One certainty is, however, that the global economy appears to be back on track; the eurozone appears to have turned a corner with manufacturing on the rise and unemployment falling. Good news at last. For now, the main watching brief will be over in the US where any hints of when (and by how much) the Federal Reserve will taper its economic stimulus should guide the markets on both sides of the Atlantic. If, as expected, they start the process in September, we can expect a strong dollar on the lead up and one would imagine for the remainder of the year.
GBP - Mark Carney finally finds his feet beneath his BoE desk
Since our last monthly update, we’ve seen more positive releases into the market with the recent Purchasing Managers Index (PMI) surprising all around. Manufacturing PMI made the biggest advance, hitting its highest levels since March 2011. Services PMI has consistently been on an upward grind since February this year and has seen the biggest jump on a month-by-month basis occur in this latest reading where it’s at its highest since December 2006 and currently setting the pace internationally on the indicator. Sterling appreciated only mildly against the US dollar on the month thanks to mixed data from the US of late, pushing back tapering.
A new age abounds for monetary policy at the Bank of England (BoE) with the new Governor, Mark Carney, unveiling the Bank's new framework for forward guidance. It is likely that he will push for a time-related forward guidance given his successful experience with it at the helm of the Bank of Canada. It may be used instead of a data-related guidance seen in the US, targeting a certain level on a data point, e.g. 6.5% unemployment for any potential rate changes.
Since taking up office, we have yet to see Mr Carney flex his muscles. With data surprising on the upside, it will be interesting to see his stance. His first official statement will accompany the August inflation report. On the housing front, we’ve seen continued improvement throughout July with the latest data from Nationwide showing a 3.9% year-on-year rise by comparison to the previous reading of 1.9% from June’s year-on-year numbers. If housing prices continue to move upward we should start hearing concerns of a potential housing bubble further down the road and housing’s obfuscating effects on the real economy. The NIESR GDP estimate came in at 0.7% on the previous 0.6% reading showing that the UK has produced more goods and services in the last three months than expected. This is only an estimate, of course, so expect a change in a month’s time when the official figure is published.
What lies ahead for GBP
We have had Governor Carney present the inflation report, shedding some light on the kind of forward guidance the BoE will incorporate into their policy kit. The Governor and his Monetary Policy Committee (MPC) have named 7% unemployment as a threshold for interest rate changes: “The message is that the MPC is going to maintain the exceptional monetary stimulus until unemployment reaches 7% and then we will reconsider.” The MPC only expects unemployment to fall below the threshold in the third quarter of 2016 and reaching this level will not mean an automatic adjustment in interest rates.
Mr Carney, in his letter to George Osborne, mentioned that “if material risks to price or financial stability” do increase they will look to ‘knock out’ the 7% threshold and re-assess their policy. The Governor also mentioned to George Osborne that the MPC of the BoE will stand ready to push through further quantitative easing (QE) should the need arise. In his press statement he stressed that "what the MPC is doing is it's providing much greater clarity about how we would react to underlying economic conditions, how we'd set monetary policy."
Technically we have support at 1.149 against the euro but expect any major negativities from the August inflation report to weigh heavily pushing through the lower-bound 1.14s. Support against the USD will be nearing 1.526 on the dollar with continued levels between 1.53-1.54 and any breaks above this range moving it further upper bound to low 1.54’s.
There is a good probability that Sterling will continue to suffer in the markets for the time being, with a seemingly negative bias towards the pound at the moment. This bias will likely continue in the pricing, given the weak surrounding conditions, and go on until more positive data has been drummed into the markets, which we may see by the end of this holiday month. Expect big Sterling appreciation to be more externally news-related rather than continued positive domestic data. Any data improvements from the UK aligned with the BoE’s guidance (unemployment) will now have a greater effect on Sterling than previously.
EUR - The Euro remains buoyant as data begins to surprise on the upside
Throughout the first half of the year, the euro has managed to hold firm, showing resilience to the appalling economic data that has emanated from the eurozone. Negative data has included a growth downgrade from the European Central Bank (ECB) and eurozone unemployment reaching record levels, with youth unemployment in Greece and Spain reaching a shocking level of 55%. This prompted the International Monetary Fund (IMF) to urge further rate cuts from the ECB in order to stimulate economic growth. Despite this data, the euro lost very little ground so we're possibly starting to see signs that the eurozone could be heading out of recession. Will we go on to see the currency strengthen during the second half of the year, though? It is perhaps a little too early to say, but some of the key growth indicators have provided surprisingly strong readings. July’s Purchasing Managers Index switched to a growth reading for the first time in 18 months, coming in at 50.5 which, crucially, is above the 50 point level that separates shrinking activity and growth.
