In our FX review this week, we discuss the inflation outlook for both the US and UK, following two very different sets of releases that came out. With falling iron ore prices, AUD struggled to make any gains this week. Finally, the broader sentiment of lower commodity demand from China with a potential slowdown on the cards saw an overall risk-off way to end the week, with USD strengthening.
On Tuesday we got the US inflation print out for August. It missed expectations of 0.4%, coming in at 0.3%. When we strip out the impact of food and energy prices, it was actually just 0.1%. This provides quite strong evidence that earlier (higher) inflation prints were just transitory in nature.
What this means is that the US dollar might not hold as much potential strength in it going forwards that many people thought it did. If inflation in the US tails off, there is little need for the US Fed to step in and aggressively taper off asset purchases and raise interest rates to stem a booming economy.
Lower rates means a lower opportunity cost for investors to buy USD.
On the flip side, on Wednesday we got the UK inflation print for August. The year-on-year figure showed inflation at 3.2% vs 2% previously. This was a large jump that few were expecting. In contrast to the US, this could mean that the underlying reasons behind the rising inflation are more fundamental, and here to stay.
This could allow for a nice trade setup on GBP/USD, getting long GBP around current closing levels just above 1.3700 to target 1.4000 in coming months.
Reviewing the FX move from China
The other major story coming out from last week was fresh concerns over a slowdown in China. Commodity prices took a hit from this, particularly iron ore. Iron ore is a component in steel production, which is heavily demanded by Chinese enterprise.
Potentially lower demand out of China has the knock on impact of lower iron ore prices. This impacts the trading partners that export iron ore to China, namely Australia. We did see AUD/USD move lower, especially as we came to the end of the week. The pair closed around 0.7260.
This does look like a favourable opportunity to buy AUD, if this China story fails to deliver. However, we would trade this with an appropriate stop loss, or marry it up with being long a risk off pair, such as being short CAD/CHF.
Still in the ranges
Concerns over China, along with equity volatility on Friday meant that the USD closed the week with a strong bid. Yet, the summer ranges for most major pairs (that we spoke of last week) still have not been broken, so we don’t read into this too much in our FX review.