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.

Markets respond well to TARP plan 23/03/2009

Following last week’s dramatic collapse in the USD and uneasiness about poor policy coordination and dismal economic news, the dollar and equities have got off to a strong start this week. Given than there have been plenty of reasons to criticise Treasury Secretary Tim Geithner the market was holding its breath ahead of today’s announcement on the dealing with toxic assets. As part of the plan, the government will match private sector money with treasury funds to buy up to $1 trillion of toxic assets from the balance sheets of failing institutions. So far there has been positive reaction to the plan.

Foreign Exchange Update 18/03/2009

USD– Given the weak state of the US economy and with interest rates are effectively at their lowest possible rate per cent today’s FOMC announcement is squarely based around whether or not it will join the Bank of England and start monetising government debt  or quantitative easing” (QE). The USD has weakened over the course of the day, breaking clearly through the 1.30 level to trade at 1.3150 at 2.30pm GMT, signifying that the market believes that threat of deflation has receded. Consequently, the market believes that the Fed will delay outright quantitative easing and the purchase of US Treasuries. This follows a positive and slightly better than expected US CPI today, a 22.2% m/m boost in US housing starts (rising for the first time in eight months and the sharpest rise since January 1990) yesterday’s better than expected sentiment data from Germany. The bear market rally that is giving rise to this optimism will fizzle out soon, and with it generate a better analysis of the three pieces of economic news just mentioned. First, the rise in CPI is most likely a result of deep discounting at the end of the holiday season. Price cuts are likely to resume if consumer spending deteriorates further; very likely with a skyrocketing unemployment rate. Second, housing starts remain in dire state, 47.3% down on the year. January’s figure was the lowest since records began in 1959 (when the US population was 177 million!). It is too soon to call a bottom to this market but many commentators will so long as this temporary rally lasts.  

EUR– The single currency appears to be the main beneficiary from the the more upbeat mood. Increasingly, the public spat between European and US policy maker over the need for a coordinated fiscal stimulus should dominate the exchange rate. Roughly put, when economic conditions point to a deep recession rather than depression European policy makers look vindicated in their caution towards the  aggressive stimulus measures favoured by the UK and US. Moreover, any sign of a bottoming out of the economic picture removes the need for a safe haven currency, attracts yield seekers, and provides surplus countries with another region to place their FX reserves. However, what a further strengthening Euro will do to already emaciated German exports, let alone Eastern European debt repayments one shudders to think.  The upbeat assessment is also, in my opinion, way overdone. Nevertheless, EURUSD is still above 1.30, and against sterling the single currency has hit the dizzy heights of 0.94.

Sterling experienced a sharp sell-off today, with the FT reporting that the IMF is making a sharp downward revision to its forecast for 2009 and 2010 and a record rise in unemployment refocusing the FX spotlight on the weakness of the British economy. Tomorrows IMF report forecasts that the UK will remain in recession throughout 2010, falling 0.2% after a drop of 3.8% in output this year. Only Japan is expected to experience a sharper fall in output. Data released this morning shows that  jobless claims rose by 138.4k, considerably higher than the market expectation of 84k and the highest rate since records began in 1971. Minutes from the Bank of England  showed unanimous decisions both to cut rates and to initiate QE. Despite a sharp initial sell-off GBPUSD is back above the 1.39 handle. EURGBP has moved a penny higher from 0.928 to 0.938.

FX Mid Morning Update 17/03/2009

The foreign exchange market has had a relatively quiet session in Asian and early European trading as doubts have emerged about the sustainability of the recent rally in equities. Although markets have yet to reverse the gains made in the last week, there appear to be signs that the recent rise is increasingly resembling a bear market rally, rather than a true reversal in sentiment. Overnight,  the Nikkei closed up 3.18% but the Hang Seng closed lower at -0.33%. European equity markets are also down slightly. The movement in the FX  market has been very closely correlated. The performance of the Dollar was almost perfectly inverse to the the Dow Jones, falling to lows against the EUR and GBP before rising at around the NY close. In the last 12 hours, the main currency pairs have been trading in a very narrow range. EURUSD, having twice above the key psychological level of 1.30 in the last 24 hours, has settled to a very narrow range of around 1.2980. Cable looks heavier although has displayed little price action, setting around the 1.4950 level. USDJPY, which many market participants had been predicting would breach the 100 level following last week’s SNB intervention has also remained tightly ranged bound, trading between 98.05 and 98.78 in the last 12 hours. Fundamentally, the evidence in favour of a sustained equity market rally- feeding risk appetite and so a sell off in the USD- is too flimsy. Unexpected news from the banking sectors has been the main driver- macroeconomic data remains dismal and government policy unclear.

Expect EURUSD and GBPUSD to remain biased to the downside. Any sustained break in EURUSD above 1.30 should see the pair target 1.3300. That is unlikely to happen without a strong rally in the S&P/Dow.                            

NEWS  

JPY: Finance minister Kaoru Yosano comments that both Japan and the world economy are on the verge of a deflationary spiral. The Tertiary activity index rose 0.4% in January – the first increase in three months and thwarting the consensus forecast for a 0.5% fall after a 1.6% drop in December.  

EUR: ECB Executive Board member Juergen Stark is quoted in Handelsblatt: “We have a little more wiggle room on reducing rates. To fix a threshold at which we will stop does not make sense in the current situation … For me personally though, the threshold is not far from where we are now”. Asked about pushing interest rates toward zero, Stark said such a step would not necessarily reactivate the interbank lending market and that there would be a danger that unprofitable investments were made and the foundation for new excesses established.