Manufacturing data surprised as well with a reading of 50.3. German data was again the largest contributor but the economies of France, Italy and Spain also registered a further easing of contraction and solid growth among their manufacturers. On top of this, unemployment levels dropped for the first time in two years, coming down 24,000 to 19.26 million. This data raises hopes that the region can finally start to claw its way out of recession and although we have seen false dawns before it does improve confidence in the area and provide some much needed optimism.
What lies ahead for EUR
Numerous factors will determine the direction of the euro rates in the short to medium-term. Whilst the eurozone as a whole starts to show signs of life there are still divisions within the region, exacerbated by Germany challenging the legality of the European Central Banks ‘Outright Monetary Transactions' programme through the German Supreme Court. Although a decision is not due until the autumn, such a division will surely prove detrimental to the single currency. Meanwhile, European Central Bank President, Mario Draghi, claimed that he “sees no challenge to the ECB from lower rates”, potentially hinting at further rate cuts or perhaps more likely a sustained period of extremely low interest rates which, given Germany's increasing inflation, indicates further conflict to come between the ECB and Germany. This could certainly rest heavily on the euro’s shoulders. With economic growth still far from guaranteed, investors will be looking for more explicit forward guidance from Mario Draghi, although it is likely that he will remain as vague as possible and avoid including any dates or economic targets. Most analysts at present therefore consider the euro to have a neutral outlook for the foreseeable future, with the likelihood being that we will see rates remain range-bound for quite some time to come.
USD - 'Will they or won’t they' saga continues and drags the dollar lower with it
Over the past month, the Greenback has weakened across the board and in particular versus the pound, having fallen nearly 4%. Will or won’t the Federal Reserve taper down on QE has been the general question on people's mind over recent weeks and this continuing uncertainty has been the dollar’s undoing.
To add to this, a recent spate of substandard economic figures has also helped to cloud the economic outlook and it has become increasingly difficult for Federal Reserve President, Ben Bernanke, to offer the markets any clear future forecast. Central banks around the globe are trying desperately to offer investors and the market some form of forward guidance; however, Bernanke himself has told us that interest rates will remain low for an extended period of time until employment levels come back to the desired levels. He has gone as far as saying that QE will be reduced, it's just not yet known to what extend and at what time.
What lies ahead for USD
Although the US dollar has weekend in the past month, the forward projections are relatively upbeat and if certain criteria are met, then sub 1.50 (Interbank) versus the pound could be seen in the short-term. The Federal Reserve has hinted at the possibility of higher interest rates only if unemployment levels fall to 6.5%, while maintaining a level of inflation below 2.5%.
With current unemployment levels at 7.4%, predictions are that we could see unemployment reach 6.5% by the summer of 2015, with any rise in GDP growth likely to bring this prediction forward a year.
If these unemployment predictions materialise then the Greenback could benefit across the board as its safe-haven appeal will be boosted, with investors flocking to a currency with a renewed positive economic outlook.
AUD - Aussie dollar continues to show signs of weakness
Over the last four weeks, Australia’s dollar has lost up to 7% versus the pound on the back of an ease in monetary policy from the Reserve Bank of Australia (RBA), weak growth out of China, and some softer economic data releases. The cut in the Australian cash rate from 2.75% down to 2.5% announced by the RBA last week was much anticipated but speculation of up to two more rate cuts over the next 12 months has also been priced into the exchange rate.
Since 12 March 2013 when we’ve seen GBP/AUD hit the lowest level ever at 1.4380 Interbank; the currency pair has rallied 20% to a three year high of 1.7268 Interbank.
So for those clients looking to buy Aussie dollars, now is a great time. The AUD depreciation means that to buy A$200k in today’s market, it will cost you almost £23K less that it would have just four months ago. Obviously, if you flip this around the other way, for clients looking to sell AUD and buy GBP then this is unwelcome news and maybe now is the time to bite the bullet and cut your losses. Speak to one of our brokers who will be well placed to explain exactly how we can help you regardless of your requirement.