The economic figures in the United States may be a lot worse than most people expected, but trading shows that the market still thinks the weakness is temporary.
The US dollar experienced notable gains last month against most major currencies, including the euro, British pound, Swiss franc, New Zealand dollar, Swedish krona, Danish krone and Norwegian krone. It did, however, decline against the Canadian dollar, Japanese yen and slightly against the Australian dollar.
This occurred despite the US economic slowdown continuing in most major sectors. It showed that the markets still believe that the slowdown is temporary, and therefore the Federal Reserve’s policy will not be changed any time soon. The tapering process will continue smoothly until the end of the year.
As for commodities, gold, silver and natural gas were among the worst performers last month. Gold lost almost 3 per cent, silver slipped by 1.82 per cent and natural gas tumbled by 4.07 per cent. The best performing commodity last month was cocoa, which added about 5.44 per cent.
In the euro zone, disinflation continued and economic activity deteriorated further, which led the European Central Bank to hint at intervention. It did indeed ease further by cutting the three major interest rates and announcing new quantitative easing and targeted long-term refinancing operation (LTRO) loans for four years. The ECB also cut its inflation forecast for this year to 0.7 per cent, which means that the bank is not willing to act again if inflation stays above that projection. However, targeted LTRO could be the only option to increase lending because a negative deposit rate will lead the banks to inject more liquidity to the bond market, which is exactly what happened in with the first two LTRO loans in 2011 and 2012.
There are no major changes from the Bank of England, as the economy is still recovering and inflation remains well below the 2 per cent target. The bank is using currency exchange to control inflation for the time being, so the it is not concerned with the rising pound for as long as inflation stays below 2 per cent.
In Japan, the sales tax hike effect began to show up with the release of some weaker-than-expected figures while inflation remains on the rise. However, the Bank of Japan is unwilling to add more stimulus, waiting for further evidence on the effect of the sales tax hike.
In the US, many economic releases came in with lower-than-expected figures and some of them came in contrary to expectations. The second GDP estimate showed that the economy posted a 1 per cent decline in the first quarter of this year while the trade deficit, industrial production and retail sales figures of the beginning of the second quarter suggest that its GDP will be below estimates.
What is concerning right now is that the US economy needs to grow by 5 per cent in each quarter until the end of the year to reach the Fed’s growth target. The current economic activity levels put it far off course.
In the meantime, uncertainty regarding the first Fed fund rate hike remains, which has led to a significant drop in volatility. However, the next few weeks should bring more answers regarding the Fed’s policy. The US year-on-year consumer price index hit 2 per cent, while the Fed’s inflation index remains at 1.1 per cent.
The game-changer in the next few weeks will be in whether inflation accelerates faster than expected or the economy deteriorates further. This will allow the Fed to decide whether it will accelerate the tapering process or taper the tapering. Any change in the pace of the current policy that works against the markets’ expectations is likely to create a notable move.
Nour Al Hammoury is a market strategist at ADS Securities.
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