By Dean Popplewell
Volatility in the forex market space has been in short supply throughout this year. If anything, it has been regionally contained by central banks' policy and this despite the uptick to both geopolitical and economic event risks. Sustainable forex volatility will only occur with greater G10 rate divergence, or in other words varying degrees of a tighter monetary policy. The plethora of overnight data is expected to give an indication of what is required by various central banks, in particular the BoE, the supposed major economy frontrunner for a post-recession rate hike.
Governor Carney at the BoE has been touted to be the first of the major developed countries to tighten their monetary policy. However, similar to the Fed, higher rates will be a function of "less" spare capacity in the UK labor markets. This morning's UK data shows that there is a lack of wage pressure. Average weekly earnings, including bonuses fell by -0.2% y/y - the first negative reading in five-years - even as the labor market continues to strengthen (July claimant count -33.6k).
UK wages still provide slack
The decline in total pay will pose a challenge for the BoE's timing for their first post-recession monetary policy tightening. A good percentage of the market has been pricing in a hike as early as this November. This morning's BoE wage forecasts will force the market to have a rethink on rate rise timing. As expected, UK policy makers would prefer to see incomes rising at a steady level before deciding whether to tighten monetary policy. The BoE's Quarterly Inflation Report contains both a hawkish and dovish message, nothing new from a central bank. Carney indicated that annual inflation would stay at roughly +2% over the next two to three years as long as interest rates rise in expectations in financial markets. However, with the BoE slashing UK wage growth forecast for the remainder of this year in half to +1.25% from +2.5% will prompt investors to push their UK rate hike timing further out the curve. The bank's forecasts suggest a first rate hike in early 2015 rather than a Q4 move and just ahead of the Fed's expected first hike in mid-2015.
Sterling has taken a battering after this morning's UK reports, falling from £1.6800 to a 10-week low just ahead of £1.6700 and nor should it stop there. Overall, the market has been very bullish that the BoE would be the first to go. Both the ECB, who is fighting deflation concerns, and the BoJ, sales tax growth worries, do not provide much opposition to a UK rate hike. Nonetheless, both economies provide support for a weaker global growth scenario, a variable that obviously will trump the timing of a rate hike for Ms. Yellen and Mr. Carney. The market will be disappointed with the BoE interpretation on rate timing. This will call into question long GBP position outright and on the crosses. The pound falling through May's low £1.6689 opens up the way to test the 200-DMA at around £1.6645, while EUR/GBP will find decorum of support for the time being. Last Friday's peak of €0.7989 threatens further technical gains to €0.8015 and €0.8030.
Japan's modest growth
The BoJ continues to wash away its worries with "modest" growth lingo, but will always embrace a weaker yen no matter how it's achieved. Last night's initial estimate of Japan's Q2 GDP saw the economy contract by the biggest margin since the great earthquake over 3 years ago. Nevertheless, the headline was not as bad as expected. Among the various components, private consumption was down -5% - bigger than -3.7% drop estimated - and net exports contribution was at -1.1%. From a stronger economic standing the government's consumption estimate were the only positive components, rising +0.4% from +0.1% in Q1. No matter the headline, Japanese officials continue to talk up the economy. Economic Minister Amari said gradual "recovery trend is continuing and policy response would be flexible." Officials did not allude to the possibility of further stimulus, attributing the weakness to the impact of April's sales tax hike and stating that no extra budget is needed at this point. This is like the ECB; the market will have to wait and see how lower rates and more credit will play out before opening the liquidity tap again. The BoJ's governor Kuroda released the minutes of mid-July meeting, stating that Japanese policy makers would examine "risks and modify policies if necessary."
Yellen's Jackson Hole Economic Symposium speech
Yesterday's US June JOLTS report showed that job openings swelled to their highest level in ten years, more or less in line with expectations. The data indicates there are about two unemployed job seekers for each available job in the US economy. The report also saw a rise in the number of US workers quitting their jobs (+2.53m vs. May's +2.49m). This would suggest strength and flexibility in the US labor market. A sign that more individuals have quit gainful employment usually indicates that they are also confident in finding other work and sometimes with higher pay.
Ms. Yellen has indicated that the report is one of her "key" metrics for gauging labor demand in the US economy, and investors will be closely watching her remarks for hawkish tones at her Jackson Hole Economic Symposium speech in late August. It is here that the market will be hoping to gauge the Fed's current thought process. Fixed income dealers in particular will be hoping to be in a position to better align their expectations on the pace of Fed rate hikes for the foreseeable future - the "mighty" dollar has found higher short-term rates very supportive!