Brave New World

FX Review 24/03/2009

Equity markets across Europe have are broadly flat in mid-morning European trading, after initially opening higher. Overall, risk appetite appears to be higher following yesterday’s stunning rally, with a Dow Jones up 6.8%. Overnight in Asia, the Japanese yen was the main victim of the change in sentiment, with the JPY rising from 96.5 to 98.0, and EURJPY rising to a 5 month high from 132 t0 134. However, given that JPY looked set to lose its safe haven status, the yen was likely to be weakened in any risk environment.

The EUR and the AUD appear to be the main beneficiaries from the new positive environment ignited by the Fed’s quantitative easing decision and Geithner’s plan to remove banks’ toxic assets.  The AUD has benefitted strongly in the last few days from the rise in commodities, on the back of a weakening USD. The RBA’s decision to keep rates on hold last week was accompanied by minutes suggesting that rates may still head lower if monetary easing was not gaining any traction. Given that rates are at 3.25% Australia is still some way off the need to introduce quantitative easing (QE). This has boosted the AUD, especially given what now looks like a QE race by other central banks. The European Central Bank is often considered to be the last refuge of the monetarist, and their central bankers would balk at any suggestion that they are about to enter the QE race. However, the EUR was chief beneficiary of the US money printing announcement last week and is increasingly looking like the new safe haven currency, with both the ECB and the main Eurozone governments advocating prudence on monetary and fiscal expansion. How long this stance can be maintained is increasingly open to question. Revised projections for German growth published yesterday show the region heading the way of depression- ridden Japan. The IMK, a German think tank, now expects Germany’s GDP to contract 5% in 2009 – more than double the expected fall back in January. This was by no means the worst prediction – Commerzbank expect a contraction in the region of 6-7% in 2009). The 5% rise in EURUSD last week will have tested the strongest of monetarist nerves in the European Central Bank. Definitive, surprising decisions is not the style of the ECB, but drastic times call for drastic measures and the effectiveness of the Fed’s move last week may given some European policy makers food for thought. The GBP has made gains against the USD and JPY but this has been less pronounced than the strength of the EUR or AUD. This morning’s surprising CPI announcement (up 3.2% y/y vs the expected 2.6%) was, according to BoE Governor Mervyn King, due to the sharp decline in sterling over the last few months. He expects renewed deflationary pressures over the next few months. The currency looks vulnerable at these levels against the USD, near the top of its range in the last few months. With Bank of England comments that there appears to be no improvement in lending the outlook overall is bearish.