20151014 – DEFLATION?

High Low High Low
EUR/USD 1.1420 1.1377 USD/ZAR 13.5756 13.4421
GBP/USD 1.5291 1.5247 GBP/ZAR 20.71 20.54
EUR/GBP 0.7474 0.7447 USD/RUB 64.20 60.73
GBP/EUR 1.3428 1.3380 USD/ILS 3.8841 3.8516
USD/JPY 119.81 119.48 S&P 500 2006 1997
GBP/CHF 1.4647 1.4591 Oil (Brent) 49.94 49.30
GBP/AUD 2.1194 2.1035 Gold 1175.1 1166.4

 

Yet another nail in the coffin for interest rate normalisation yesterday as year on year CPI in the UK went into negative territory. Granted this is just one inflation measure, and not really the one usually focussed upon, but there’s nothing like a negative headline number to dampen interest rate expectations. Not surprisingly the pound took a beating yesterday – by early afternoon GBP/USD had dropped from close to 1.54 to 1.52. It is currently recovering, but there is a distinct possibility that this won’t last for long. As I’ve said in recent weeks I fear GBP will likely underperform USD and EUR in the coming months.

 

While the Bank of England and the Federal Reserve in the United States are retreating from their plans to normalise policy, it’s worth pointing out that these are not the only economies where weaker prices are being published. Last month Spain shocked the macro world with much more negative inflation than expected, and a recent revision, while a little less grim was still deeply negative. In France prices don’t appear to be changing on an annualised basis. It’s worth pointing out that wholesale inflation in India remains in deeply negative territory (WPI has tended to be the main inflation measure in India, presumably because the history of the series is more substantive than more consumer oriented measures). Furthermore, Chinese inflation rises are decelerating quite sharply as well. The spectre of disinflation, or deflation if you have a flair for the dramatic, is quite pervasive globally, even if we are clearly still feeling the ripples from the energy price collapse last year. I should make it clear – with regards to the UK numbers – that core CPI was comfortably in positive territory which keeps me believing that we’re not going to be freaking out about falling prices for very long. By the way, pensioners will now be getting a better deal, as their fixed incomes are looking a little bit healthier if the prices in their consumption baskets are falling (if!!!), who says falling prices are a bad thing? The bottom line is that any weakness in either GBP or USD due to a re-assessment of interest rate hikes is purely based on changing expectations. Other central banks are steadfastly in easing territory and will remain there for a far longer time.

 

There was other ugly data yesterday, with a very uninspiring set of ZEW data published in Germany. German current conditions looked awful, and sentiment appears to have fallen off a cliff. But as I’ve maintained over the last few weeks the underlying data in the US and UK still looks reasonable to me, and small business optimism in the US reflects this with further gains according to the data yesterday. Later on today we get industrial production numbers out of the Eurozone, Italian inflation numbers, a host of labour market data in the UK and retail sales data in the United States. These will further add to the picture, which seems to be pointing towards an easing of financial conditions pretty much across the board that will set up a revival in activity in the months ahead. I wager that as we move through earnings season there will be plenty of opportunities to increase equities exposure as the conditions are being set for a fairly decent risk rally. My expectation of a rally is of course based on the assumption that what we are currently seeing is actually not that serious, more mid-cycle than end cycle. Time will tell…

 

Yesterday’s high in cable, 1.5388, represents a fairly important level now. Unless GBP/USD is able to hurdle this level, the bias has to be for further weakening. 1.1460 is the level to watch for EUR/USD, but I have very low conviction on where we go from here, EUR/USD may well still be deep within a complex corrective pattern. GBP weakness therefore represents relatively low hanging fruit as views go, as does the expectation of a continuing recovery for emerging market currencies. We will continue to monitor the markets on your behalf, and report via back our blog and twitter account (@parityfxplc).

 

 

 

 

 

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