Brave New World

Currency Review 05/05/2009

News 

• AUD: RBA keeps cash rate at 3%- “signs of stabilisation, Chinese economy has picked up speed”
• AUD: Building approvals up 3.5% vs 2.3% consensus forecast
• AUD: AIG performance of services 39.8, vs 35.5 previous
• CHF: SNB will use currency policy to prevent deflation
• GBP: PMI construction reading 38.1 vs 31.9 consensus forecast
• EUR: Factory gate prices fell 3.1% in the year to April- biggest drop in 22 years
• USD: Bernanke expects economic recovery by end of year, warns of credit market relapse

Commentary

The last six months has seen market participants often acting in unison to the dramatic financial developments that have unfolded. In currency markets this has been demonstrated by the strength of the USD and the JPY against other “high beta” currencies, such as the AUD, EUR and GBP. A reduction in confidence generally meant that the Dollar and the Yen would rally against currencies that typically did well when equity markets rallied. Now, as certain markets are showing signs of recovery following the global economic freefall, appetite for risk is becoming more varied with some markets beginning to turn bullish as prospects look increasingly good for a sustained recovery.

The Australian dollar has been chief beneficiary of the G10 currencies from this more benign environment. The AUD has gained more than 14% against the USD since March 4th; around the beginning of the most recent rally. The RBA’s decision to keep its cash rate at 3.00% was accompanied by a statement expressing confidence in the Australian economy, making reference to China’s seemingly strong recovery. What was particularly encouraging was economic data released this morning showing a resilient and strengthening domestic economy, with construction and consumption both posting healthy gains. The AUD has rallied strongly against the dollar, building on the gains made on Friday. 

Sterling has also been a gainer in this increasingly sanguine mood. Better than expected construction data suggested that, at the very least, the rate of decline in construction is slowing and confidence is no longer at rock bottom. Renewed confidence in the banking sector and more generally the financial system- LIBOR is now below 1% and, more importantly, the TED spread is back to pre-Lehman levels- has been beneficial to Sterling, whose country has relied so heavily on financial services. GBPUSD is now near the top end of its 2009 range. However, the currency is looking vulnerable. The Fed’s Stress Test results are released on Thursday and are widely expected to conclude that a number of banks need fresh capital. A renewed focus on toxic assets, a very important part of the current problem, could see confidence fraying and a sell-off in Sterling. In the meantime though, it is likely to benefit from the more upbeat mood; at least relative to other European currencies.

The EUR continues to look weak, with more worrying deflationary data and an increasingly incoherent policy response by monetary and fiscal authorities. Open splits are appearing between the ECB members about the threat posed by inflation. Similarly, the ruling grand coalition in Germany looks under strain, with the CDU and SPD looking more like parties in competition rather than partners in government. The European Commission expects economic recovery to start in the second half of 2010, later than most other G10 countries. With so many variables and such tentative steps and indecision this could drag on for much longer. Germany is expecting a decline of 6% in GDP for 2009, worse than any other large developed world country save Japan. The EUR is not gaining to the same degree as other currencies against the USD in these relatively optimistic times.