The next best performer... RBNZ and the Haka interest rate cut!

The best performing currency last week was the euro – why? Didn’t you hear everything is resolved?! Sorry, we couldn’t resist, but the situation is actually far from it. The only reason the euro went up is because the Greek government managed to pass the legislation that the Eurozone demanded before any negotiations of a third bailout package. As a reward for doing what was dictated, Greece received a €7bn bridge loan. Unfortunately, the Greek government received very little of the loan as it was quickly directed towards repaying debts to the ECB and IMF.

The next best performer was the NZD. The Reserve Bank of New Zealand cut interest rates by 25bp last week for the second time in a row due to softening economic outlook and inflation. The RBNZ said that further easing seems likely and a further drop in the currency is necessary, which would normally be a negative for the currency. However, the NZD rallied hard because the RBNZ dropped the reference to the NZD being "over-valued" or "unjustifiably high" in its announcement. Meanwhile, the AUD was the worst performer last week as it fell to fresh multi-year lows due to the sharp slowdown in Chinese manufacturing activity. As for last week’s dual winners the USD and GBP, they took a break after their spectacular gains in the month of July to quietly correct and work off their overextended gains.

The peso has been trading in a negative territory since mid-July due to the rout in commodities. The domestic economy is growing at a slow pace however the jobless rate fell to 4.41% in June. Thus, there is another factor at play here. The peso happens to be one of the most liquid currencies in the sphere of emerging markets. Thus, if investors fear problems in EM they will sell the peso regardless of their view of the Mexican economy itself. That is what is currently happening as investors fear monetary tightening by the US Federal Reserve. The worry is that a rise in interest rates in the U.S. will cause the debt servicing to rise on the roughly $4.5 trillion dollars in EM loans. Complicating the matter is that most of the EM countries rely on commodity exports and/or Chinese growth, thus they are getting hit by a double whammy – decreasing export revenues and increasing debt servicing costs.

Having said this, according to Citi there is another factor at play in the peso’s weakness. Citi’s research shows that the foreign exchange flows handled by the bank on behalf of its clients flow into real money accounts, leveraged accounts, corporates, and banks. Its latest date shows that USDMXN transactions flows into the first three categories has been neutral over the year, but flows by banks has been strongly negative. So what does this mean? It means that the Mexican people themselves are responsible as they are converting their pesos into USD and depositing them in USD accounts at their banks. Hmmm, they must know something that the rest of us don’t.

The key events for this upcoming week are the FOMC rate decision and Q2 GDP report. While we are not looking for the Fed to raise interest rates in July, most economists expect the first interest rate hike in 8 years at the September FOMC meeting. Also, remember that Chair Yellen indicated at her semi-annual testimony on Capitol Hill that her preference was to start raising rates earlier so that monetary policy can be tightened at a more gradual pace going forward. All we can say about this is we wonder if she will be able to pull the trigger if China keeps slowing, world trade volume drops for a 7th month in a row, and oil fall below the March low of $42.

The US Fed Decision and Commodity Currencies

The currencies of commodity-exporting nations including Australia, New Zealand, Canada, Brazil and Indonesia are near the lowest in at least 4 years as the market braces for a Federal Reserve statement tomorrow that may indicate it is ready to raise interest rates – it’s not likely that the Fed will make actually make a move this week, but economists and analysts aren’t expecting anything more than indications that September is when we’ll see the first hike in rates in several years.

The market is hotly awaiting the post-meeting comments for hints of a rate increase and should that happen, then expect another surge in the USD and further downward pressure on currencies of the aforementioned nations. These nations are hoping that Fed Chairperson Janet Yellen will portray a cautious tone in her statement, which would pause a sell-off in AUD, NZD, CAD, BRL and IDR.
“Commodities are very much in the forefront of markets’ minds and commodity-linked currencies are definitely under pressure,” said Sam Tuck, a senior currency strategist at ANZ Bank New Zealand Ltd. in Auckland. “The majority in the market believes Yellen will remove patient” from the Fed’s pledge on interest-rate policy, he said.

New Zealand’s currency weakened last week after the whole milk price index fell almost 10% in a GlobalDairyTrade auction. The Aussie has been falling amid a decline in prices for iron ore and prospects for a further interest rate cut, with the Reserve Bank of Australia’s March 3 meeting minutes released yesterday reiterating an easing bias. And energy makes up the bulk of Canadian, Brazilian and Indonesian exports. Therefore, a sharp decline in energy, gold, dairy and metals combined with a mix of a strong dollar and a weakening Chinese economy plus looser monetary policy (except for Brazil where rates are still high) – what you get is a flood of commodity bears in full-force to claw down the value of commodity currencies.

Market strategist for IG feels that tomorrow's meeting has the possibility to be a boon for the disintegrating commodity sector. In a note from this past Monday morning, IG said that, "The Fed policy statement release may actually halt the USD bulls." The note further states that "Expectations are low for any major divergence from current language or action. The FOMC may even be a little more cautious about the current market and economic conditions. This would see a quick unwind in oversold markets: Oil and industrial metals would likely rise and a likely drop in the USD would transpire."