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FX Weekly Report (6/7/2012): Equities shed their gains following key central bank actions

Markets were rocked this week and risk appetite hit hard as a combination of several key central bank actions and disappointing data from the US put the spotlight back on the global growth story, highlighting how fragile the economic recovery has been.

By Gaurav Kashyap, Head of DGCX desk at Alpari ME DMCC

Equities, currency and commodity markets shed all their gains to approach pre-EU summit levels as the US Dollar index roared past 83 levels and approached those June highs of 83.50.

Following all the optimism from last week’s EU Summit, all attention turned to the rate decisions of four key central banks and their views on the global economic recovery. Early in the week, the Reserve Bank of Australia (RBA) sprung no surprises and held rates unchanged at 3.50% and as the US celebrated their independence with an impressive show of fireworks from coast to coast, it was the actions on Thursday which led to extended fireworks in the financial markets.

The Bank of England (BOE) held rates unchanged at 0.50% and increased the asset purchase target by £50 billion to a revised £375 billion. The moves were expected, and are in an effort to prop up a stumbling UK economy which is threatened by recession. With inflation easing on the back of falling oil prices, weakening output data from the UK forced the MPC to act. Simultaneous to the BOE decision, the People’s Bank of China (PBoC) delivered a surprise 31 basis point cut to their one year benchmark lending rate to 6.00% and cut their deposit rate by 25 basis points to a revised 3.00%.

Similar to the BOE’s actions, the PBoC are desperate to stabilize future growth prospects in the world’s second largest economy. The unanticipated cut was the second such cut by the PBoC this year and was reminiscent of their actions last month when they delivered a surprise rate cut at the same time the BoE announced one month ago. The timing of the PBoC’s announcement is suspicious to say the least considering the slew of economic data releasing from China next week.

Inflation data, trade data, industrial production and GDP data are all on tap for release in the week ahead and the premeditated, surprise cut seems like China is bracing itself and warning global markets for more slowdowns in their key releases in the week ahead. Unlike last month, markets viewed the surprise Chinese move with great optimism – commodity markets and higher yielding assets got a boost following that announcement. However this month, markets took the news with a big dose of skepticism, voiding the markets of risk appetite and taking Gold and Crude below 1600 levels and 86 levels respectively.

Amidst the risk off environment created by the PBoC, Draghi announced rate cuts for the Euro-zone which failed to impress markets and improve risk appetite. As largely anticipated, the ECB delivered a 25 basis point rate cut to the main refinancing rate, bringing to down to a record low 0.75% and also lowered the deposit rate to 0.00%.

More surprisingly, the ECB also cut the deposit rate to 0.00% which will see no interest paid on overnight deposits with the bank in effort to get some of that €800 billion out of ECB coffers and into the stumbling Euro-zone economy. In his press conference following the announcement, the ECB President dampening sentiment and painted a bleak picture for the Euro-zone saying that “downside risks to the euro-area economic outlook have materialized” and that “economic growth in the euro area continues to remain weak with heightened uncertainty weighing on both confidence and sentiment.” The bearish overtones extended the risk off mood and the Euro fell to a one month low against the Greenback.

As if there weren’t enough fireworks on Wednesday & Thursday, markets had Friday’s US Nonfarm payrolls to deal with. And unfortunately the release did little to improve market sentiment. The US Nonfarm payrolls for June missed expectations yet again with overall payrolls coming in at 80K, well below expectations of 100K.

Hiring in private payrolls also fell below expectations, dropping to 84K from an expected 106K. Manufacturing payrolls came in at 11K, up from an expected 7K. The overall unemployment rate was unchanged and in line with expectations at 8.2%. June’s figure capped the weakest quarter of jobs growth in two years, where an average of only 75K new jobs were added each month, this well below the 226K monthly average in the first quarter of this year.

Those who fell out of the labor force increased by 34K to more than 87K, but this was not large enough to warrant any changes in the participation rate which was unchanged at 63.8%. The report, along with the ISM index for manufacturing which came in weaker earlier in the week, reinforced the fact that the US economy continues to struggle with slowing output amidst a global slowdown and this no doubt will see the debate of QE3 re-ignite in the markets once again. But the figure is not weak enough to force the Fed into introducing additional QE measures when they next convene at the end of July and as a result the US Dollar will continue to benefit. The US Dollar Index looks primed to test those June highs of 83.50 once again, with commodities and higher yielding assets remaining under pressure against the Greenback.