Currency markets heat up

Two events are set to grab the most attention this week – the outcome of the US Federal Reserve’s policy meeting and the referendum on Scottish independence. Both are important for currency markets, which is where most of the action has been taking place recently.

Dollar domination

The US Dollar continues to rally boosted by the relative strength of the US economy. We believe this theme has a lot further to run as the divergence widens between the US, Japan and the Eurozone with regards to the outlook for monetary policy.

Further support for the US Dollar came in the form of a technical note issued by economists at the San Francisco Federal Reserve who pointed out that market expectations for the path of US interest rates is lower than that anticipated by the Federal Open Market Committee (FOMC).

This also caused a sell-off in US long bonds with 10-year treasury yields back up to around 2.60% (from below 2.40%) in a matter of weeks.

These events demonstrate the sensitivity of markets to what the Fed has to say after this week’s meeting. The focus will be on nuances in the Fed’s language that indicate any potential amendment to the pledge to keep rates on hold for a “considerable time”.

Looking at recent data – including stronger retail and lending figures as well as lower petrol prices, job growth and easier lending conditions – we expect the market will need to get used to the idea of a sooner-than expected rate rise, most likely in the second quarter of next year.

Scottish referendum

The British Pound has been weakening against the US Dollar driven by shifts in yield differentials and the fall in the Euro.

If the Scots vote ‘aye’ to their referendum for independence this week, there is likely to be further fallout for the Pound. Longer term, there will be other implications across the European region.

China numbers disappoint

Numbers released by China over the weekend were disappointing and likely to lead to more stimulus measures. The poor data included:

 Lower fixed-asset investment driven by cooling property investment

 Reduced industrial production driven by a slowdown in infrastructure spending

 Lower-than-expected retail sales despite recent indicators suggesting the labour

market remains strong



 A slowdown in year-on-year outstanding credit growth – a drop in outstanding social financing from 15.9% y/y in July to 15.1%.

Whilst all these credit indicators are a negative for China in the near term, it’s a good sign that there is a focus on weaning China off its dependence on credit to a more sustainable growth trajectory.

Finally, Australia

A final word on Australia where the economy is still adjusting to a sharp slowdown in mining investment but is doing better than expected. We expect the RBA to maintain its view and keep the target cash rate at its current low level of 2.5%.

With regards to currency, the Australian Dollar is currently the only G10 currency that is up against the USD for the year.