FX Daily: Iraqi tensions lead central banks to review inflation outlook

16th June 2014

  • The world’s major central banks are moving their investments into equities as low global interest rates hurt their investments, according to research by the Official Monetary and Financial Institutions Forum. (The FT)
  • The factors behind the long drawn out period of weak post-financial crisis UK productivity growth has evolved as the years have gone by, but in the past couple of years low investment and inefficient allocation of resources are the prime suspects, a BoE research paper finds. (MNI)
  • ECB’s Nowotny has said the Bank’s upcoming stress test of European lenders may actually wind up being too strict, saying the ECB is “going very far beyond what the US did” and that it can “lead to excess”. (MNI)
  • Greek PM Samaras reiterated that his government will announce relief measures for the lower income group and those hit by pension cuts and present a complete tax cut plan within the next six months. Samaras will also confident early national elections could be avoided when President Papoulias’ term ends in March. (To Vima)
  •  China’s Premier Li wrote that this year’s economic pace is “normal” and that his government is confident that the growth target of around 7.5% will be met, pledging to make “anticipatory and moderate” adjustments when necessary. (The Times)
  • Rising immigration has emerged as the latest concern for the RBNZ, ending some expectations that the bank would reduce its pace of rate hikes. (MNI Market News)
  • RBA’s Kent commented overnight that a falling AUD, wage growth and low rates were aiding the economic rebalancing and the non-mining economy had picked up slightly from late last year. (MNI Market News)
  •  UK Rightmove House Prices rose 0.1% on the month in June, following a 3.6% monthly gain in April. Annual house price growth stood at 7.7% in June, down from 8.95 in April.

Risk was back on the agenda Monday morning, with the usual beneficiaries up and the usually casualties down. The Japanese yen and the Swiss franc were two of the best performing G10 currencies overnight. Yen steadily fell lower in the Asian session this morning, all the way from a Y102.08 open to hit a session low of Y101.72. Admittedly Abe’s announcement of a reduction in corporate tax rates may have had some impact in its slide. USDCHF broke below the CHF0.90 level to print a session low of CHF0.8987. Gold made further gains up by $7 to $1,284.24 this morning. WTI crude oil futures for July ’14 delivery were last up $0.10 at $107.01 per barrel as prices continued to be buoyed by geopolitical concerns. The progression of Sunni insurgents in Iraq is threatening the regions oil supply, which account for 3 million barrels a day in world oil supply. The country’s second largest oil refinery in Baiji may have already fallen to the ISIS. Libya, Yemen and Syria have already been taken off the oil supply grid due to civil conflict and if it hadn’t been for the shale-gas revolution in the West, global oil prices would already have been sharply higher. The world cannot easily offset the loss of 3million barrels a day of oil output, over 3% of total global supply. Saudi Arabia has already raised production to offset the decline in supply from the Libyan conflict. It will have limit capability to compensate for Iraq. The one caveat at this stage is that it is still uncertain if ISIS is able to orchestrate anything more than terrorist acts on the Shia regions rather than a full civil war.

The escalation in tensions will see the usual safe haven currencies in demand. The dollar finds itself in more conflicted territory as higher global oil prices implicitly mean a widening current account deficit arguing for a weaker currency while liquidity premium means it should gain on risk aversion. We prefer to play risk aversion through the world’s default safe havens, playing a long yen position against short euro seems to be the most obvious trade. Geopolitical tensions however cause only short-term reactions in the currency space, and we can expect a V-shaped recovery in Yen and CHF crosses.

The long-term impact of a suspension of Iraqi oil production would be felt through higher inflation and more urgency for global central banks to hike interest rates. US monetary policy takes centre stage this week with the June 18th FOMC meeting, Chair Janet Yellen press conference and the staff projections. The PCE measure of inflation has already reached the staff’s upper bound of their Q4 2014 target of 1.4%-1.6%. The corresponding rise in core PCE deflator confirms that this is more than temporary. We can expect FOMC staff to upgrade their inflation target and lower their unemployment target at this week’s meeting. This has to translate into a hawkish change in the dot plot chart. Despite Chair Yellen seeking to downplay the chart’s importance, a projection of members’ expectations for the Fed funds rate is crucial as we head into a tightening cycle. The Fed statement is likely to be reissued word for word and Janet Yellen is likely to give little away in her press conference while retaining the same dovish tone. Thus markets will look to the dot chair for their only real clue to the FOMC’s discussions. The threat to global energy prices from the Ukraine crisis and now from Iraq cannot be overlooked in the members’ discussion of inflation. We look for a slightly from hawkish tone to the FOMC meeting and a stronger dollar as a result. This will have most impact on the euro-dollar cross as the market continues to target the $1.3503, post June ECB press conference low. Will a hawkish FOMC meeting be enough to allow euro-dollar to break below the $1.350 key support level?