At the risk of sounding like a broken record, global sentiment took another hit last week as the US and China escalated trade tensions for the umpteenth time. With yields falling around the world and central banks running out of traditional tools to use, countries are increasingly looking at tactics such as negative interest rates, QE and currency intervention as ways to support their economies.
The irony of this is that these unconventional policies have been so widely used in the US, Japan and Europe, among other countries, that they are picking up a conventional feel. However, it is important to remember that these tools are unconventional and no one fully understands the entire implication of these policies. To this end, Australia, one of the countries most impacted by a global trade tensions, has been assessing the suitability of measures adopted elsewhere.
The main take away is that none of the unconventional methods are particular appealing. Unconventional methods likely won't become a real option until the cash rate moves into the .25%-.50% range (currently at 1.0%). The RBA most likely will want to avoid the cash rate going to .25% as that leaves it only one cut away from zero. As such, .50% might be the key level at which the RBA could prefer unconventional steps before further rate cuts. Looking ahead, markets should remain focused on central bank policy responses to increased risks. While this week is light on central bank meetings, September will usher in a wave of key central bank decisions. Even though central banks have shown a willingness to respond to soft economic data, Australia's study of available monetary policy tools illustrates that central banks are running out of levers to pull. The conventional reaction to this would be to use fiscal policy to backstop monetary policy. Unfortunately, it remains to be seen whether the fiscal help will arrive. Case in point, Germany has indicated it would provide fiscal stimulus only if the economy hits a deep recession. Without fiscal support, central banks will have little choice but use unconventional measures despite it being unclear whether or not the positives outweigh the negatives.
For most of last week, the EUR remained under pressure and near the bottom of its most recent ranges. Markets continue to anticipate weak EZ economic data combined with expectations of additional monetary stimulus measures from the ECB. An escalation of the trade war between the U.S. and China caused U.S. interest rates to crash Friday sending the euro to its best levels over the past week. Continue to expect further choppy and consolidative markets with the EUR trading sideways this week.
The GBP has recently benefited against both the U.S. dollar and EUR from an apparent thaw in the Brexit negotiations as comments from German Chancellor Merkel indicated a greater willingness to work through some of the more contentious issues. U.K. economic fundamentals remain weak but the market has been caught too short of GBP this week. Expect more sideways trading this week.
For the past three months, the JPY has been the top performing major currency appreciating by nearly 4%, followed by the Swiss franc. The continuing safe haven status of this currency combined with the collapse of U.S. interest rates is behind the JPY’s outperformance. Continue to expect the JPY to track U.S. – Japanese interest rate differentials. Heightened trade tensions will only continue to add to further JPY appreciation. Expect a steady to stronger JPY this week.
Positive economic readings for manufacturing and inflation supported the loonie and the case for BoC to hold rates in the near term. Fed comments reaffirming data dependency and further trade concerns due to additional Chinese tariffs on the US resulted in equity and oil selloffs and pushed USD/CAD back above $1.33. Expect USD/CAD to continue to move higher as global growth concerns persist.
Since the CNY broke through the key psychological level of 7.00/$ on August 5th, the CNY has remained vulnerable to further weakness. On Friday, the CNY tested its lowest levels since August 5th at near 7.13/$ as China hit the U.S. with more tariffs along with the White House's retaliation. Continue to expect a steady to weaker CNY as both sides remain dug in with no end in sight.
The AUD has been sliding lower throughout the year, but received some support this week off positive labor data and RBA minutes that pushed for a period of stability. Given recent developments in the US-China trade war, global uncertainty continues providing the case for a lower AUD as the RBA will have to resume cuts. Moving into next week, expect AUD to continue to move along current historic lows.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 0.25%
Expectations for rates to remain unchanged at 1.50%
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