EUR/USD: Financial Crisis Made In China?

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EUR/USD: Financial Crisis Made In China?

(short taken at 1.1600)

• The scale of a sell off in global stock markets have thrown into doubt whether the Federal Reserve will raise interest rates this year, and pushed up implied volatility in the foreign exchange market – a broad measure of currency swings – to its highest in two years. Commodities such as crude oil and copper have also tumbled to multi-year lows as investors take fright over signs of waning demand in China, the world’s leading consumer of raw materials.
• Apart from receding expectations for a Fed rate rise in September which has seen favourable bets in the USD being cut, other major and liquid currencies like the EUR and the JPY have been helped as the market turmoil prompted the unwinding of carry trades. Ultra-low interest rates in the Eurozone and Japan have prompted investors to borrow in EUR and JPY to purchase currencies that provide higher returns, typically commodity currencies such as the AUD and NZD. In times of financial stress, investors sell those higher-yielding currencies and flock back to the EUR and JPY.
• Was yesterday’s market panic the begin of new financial crisis “made in China”? We should notice that shares in China had soared 150% in the 12 months to mid-June as individual investors piled into the rising market, often borrowing heavily to do so. At that point, Chinese stock market only needed a trigger for a big selloff. The trigger was a fear of no more stimulus that central banks have been providing for the past seven years. China’s stock markets have now given up all their gains for the year. But we do not expect repeat of 2008 global financial crisis. The recent slump has simply taken the Shanghai composite index back to where it was earlier in the year. Recent data from major economies, including the US, Eurozone and even Japan, have generally been good or improving. Aside from the bad news from China, there is very little to support fears of a major global downturn. Moreover, even China’s recent economic data suggest that growth remains sluggish, but they are not weak enough to justify fears of a hard landing.
• Falls in commodities prices are, of course, bad news for commodity producers, but an extended period of lower commodity prices would be a net positive for the global economy. Worries that the latest declines in oil prices will significantly increase global deflation risks are exaggerated, because these declines are small compared to those in the second half of last year. That is why we can still expect inflation to accelerate in the coming months.
• After yesterday’s market panic the USD is rising again today as US Treasury yields climbed. 10-year U.S. Treasury yields, which at one point had fallen to 1.905% on Monday, recovered to trade at 2.08% today. However, investors are still cautious given worries of a China-led slowdown in global growth.
• Atlanta Fed President Dennis Lockhart said the steep drop in oil prices clouds the inflation outlook, even as the Fed has signaled it needs reasonable confidence that inflation is heading back toward its 2% goal before raising rates. He added: “It’s going to be very tricky between now and year end to read the underlying trends in inflation because of the complicated factors of the falling oil prices playing through to gasoline prices, falling commodity prices on a global basis possibly playing through to other goods at least that are in the core inflation numbers.” He added: “Currently, developments such as the appreciation of the USD, the devaluation of the Chinese currency, and the further decline of oil prices are complicating factors in predicting the pace of growth.” Lockhart reiterated his own bank’s baseline forecast of moderate economic growth, continued employment gains, and gradually rising inflation.
• Just two weeks ago, Dennis Lockhart said he was “very disposed” to a rate hike in September. This time he said that the Fed would likely begin raising rates sometime this year.
• Federal Reserve Bank could provide further clues on monetary policy at its annual Jackson Hole conference starting Thursday.
• While the Fed announced in May that Yellen would not be attending this year’s conference, Fed Vice Chairman Stanley Fischer is scheduled to deliver comments on inflation during a panel discussion at Jackson Hole on Saturday. Financial markets will be closely examining those comments for any hints about whether the Fed is still likely to boost interest rates at its September 16-17 meeting despite a huge sell-off in recent days in stocks.
• In our opinion the likelihood of an interest hike in September is significantly lower today, not because of fear of global financial crisis, but due to strong political pressure on Fed policymakers not to raise interest rates in September. However, in our opinion a hike in October is still very likely.
• US macroeconomic figures remain strong. The Chicago Fed National Activity Index released yesterday, a weighted average of 85 national economic indicators, rose to 0.34 for June, its highest since last November, from -0.07 in June and -0.29 in May. US Conference Board consumer confidence and new home sales data will be released today.
• Ifo economic institute’s business climate index, based on a monthly survey of some 7k firms, rose slightly to 108.3 in August from 108.0 in July. The reading was the strongest since May and close to our expectations (108.2), above the market consensus of 107.7. The current conditions component rose to 114.8, its highest level since April 2014, from 113.9. But the expectations index fell for the fourth time in five months, to 102.2 from 102.3.
• August’s German Ifo survey suggested that GDP growth had continued to accelerate in the third quarter. Today’s breakdown of second-quarter German GDP showed that the 0.4% quarterly expansion was related to strong exports. The net trade component contributed 0.8 percentage points to GDP growth, partly offset by a 0.4 percentage points drag from inventories. Looking ahead, the latest rise in the EUR (if persistent) presents a downside risk to German export prospects. Consumer spending was slightly disappointing with only 0.2% growth.
• The European Central Bank vice president Vitor Constancio said the bank is confident that its asset purchases will lift inflation back to its target but stands ready to take additional measures in case of a material change in the inflation outlook.
• The People’s Bank of China said it was lowering the one-year benchmark bank lending rate by 25 basis points to 4.6%, effective from August 26. The central bank also reduced one-year benchmark deposit rates by 25 basis points. At the same time, the PBOC said it was also lowering the reserve requirement ratio by 50 basis points to 18.0% for most big banks. The change will be effective on September 6.
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Significant technical analysis’ levels:

Resistance: 1.1623 (hourly high Aug 25), 1.1715 (high Aug 24), 1.1775 (23.6% of 1.6040-1.0457)

Support: 1.1328 (200-dma), 1.1230 (low Aug 21), 1.1215 (high Aug 12)

Source: Growth Aces Forex Trading Strategies