After a wild ride on Thursday, Friday’s price action in the equity and currency markets will again be determined by Chinese economic reports, including the latest inflation and industrial production data.
Today's rally in equities and currencies was driven primarily by Chinese trade figures, which, at first glance, fell short of expectations after the country's trade surplus shrank to $17.82B from $27.12B. However, the market reaction was very positive because exports and imports rose strongly. Not only did exports recover, but imports rose by a whopping 10.9%.
The last decade has been all about watching Chinese exports as a measure of global demand, but with the new leadership, China's focus on domestic consumption is making imports increasingly significant. China is still an export-dependent economy, but a rise in imports suggests that the export sector, or the economy as a whole, is performing well enough to fuel domestic demand.
It is for this very reason that investors have responded positively to the apparent stabilization in Chinese trade data, and without the good news from China last night, currencies and equities would have probably resumed their slides.
More data is expected from China tonight, and the focus will be on inflation and industrial production. Price pressures are expected to increase slightly, but industrial production could see a stronger rise because healthier imports imply the need for increased manufacturing production. If tonight's Chinese data beats expectations, we could see a stronger rally in equities and currencies.
Meanwhile, the US dollar (USD) lost value against all major currencies today with the exception of the Japanese yen (JPY). US weekly jobless claims rose slightly from 328K to 333K, but the absolute amount of claims is still low and consistent with an overall recovery in the labor market.
Unfortunately, this data had very little impact on the dollar, and instead, falling Treasury yields kept the greenback under pressure.
Today's 30-year bond auction saw the lowest bid-to-cover ratio since the US lost its AAA rating in August 2011. This may reflect weaker demand for US assets, but according to Bloomberg, demand from an investor class that includes foreign central banks was above average.
As there are no US economic reports scheduled for release over the next 24 hours, Chinese data will drive flows in equities and currencies into the end of the week.
Another Wild Night for AUD/USD?
The Australian dollar (AUD) endured some wild price swings overnight, having initially fallen on weaker employment numbers only to recover strongly on the back of the Chinese trade data. Australia feeds China's thirst for iron ore and relies on its demand for growth. Since the volume of iron ore imported by China in July was the largest this year, it came as a very good sign for Australia's economic outlook.
See also: AUD/USD Dodges Dour Data
Traders should expect the volatility in the AUD and Aussie related pairs to continue over the next 24 hours with Chinese inflation and industrial production numbers scheduled for release along with the Reserve Bank of Australia (RBA) quarterly statement on monetary policy, which is not expected to be supportive of the AUD.
Considering that the RBA cut interest rates by 25 basis points (bps) at its last meeting, the quarterly statement should contain a more dovish tone that could counteract some of the upside pressure on the currency.
The Australian dollar won't be the only currency in focus, however. Canada is also scheduled to release its employment report, and job growth is expected to have accelerated in the month of July as employment conditions improve in the manufacturing sector. According to the latest IVEY PMI report, employment returned to expansion in July.
The Canadian dollar (CAD) rose strongly today in anticipation of this key release, but higher house prices also helped.
Stronger housing market numbers were released from New Zealand as well, but the rise in the New Zealand dollar (NZD) can be attributed mostly to Chinese data.
New UK Trade Data Due on Friday
The overall improvement in risk appetite today also drove the British pound (GBP) higher against the US dollar. No UK data was released this morning, but UK trade data is expected on Friday. With upticks in industrial production and the manufacturing PMI index, our views are in line with the consensus forecast for an improvement in trade conditions.
As trade and retail sales are the primary components of GDP, a smaller deficit would also be consistent with the upgraded Bank of England (BoE) GDP forecasts. The BoE now expects 2013 GDP growth to be 1.5%, up from the meager 0.2% growth experienced in 2012.
Currently, GBPUSD is trading above 1.55, and while further gains are possible, especially if the trade numbers surprise to the upside, we still believe that gains will be limited to the June high of 1.5750. The same is true for EURGBP, where we expect losses to be limited to 0.84.
How Far Can USD/JPY Fall?
The Japanese yen traded lower against all major currencies on Thursday, and at one point, it looked like USDJPY would close lower for the fifth consecutive trading session, but a gradual recovery after the European close left the pair in positive territory.
The continued slide in the Nikkei and lack of upward momentum in US yields has prevented USDJPY from rallying materially. From a technical perspective, there is no major support for the pair until 95, and even then, beyond the psychological significance of this level, there is not much standing in the way of USDJPY revisiting its June lows at 94.
See also: A Runaway USD/JPY Move Few Would Expect
From a fundamental perspective, the reasons for buying USD/JPY including Fed tapering and BoJ easing remain intact but at this stage, we would prefer to wait for the currency pair to stabilize and start to turn higher before buying.
By Kathy Lien of BK Asset Management