In early August this year Atlanta Fed President Dennis Lockhart stated that there was a very high bar to not acting on rates at the September FOMC meeting. We all know what happened a few days later as Chinese authorities, in response to continued economic weakness, surprised markets by a surprise devaluation of the Chinese yuan in response to some very weak trade data, and concerns about a slowing Chinese economy.
These actions probably prompted the Federal Reserve to hold off a possible September rate rise, over concerns about weakening US data, as well as concerns about “financial and international developments”.
This line was subsequently dropped in October’s FOMC statement, suggesting that Fed officials were becoming less worried about events in China and emerging markets, and if Friday’s outstanding October jobs report is any guide then the prospect of the Federal Reserve acting on interest rates next month has taken a very big step closer to becoming a reality, which could have serious implications for emerging markets in the coming weeks.
A figure of 271k new jobs, the best number this year, as well as a bigger than expected rise in average earnings and an upward revision of 12k to the previous months numbers, has raised market expectations to such an extent that the Federal Reserve will be hard pressed to row back from a small rise in interest rates in six weeks’ time.
What Friday’s number has also done is give the Federal Reserve an even bigger problem in the shape of the another sharp rally in the US Dollar which has raised expectations to such an extent that the Fed will be hard pressed to play down expectations of further rate rises in the near term, if rates do go up in December.
With US companies already claiming that the strong US dollar is hurting their profit margins further US dollar gains are going to be increasingly difficult to stop, at a time when the European Central Bank may ease policy further, though the prospect of that has receded a little after Fridays sharp fall in the euro.
The bigger problem remains China and this weekend’s October trade data only served to reinforce those concerns. Last week’s Chinese PMI data appeared to suggest that the recent slowdown in the Chinese economy may be starting to show some signs of a recovery. The weekend trade data would appear to suggest that belief remains premature.
The latest October trade data saw imports plunge by 18.8% suggesting that internal demand continues to remain weak, while commodity prices also remain under pressure.
Chinese exports also saw a decline of 6.9%, and though not as bad as the slide in imports the strength of the Yuan since the August devaluation is going to continue to hinder China’s economy on the export front. The yuan is now back at the levels it was against both the euro and the Japanese yen prior to August’s devaluation, making Chinese exports much more expensive in its two biggest export markets. In this year alone exports to Japan have declined 9%, and to the EU they have declined 3.7%.
This suggests that it seems likely that at some point Chinese authorities may have to take further steps to ease policy further, with potentially another move in the US dollar peg likely in the coming weeks, and months.
The surprisingly bullish US jobs report is also bad news for the Bank of England as well, cutting as it did the rug out from under the pound as the divergence between US and UK monetary policy diverged further last week.
Last week the pound slid 400 points against the US dollar after a surprisingly dovish quarterly inflation report, pushed rate rise expectations out until late 2016 over concerns about the Chinese economy, and Europe.
This week’s UK unemployment and wages data could well pile further pressure on the Bank of England’s relaxed policy stance, particularly if it comes in as strong as last week’s US data.
Wages in particular are already rising faster than US wages, making the disparity between US and UK central bank policy all the more perplexing.
EURUSD – Friday’s sharp fall below the May and July lows at 1.0820 now opens up the prospect of a retest of the 1.0460 lows of earlier this year. For this to unfold we need to stay below 1.0830 and the 1.0980 area.
GBPUSD – the fall below the May lows at 1.5085 opens up the real possibility of a move below the 1.5000 level towards the lows this year at 1.4565. We need a recovery back above 1.5220 to stabilise and avoid this potential scenario.
EURGBP – last week’s key day reversal from 0.7041 suggests a return to the 0.7300 area in the short term. For this to unfold we need to hold above the 0.7075 area, and move above the 0.7160 area, and the highs last week.
USDJPY – last week’s push through 122.00 now opens up the prospect of a move towards the 124.00 area and August highs at 125.30. Only a move below the 121.80 area would delay the prospect of this scenario unfolding.
Equity market calls
FTSE100 is expected to open 16 points higher at 6,370
DAX is expected to open 47 points higher at 11,035
CAC40 is expected to open 26 points higher at 5,010
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