The dollar dropped as the outlook for the Fed to increase rates is getting more vague. Weak reports from Germany spurred speculations that the European Central Bank will expand its quantitative easing. The zloty was steady after significant gains on Monday.
Once again, the German reports missed expectations. The report on orders in industry missed the forecast. In August orders dropped 1.8 percent against the plus 0.5 percent that was forecast. In the prior month orders dropped 2.2 percent. On a yearly basis the reading showed an increase of 1.9 percent.
The latest reports from Germany have shown a negative impact of the turmoil in the emerging market economies. The slowdown in China and other emerging economies has negatively affected the expectation of German companies. As a result, the sentiment indexes deteriorated and the orders report was weaker than expected. Moreover, the scandal in the automotive sector regarding Volkswagen deteriorated the outlook (however, the latest data did not take it into account).
A relief is that the readings concerning consumption and employment are quite good. As a result, the risk of significant slowdown in Germany is limited as the internal demand will limit the impact of external factors.
Nevertheless, every slippage in the European economy will be taken as an additional argument to prove the need of additional stimulus from the European Central Bank. The eurozone is stagnating and the inflation has returned to negative levels. Moreover, the emerging markets turmoil is creating additional negative pressure on the economy. Given the situation, the ECB's target is getting more distant and it is not very likely that it will be met without additional support from the monetary policy to the economy.
Hikes more distant
The report on international trade in the US showed that a strong dollar is hurting the economy. Trade deficit increased by the most in five months. In August, it rose 15.6 percent to 48.3 billion dollars from 41.8 billion dollars in the prior month. Import increased 1.2 percent, whereas export dropped 2 percent.
Given the situation, the Federal Reserve is in a difficult position. Earlier the data from the labor market missed the forecast (employment increased 142k against the 203k that was expected). Moreover, the data concerning industry create some doubts (especially the ISM index). Although consumption and service sector are performing quite good, the overall assessment of the US economy has been deteriorated.
Investors shifted the expectations for interest rate hike to March 2016. In the meantime, Federal Reserve Chair Janet Yellen said during her last speech that the central bank will increase rates by the end of the year.
As a result, the credibility of the Fed is in peril. However, we expect that in spite of low probability based on the futures market, the Fed will eventually hike. A similar scenario will lead to significant gains of the dollar.
Weakness of the economy may push the Bank of Japan to provide additional stimulus. The monetary authorities will reveal the decision on Wednesday. Some commentators see a chance for additional auctions. The deterioration in the economic situation may push the Bank of England to postpone tightening. The outlook for longer zero rate policy may support risk assets.
The Monetary Policy Council left interest rates unchanged. The main rate remained at 1.50 percent. It is the lowest level in history. It did not affect the zloty, as the decision was expected.
After the increase on Monday, today the zloty was steady. The chance for a longer dovish policy in the major economies will support the emerging market currencies. However, the zloty has been recently negatively affected by the deterioration of the economic reports and heightened political risk. These factors will limit the appreciation potential of the zloty.