FX Matters July 2021 | Article – HSBC VisionGo

Central banks shifting, amid rising delta variant cases
Finance  ·    ·  16 mins read

  • FOMC said “economy has made progress” but still “some way away” from “substantial further progress”
  • ECB changes forward guidance to reflect new inflation target of 2%
  • RBNZ holds rates at 0.25% but ends QE on 23 July

Summary – A “risk-off” change from Delta

The US Dollar Index (DXY) dipped 0.3%[1] this month on the back of a still-patient Federal Reserve (Fed). Its best one-day performance came on 13 July, when it rose 0.5% on the news that US core CPI for June accelerated by 0.9% from a month earlier, against an estimated 0.4%. However, most of these gains were erased the next day as Fed Chair Jerome Powell maintained the view that inflation was transitory and DXY fell 0.4%. Worsening risk sentiment led to broader USD strength in the middle of the month, but the USD was unable to hold onto its gains after Powell affirmed that the economy was still “some way away” from “substantial further progress” during the Federal Open Market Committee (FOMC) meeting on 28 July.

July saw the EUR rise a modest 0.1% against the USD. On 8 July, the European Central Bank (ECB) published its new monetary policy strategy, which set a symmetric inflation target of 2% over the medium term compared to the previous target of “below, but close to, 2%”. Further clarification around the ECB’s new forward guidance came on 22 July, when the central bank stated that it expected key interest rates to remain “at present or lower levels” until a few conditions were met.

The GBP strengthened 0.5% against the USD in July. The month saw the GBP influenced by concerns around increasing COVID-19 case counts, with the GBP tumbling 0.7% against the USD when the UK economy re-opened on 19 July. That said, as the case counts decreased and the Fed offered no material surprises during the FOMC meeting, the GBP marched higher. There were a few Bank of England (BOE) speakers this month, with Monetary Policy Committee (MPC) member Michael Saunders commenting on 15 July that “it may become appropriate fairly soon” to withdraw some monetary stimulus, although other speakers later in the month stuck to their more neutral or dovish stances.

Elsewhere: Worth its weight in gold

Gold climbed 2.5% in July as it comfortably cleared multiple hurdles in its way. On 2 July, when US non-farm payrolls beat expectations, the precious metal was unruffled and finished up 0.6% on the day. Another obstacle arose in the form of higher-than-expected US inflation data on 13 July, but gold steadied to end 0.1% up on the day. On 28 July, gold initially fell as the FOMC stated that the “economy has made progress”, but eventually ended up 0.5% and closed at around USD1815 per ounce this month. Meanwhile, Brent had a rough ride with prices vacillating on news about the Organization of the Petroleum Exporting Countries (OPEC) and its allies (known as OPEC+) before finally ending the month up 1.6%.

US: Fed lower

The US Dollar Index (DXY) fell 0.3% over the course of the month. On 2 July, US non-farm payrolls rose by 850k in June, the strongest gain in the past 10 months. Nonetheless, the DXY fell 0.4% on the day, possibly due to a worse-than-expected unemployment rate, which printed at 5.9% against expectations for 5.6%.

The DXY’s best one-day performance came on 13 July, when it rose 0.5% on news that US core CPI for June accelerated by 0.9% from a month ago MoM, which topped estimates for a 0.4% increase. However, most of these gains were erased the next day, with the DXY falling 0.4%, as the Federal Reserve (Fed) Chair Powell maintained the view that the surge in consumer prices in June was transitory during his testimony to Congress. Powell also reiterated the Fed is still far from reaching its goals of making “substantial further progress” needed for tapering to begin.

In the middle of the month, rising Delta variant cases sparked a broader “risk-off” move in markets, propelling the DXY higher. The DXY achieved new closing highs over the next four trading sessions as the resurgence of the virus led investors to rethink the growth outlook, but eventually reversed its gains as markets settled to wait for the Federal Open Market Committee (FOMC) meeting on 28 July. That said, the Fed failed to live up to the hype. While the policy statement said “the economy has made progress”, it maintained that rising inflation was “largely reflecting transitory factors”, and failed to give any specific details on tapering. During the press conference, Powell further affirmed that there was still “some way away” from “substantial further progress”. The DXY ended the day down 0.1%.

In an echo of Powell’s comments, economic data generally surprised to the downside. US 2Q GDP (advance estimate) grew 6.5% on a quarter-over-quarter annualised basis, lower than the 8.5% consensus, and initial jobless claims for the month of July all came in worse than expected. However, retail activity was resilient, with advance retail sales for June rising 0.6% from a month ago as opposed to the consensus of a 0.3% decline.

Eurozone: Little-changed on changes

The EUR rose 0.1% this month. The EUR started the month on the back foot, weakening 0.3% against the USD on 6 July following worse-than-expected economic data. The forward-looking German ZEW economic sentiment indicator plunged to 63.3 in July compared to the consensus of 75.2, and the aggregate Eurozone ZEW economic sentiment indicator plummeted to 61.2 in July, far below the prior month’s reading of 81.3.

On 13 July, a hefty US CPI print led the EUR to fall 0.7% against the USD for its worst one-day performance in July. However, the currency managed to claw back some gains the next day, with EUR-USD rising 0.5% on the back of the Federal Reserve (Fed) Chair Powell’s dovish testimony to Congress. For the rest of the month, the EUR mostly drifted lower until the Federal Open Market Committee (FOMC) meeting on 28 July. With the Fed staying accommodative, market sentiment improved and the EUR was given the green light to grind higher into the month’s end.

The month of July also brought changes to the European Central Bank’s (ECB) monetary policy strategy. On 8 July, the ECB published its new strategy, which set a symmetric inflation target of 2% over the medium term compared to the previous target of “below, but close to, 2%”. The ECB further mentioned that this target would allow for moderate and transitory deviations from the 2% target; the EUR ended the day up 0.5% against the USD.

Further clarification of the ECB’s forward guidance was made on 22 July, when the central bank stated that it expected key interest rates to remain at “present or lower levels” until three conditions were met – inflation has to reach 2% at the midpoint of the projection horizon, remain “durably” at 2% for the rest of the projection horizon, and the Governing Council has to determine that there has been “sufficiently advanced” progress towards the new 2% aim. EUR-USD fell 0.2% on the day.

On the data front, economic releases painted a mixed picture in the Eurozone. For instance, Germany’s Ifo numbers came in weaker than expected on 26 July. The EUR was seemingly unfazed on this data and strengthened 0.3% against the USD. On the flip side, on 23 July Markit Eurozone Purchasing Managers’ Indices (PMI) beat expectations and the composite print of 60.6 was the highest in 21 years, and Eurozone Q2 GDP expanded by 2% QoQ versus the estimated 1.5%.

UK: Between fear and cheer

The GBP strengthened 0.5% against the USD in July. At the start of the month, the GBP traded mostly sideways, possibly buoyed by optimism around the re-opening of the UK economy, which was announced on 5 July by UK Prime Minister Boris Johnson.

Towards the middle of the month, rising COVID-19 case counts – reaching over 50,000 daily cases on 16 July, the highest since January – led markets to grow apprehensive about the potential fallout from an economic re-opening. GBP-USD slipped 0.5% on the day and tumbled 0.7% against the USD even as the UK finally re-opened on 19 July. This free fall from “Freedom Day” (i.e., the date that the UK government ends all legal, social and economic restrictions imposed to mitigate the effects of the Covid-19 pandemic) led GBP-USD to dip below 1.36 intraday for the first time since February. However, as daily case counts decreased and the Federal Reserve (Fed) remained accommodative, the GBP eventually regained its footing.

Domestically, the economic backdrop appeared challenging for the UK. Industrial and manufacturing production data missed the mark, with the latter falling 0.1% from a month ago in May compared to the consensus of a 1% increase. Both manufacturing and services Purchasing Managers’ Indices (PMI) also disappointed expectations. That said, although growth seemed to have slowed down, inflation has picked up; core CPI for June rose 2.3% from a year ago, above an expected 2%, and retail prices index (RPI) for the same month increased 3.9% from a year ago as opposed to the 3.4% consensus.

The GBP also saw a host of Bank of England (BOE) speakers this month. On 1 July, Governor Andrew Bailey noted that it was important “to ensure that recovery is not undermined by a premature tightening in monetary conditions”; GBP-USD ended down 0.5%. On 15 July, Monetary Policy Committee (MPC) member Michael Saunders commented that if activity and inflation indicators remained in line with recent trends, then “it may become appropriate fairly soon to withdraw some of the current monetary stimulus”. Despite this, the GBP fell 0.2% alongside worse-than-expected labour market data that day. Notwithstanding Saunders’ hawkish tilt, BOE speakers later in the month all remained neutral or dovish, with Deputy Governor Ben Broadbent maintaining the transitory inflation narrative.

Japan: A faster, higher, stronger JPY

The JPY rose 1.3% against the USD. The largest gain occurred on 8 July, with USD-JPY falling 0.9%, as the JPY benefited from the “risk-off” sentiment rippling across markets. Over the next few days, USD-JPY oscillated on US news: first rising 0.2% on an unexpected surge in US core CPI data on 13 July, but falling 0.6% the next day as the Federal Reserve (Fed) Chair Jerome Powell’s comments downplayed the recent inflation surge as transitory.

On 16 July, the Bank of Japan (BOJ) held its policy rate at -0.1% and trimmed its growth forecast for 2021, but USD-JPY was seemingly unmoved on the announcement likely because markets had already anticipated the decision. As risk appetite continued to falter amid worsening COVID-19 case counts, USD-JPY fell on July 19 to 109.07 intraday, its lowest since the end of May.

Reflecting the BOJ’s worsening growth outlook, the domestic landscape was difficult. Although core machine orders for May exceeded expectations, jumping 7.8% from a month ago, against an expected 2.4% rise, tertiary industry activity fell 2.7% from a month ago in the same month, compared to the consensus of a 0.9% decrease. COVID-19 continued to weigh on the Japanese economy, with Tokyo extending its 12 July state of emergency to the end of August and new restrictions being imposed in a few prefectures.

China: The calm after a storm

The CNY was up 0.1% against the USD in July, but this belied the swings in the currency throughout the course of the month. On 9 July, the State Council cut the reserve requirement ratio (RRR) by 50bp, but despite concerns that this move signalled a possible slowdown in China’s growth, the CNY ended the day up 0.2% against the USD. Thereafter, these fears were allayed as economic data generally came in better than expected – for instance, retail sales for June rose 12.1% from a year ago, against an expected 10.8%. On the back of these positive surprises, USD-CNY nearly touched 6.45 on 14 July. Towards the end of July, a regulatory crackdown by the Chinese government sparked fear in markets and USD-CNY rose 0.4% on 27 July to close at 6.51, the highest since April. However, USD-CNY was not aloft for long and the CNY erased its losses after the Chinese government moved to calm markets on 28 July.

Canada: Little fuel to get by

The CAD slipped 0.6% against the USD this month. Most of the CAD’s declines came amidst falling oil prices. For instance, the CAD fell 0.9% on 6 July as a breakdown in talks among the Organization of the Petroleum Exporting Countries (OPEC) and its allies (known as OPEC+) led to greater uncertainty in markets (Bloomberg, 6 July), and retreated another 1% on 19 July after an OPEC+ deal was reached. That said, better-than expected economic data managed to support the currency, with net change in employment printing at 230.7k against an expected 175k on 9 July; the CAD strengthened 0.7% on the day. On 14 July, the Bank of Canada (BOC) left rates unchanged at 0.25% and tapered its pace of purchases to CAD2bn per week from CAD3bn previously. Nevertheless, as this decision was widely expected by markets, the CAD was little moved and USD-CAD fell 0.1% on the day. Towards the end of the month, a wave of risk aversion led USD-CAD to jump 1% on 19 July but as this faded, the CAD pared these losses.

Australia: One-way decline

The AUD saw an almost one-way decline against the USD in July, and ended the month down 2%. On 6 July, the Reserve Bank of Australia (RBA) left rates unchanged at 0.1% and extended its QE programme, but announced a slight taper to AUD4bn per week from AUD5bn previously; the AUD ended 0.4% down on the day. The currency saw little support from the domestic outlook as well. The Delta variant outbreak continued to worsen in Australia, with the Sydney lockdown, which was initially expected to end on 31 July, further extended to 28 August. Even bright spots in economic data were unable to give the AUD a much-needed uplift; for instance, despite stronger-than-expected labour market data on 15 July, the currency ended the day down 0.8%. Although AUD-USD did rise after the Federal Open Market Committee (FOMC) meeting, the gain was too meagre to make a difference and the AUD ultimately underwhelmed this month.

New Zealand: Hawkish surprises

The NZD fell 0.1% against the USD. The NZD began the month on the front foot, rising 0.8% against the USD on 2 July as the USD weakened on mixed labour market data. But the currency’s strong start halted when NZD-USD plunged 0.9% amidst “risk-off” sentiment. On 14 July, the Reserve Bank of New Zealand (RBNZ) held rates at 0.25%, but announced it would end its QE programme by 23 July. The hawkish surprise from the central bank bolstered the NZD, which ended up 1.2% against the USD on the day. Just one day later, a hefty CPI print – with 2Q CPI rising 3.3% from a year ago, above estimates of 2.7% – led markets to pull forward rate hike expectations, with markets now pricing in nearly two full hikes by the end of the year. Despite these positives, the currency was unable to stage a comeback and ended the month lower.

Norway and Sweden: Can’t catch a break

After a poor showing last month, the NOK continued to underperform, slumping 2.5% against the USD in July. The currency’s worst one-day performance came on 6 July, when the NOK tumbled 1.5% against the USD on the back of a stronger USD and lower oil prices. Although the economic data was mixed, the domestic picture was still relatively resilient; the unemployment rate registered at 2.9% in June, marginally worse than the 2.8% estimate, and May GDP rose 1.2% from a month earlier, up from 0.3% previously.

The SEK slid 0.5% against the USD this month. On 1 July, the Riksbank held rates at 0% and further suggested that the policy rate would stay at 0% through to at least the end of 2023; the SEK ended the day down 0.3% against the USD. Despite the Riksbank’s dovish announcement, the central bank did bump up its growth forecast to 4.2% in 2021, up from 3.7%. Mirroring the Riksbank’s upbeat assessment of the economy, data releases generally improved and were better than expected. May Industrial Orders rose 6.1% from a 2.5% fall a month ago, and the 2Q GDP Indicator grew 0.9% over the previous quarter, above estimates of 0.7%.

Oil: A roiling market

July was a tumultuous month for Brent, with prices rising and falling on news about the Organization of the Petroleum Exporting Countries (OPEC) and its allies (known as OPEC+) before finally ending the month up 1.6%. The month began with market participants turning their attention to the OPEC+ meeting on 1 July, but disagreements among the OPEC+ members led to talks being dragged on for the next few days. As it became clearer that OPEC+ talks had reached a deadlock, Brent tumbled 3.4% on 6 July amidst greater uncertainty around the unwinding of supply cuts (Bloomberg, 6 July). Thereafter, Brent managed to clamber upwards above USD76/b, but fell 2.3% on 14 July on news that OPEC+ had managed to reach a compromise, and fell 6.8% on 19 July after confirmation that a deal was reached. With OPEC+ talks a done deal, markets refocussed on the possibility of a strong recovery in oil demand as economies reopen, leading Brent to close the month at USD76 per barrel.

Gold: Overcoming hurdles

Gold climbed 2.5% in July. The precious metal got off to a good start, rising in the first five trading sessions of the month. Even a beat on US non-farm payrolls on 2 July was unable to dent gold’s ascent, and it rose 0.6% on the back of a weaker USD. Gold faced yet another hurdle on 13 July, when US inflation came in higher than expected; core CPI for June rose 0.9% from a month earlier, compared to an expected 0.5% increase. Although gold initially fell on the news, it eventually steadied to end 0.1% higher, and marched 1.1% higher the next day as the Federal Reserve (Fed) Chair Powell gave a dovish testimony to Congress. On 28 July, the Fed stated that the “economy has made progress”, which led to a kneejerk fall in gold prices, but without a concrete timetable on tapering, gold eventually ended the day up 0.5% alongside a softer USD and lower US yields. The precious metal closed the month at around USD1814 per ounce.

[1] This report uses Bloomberg prices.

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