Parky's quick take: 21 August

What’s in store this week for currencies and FX markets?

Will Asia provide the catalyst for more USD gains this week?

It is worthwhile watching what is happening in Asia. Previously I had mentioned the weakness seen in the likes of the Japanese yen and Chinese renminbi versus the US dollar. However, looking slightly more in-depth, the US dollar has made gains against the Indonesian rupiah, the Indian rupee, the Malaysian ringgit, the Taiwanese dollar, and the Korean won. So the US dollar’s strength is more uniform than it first looks, perhaps suggesting greater confidence that the US economy will avoid a recession, and cut interest rates more slowly; or indicating an undercurrent of concern about the performance of these Asian economies as we head towards the end of 2023.

It was a similar picture again last week, and this week could prove another critical week in terms of the performance of these Asian currencies. With there being little US data or survey evidence that should support the US dollar, if we see further declines in these Asian currencies then I think we could draw the conclusion that there is a bigger potential issue massing for them against not just the dollar, but other major currencies as well. This might still signify that the US dollar will make gains against the majors too, but I don’t expect this to be triggered by a lacklustre data calendar.

Signs of deflation become more obvious in Europe

Already this week, the German producer prices for July have recorded a sharp drop. Producer prices were down 6% year-on-year, more than overtaking the producer price deflation recorded in any of the major economies in Euroland, and second only to Portugal’s Producer Price Index deflation (which was measured at -6.7% year-on-year in July).

Weakness in industrial activity and investor confidence have also been a feature of recent weeks, and further economic weakness could be recorded in the provisional August Purchasing Managers’ Index for Euroland manufacturing and services on Wednesday, and again in the German August Information & Forschung (IFO) survey on Friday. Further signs of economic weakness coupled with price deflation at the producer level would alleviate the pressure on the European Central Bank to raise interest rates any further, but could cause the EUR a few additional problems against the US dollar.

GBP running into resistance as it tries higher again

Each time the GBP tries higher against either the USD or the EUR, it seemingly runs into resistance. The UK’s economic situation is certainly not helpful in this matter, with the UK having already benefited from predictions of a much higher UK interest rate peak, improvements in the trade balance and economic outperformance (versus consensus expectations) where the UK has not gone into recession as had been expected.

However, the economic outlook appears to be worsening (despite the upgrades from the IMF, OECD and Bank of England), with higher interest rates set to really undermine the middle classes in the coming quarters as mortgages are refinanced. I continue to see limited additional upside for the GBP against the other majors, and this week has nothing from a fundamental perspective that will come to the GBP’s rescue, in my opinion.

What reasons are there left for central banks to raise interest rates?

There are meetings of Bank Indonesia, the central bank of Turkey and the South Korean central bank this week. For the Asian central banks, there does not appear to be any need to lift interest rates any further, but for the central bank of Turkey a further hike is expected. Since the Turkish Presidential elections only a few short months ago, the consistent pressure on the Turkish lira has left the economy at risk of fresh imported inflation pressures. It would appear clear that the central bank has little other option than to raise interest rates again, but will it help arrest the lira’s decline, or simple postpone the losses for a few weeks?

I think that most major central banks have reached, or are coming very close to, the capacity of interest rate hikes that economies can absorb without a significant increase in the downward pressures on activity. Moreover, the risks are now skewed in terms of much weaker activity without much improved inflation outlooks, in my view.