Significant volatility on stocks and currencies which was mainly provoked by developments on bond market. Changes regarding inflation expectations are negative for the dollar. Focus on the incoming macro data. The zloty, due to depressed inflation, higher odds for interest rate cuts and worsening growth, weakens both to the franc and the euro.
Macro data (CET- Central European Time). Survey is supplied by Bloomberg unless otherwise noted.
- 14.30 CET: weekly jobless claims from the US (survey: 290K)
- 15.15 CET: Industrial production from the US (survey +0.4% m/m)
- 16.00 CET: Philadelphia Fed index
Volatility. Expectations. The data
Volatility that the market experienced yesterday does not occur often. In an hour the EUR/USD soared from 1.2670 to almost 1.2900. A direct impulse which generated such a move came from weaker than expected data from the US – significantly lower retail sales and PPI combined with disappointing New York state business confidence index.
Similarly wild changes were observed on equities. During the US session the Dow Jones dropped at one point over 450 points, but ended the session trimming most of the losses. There were many reasons behind the sell-off according to market participants. From the Ebola threat and recession in Europe followed by Greece issues (Athens wants to exit the IMF rescue plan earlier to get some flexibility before the election), ending even with the Hong Kong protest.
The real reason, however, is mostly other case (we covered it more broadly in Tuesday's analysis). A significant decrease in inflation expectations caused by lower than earlier anticipated global GDP growth and slide on crude oil. Depressed prices increase the risk of deflation and stagnation. It was confirmed with panic reaction on the debt market.
The yields on government bonds where the default risk is virtually zero dropped to record low levels – in Germany 0.75% on 10 year benchmarks. Even at our southern neighbour, Czech Republic, the 10 year sovereign debt dropped below 1%.
However, one of the deepest reactions was observed on US bonds where the yields dropped at one time more than 30 bps on the daily basis (from 2.2% to 1.87%). Such reaction may show that a turnaround in the monetary policy expected. It was also confirmed by the money market reaction which gives pretty accurate expectations regarding future interest rate level set by the FOMC.
At the beginning of October, according to Bloomberg the odds on monetary tightening showed that there is 74% probability of first interest rate hike before September of 2015. Currently it is only 36%. Additionally, the money market consensus assumed that the first hike will be in July of 2015 while currently that date was pushed toward December of 2015. As a result we can expect that the major argument for the dollar appreciation – tighter monetary policy – has eased markedly.
The fears about future US economy performance and threat for the inflation to stay below the target for longer may be confirmed or denied by incoming macroeconomic data. Therefore, the upcoming readings, which does not bring so much attention during a calm market, can cause some major moves on currencies traded with the dollar.
Today investors should focus on industrial production, jobless claims and business confidence in Philadelphia. If it turns out that the economy is slowing in the US we should expect that the dollar may weaken further and even 1.30 level cannot be ruled out.
The attention will also be focused on FOMC members' statements. After recent comments from John Williams 'not excluding QE4 at certain conditions' (more in the Wednesday's commentary) any words concerning future monetary policy will be closely scrutinized. Currently I would not expect that anyone can seriously consider QE4 when the Fed is finishing QE3 but a change in comments from key officials should generate a significant threat to the dollar appreciation scenario.
Another weaker day
The local market is tarnished by few factors which fundamentally set the currency rate movements. Firstly, there are expectations regarding future interest rate in Poland. Lower economic activity in the region combined with worsening GDP growth in Poland are the arguments from more monetary loosing. Yesterday, during the “craziness” of the US bonds, the Polish money market instruments anticipated even a 50 bps rate cut. It is a very strong argument pushing the zloty lower, which actually was quickly translated to the EUR/PLN rise.
Another issue is the interest rate level abroad. The ECB is not really eager (at least for now) to start the full-blown QE. As a result, the difference between monetary policy in Poland and in the euro are has shrunk. It is a argument for weaker zloty to the European currency.
A bit different the situation looks on USD/PLN. The expectations on interest rate hikes across the pond diminished. So the difference between future monetary policy is changeable. Therefore we firstly saw USD/PLN slide but later, when the situation calmed down a bit the USD/PLN returned above 3.30.
Historically speaking, however, the worsening market sentiment, threat for the lower inflation and home country economic activity is negative for the PLN. As a consequence the following days on local currency may be tough and in case on further worsening conditions (with the US) we should expect that EUR/PLN may reach 4.25 while CHF/PLN can remain above 3.50.
Expected levels of PLN according to the EUR/USD rate:
Expected GBP/PLN levels according to the GBP/PLN rate: