Sterling again steals the limelight. In early Asia, sterling inexplicably
dropped nearly eight cents in minutes (to ~$1840), and on some platforms, may
have traded below $1.1380. It almost immediately rebounded but has not resurfaced above
$1.2480.
Over the last couple of years,
there have been a number of sudden
dramatic moves in the foreign exchange market. They have involved
currencies like the New Zealand dollar and South African rand. However,
major currencies, like the Swiss franc, have also seen dramatic moves, though
there was a clear fundamental trigger. The yen has often been subject to
sharp moves. And now sterling.
There are two main schools of thought. The first looks at the
micro-market structure. The fragmentation, which is partly made possible
by technological advances, changes the liquidity distribution. There is
the rise of the algo, machine-based
trading. There has been a reduction of risk-taking (proprietary trading)
at banks. The market is more exposed to short-term leveraged
operators, often using reverse knockouts/ins, and one-touch options, which are
force multipliers.
The other approach looks at macro-developments. The price of
reducing overall volatility in the capital markets is occasional and
self-reinforcing spikes. Perhaps it is like a summer storm. The
storm itself is partly a function of the previous calm.
Remember the neoliberal argument. If the price of capital is
allowed to move, it can act as shock absorber. It can make the adjustment
so the real economy (employment, output), doesn’t have to adjustment so
much. Capital markets volatility is low. Some say it is
a function of market direction, which itself is
underwritten by the orthodox and unorthodox monetary policy
measures. The economic activity appears to have gotten more
volatile.
No news is able to rival the
dramatic move in sterling today. However, it is notable that the
German, French and Spanish industrial output data were consistently stronger
than expected. After reporting a jump in industrial orders to
five-month highs yesterday, Germany reported a 2.5% rise in industrial
production, more than twice what the median had forecast. It follows a
1.5% decline in July. Manufacturing output rose 3.3%, while energy production rose 1.1%. Construction
fell 1.2%.
French industrial output rose 2.1% in August, more than three times the
median forecast. It more than offsets the 0.5% (initially 0.6%) fall
in July. Manufacturing output jumped 2.2%. The Bloomberg
median was for a 0.3% increase. The data stands in stark contrast with
the manufacturing PMI, which has been below 50 since March and fell to 48.3 in
August from 48.6 in July.
Spanish industrial output rose 1.4% in August. Economists had
expected a small decline, though the July series was revised to 0.1% from 0.2%. Italy will report
next on Monday. In the middle of next week, the aggregate figures will be published. There are upside risks to the previous median
forecast of a 0.7% increase.
There were two reports in Asia to which we draw your attention.
First, Japan reported labor cash earnings fell 0.1% year-over-year in
August. This is down from 1.4% in
July. Real cash earnings (adjusted for inflation) slowed to 0.5% from
2.0%. The combination of low wage growth and low interest rates may
exacerbate the propensity to save (one expression of which is larger current
account surplus).
Second, although Chinese markets are still
closed for the national holiday, September reserve figures were
reported. They fell to $3.166 trillion from $3.185 trillion. This is a new five-year low. This was a somewhat larger drawdown than surveys
anticipated.
Attention turns to the US employment data, which will overshadow the
Canadian jobs report released at the same time. Outside of the
ADP data, other pieces of data pertaining to
the US employment were favorable. The one cautionary note is that in
recent years, the market has consistently over-estimated job growth in
September. The surveys suggest the median guess is around 170k, but
we suspect it has crept higher. Other details from the report will also
be important, like hourly earnings and average hours worked.
A significant challenge is that perhaps it is globalization.
Perhaps it is technology. Those with a college degree have a 2.5%
unemployment rate. The unemployment rate is more than twice as high for
high school graduates. The unemployment rate for those without high
school is almost the sum of the other two cohorts (~7.5%). That
education/economic dynamic has become a political force to be
reckoned.
The short-term market is going into the US report having extended the
dollar’s gains and with the two-year note yield near four-month highs.
The US two-year premium over EMU and the UK is the most in a decade. The CME model, based on the
futures prices, estimates a 55.1% chance of a December hike and a 14.5% chance
of a Nov move. Bloomberg puts the odds at 51.3% and 23.6%
respectively.
Between tradition and the lack of
updated forecasts, we think the bar to a November hike is very high. Even if our suspicions are accurate, that the
US delivers a robust jobs report, there still two other jobs reports that Fed
officials will see before the December meeting.
There is clearly scope for the market to price in a greater chance of a
rate hike before the end of the year. The
issue is whether it does so today.
Our recent commentary, in the emerging markets as well as out profiles of major countries (EMU, Japan,
Canada, Norway and Sweden) we show how interest rates appear to be re-emerging as
an important driver.