CNY: Former PBOC advisor, Yu Yongding commented that China should not lend a lot of money to the IMF because the cash would be used to bail out countries that are richer than China and are biased against Beijing. He said: “If we do so, it will seem like the poor is rescuing the rich, wouldn’t it?”

Key Event 10am: The German ZEW investor index came in at -3.5 (exp -7.7), better than expected. Eurozone ZEW index was -6.5 (exp -11.7). EURUSD jumped over 20 pips to 1.301 before settling back to around the 1.3000 level . The figures needed to be fairly significant to change the holding pattern in the market ahead of the US equity market opening. The ZEW surveys investor confidence, and so is less highly valued as an economic confidence indicator than other data surveying corporate sentiment.

Sterling and Inflation 13/03/2009

If sterling’s really fall is telling us that there’s a risk of inflation, then it should have been accompanied by a rise in the breakeven inflation rate (the gap between conventional and index-linked gilt yields). But my chart shows that the opposite has happened. As the pound has fallen, investors have become less worried by inflation, not more. 

The beginning of a currency war? 12/03/2009

The rules of the game have suddenly changed. In one fell swoop the Swiss National Bank has introduced by far the most aggressive monetary easing since the crisis began in 2007. In addition to cutting interest rates by the expected 0.25% the SNB announced quantitative measures as well as direct intervention in the FX market to weaken the CHF. Direct intervention, in the form of buying EURCHF, took place at the time of the announcement; pushing the pair up 400pips from 1.48 to 1.52 in a matter of minutes. Prior to today’s announcement the CHF was approaching the record high of 1.43 it set against the EUR in October. The intervention is a direct an effective measure to prevent any further appreciation against the EUR. 

It is a pretty significant event and represents a new phase in the economic crisis. The last direct intervention in the FX markets from a major economy was six years ago. Until today central bankers had a tacit agreement in place not to enter into a competitive devaluation race. Even though some European politicians argued that the UK government was talking down sterling, the rate was still determined by the market. The SNB move now paves the way for other countries, particularly those whose economies rely on exports to devalue their currencies. In particular, it could pave the way for the Bank of Japan to address the overvalued JPY and put further pressure on the ECB to add to quantitative easing. Any series of competitive devaluations is likely to boost the dollar. The other big winner is gold, which rose 16% yesterday on the back the news from Switzerland.

Market Commentary 11/03/2009

EURUSD Upside potential remains while above 1.2730/40, below may see back down to 1.2670/80 initially, key trend line support at 1.2630

GBPUSD Based on down channel base at 1.3660/70, corrective bias higher while above 21 hour SMA at 1.3750, below may see 1.3670/80

Equity markets managed to retain the gains made from yesterday’s massive rally.  European indices closed broadly flat. The change in risk appetite, followed an email from Citigroup yesterday saying that the bank had been profitable in January and February. The USD, which has benefitted from the flight to safety as markets have tumbled, experienced a modest weakening throughout most of Wednesday. EURUSD gained about 100pips in European trading, despite yet more disasterous news from Europe. German factory orders slipped a sharp -8.0% in January on the back of a -7.6% decline the prior month. This took the annual rate to -37.9% and the worst since records began in 1992. Nevertheless, the euro has managed to shrug this off as the correlation of higher stocks higher  looks to be back in play at least for now. Sterling has continued to keep it’s position against the USD. The currency has benefitted from a re-injection of some market faith in the banking system and a increasingly hopeful views on the effect of quantitative easing. The fact that the Bank of England has continued to target inflation whilst injecting fresh money into the system has reassured some in the market. Still, it is early days and it is unlikely that any last confidence will be demonstrated in the equity markets, or in the FX markets (resulting in a rally in GBP, AUD and CAD) ahead of the slow motion car crash also known as the G20 meeting, in three  weeks.

Sterling under renewed pressure 09/03/2009

As I write Cable has made a strong break through the 1.3900 support level, with little in the way of support for the pair right down to 1.3550. The pair has traded in a 9 pip range in the last 6 weeks, and any significant and lasting break below the 1.39-40 level would chart a new course for the GBP. There is little in the way of event risk but the currency is particularly sensitive to global risk sentiment. Given that most expectations are to the downside, that the global economy may now have reached its darkest hour, little is supporting sterling. The fleeting support GBP was given on Thursday following the BoE’ announcement the introduction of quantitative easing- a monetary tool as yet untried in the UK- and the subsequent sell-off on Friday demonstrates market nervousness over monetary policy in general and the UK government in particular. The announcement over the weekend that the Government is to take a 75% stake in Lloyds TSB, is the latest in along line of hodge podge announcements for the market to digest.

Yen- Further deterioration in safe haven status 09/03/2009

Nothing appears to bode well for the Japanese economy. Figures released this morning showed that the world’s second largest economy and one of the largest exporting nations has racked up a record current account deficit of JPY 172bn. The JPY has traditionally been seen as a safe haven currency, thanks largely to its trade surplus which often focused minds on the currency’s undervaluation. Related to this was the pressure the currency was under during the “golden” era of the carry trade, just a few short years ago. The JPY’s low yield relative to other currencies in times of  global macroeconomic stability and growth, particularly the AUD and NZD meant that retail investors from Japan moved funds out of Japan and institutional investors used it as a funding currency. As sentiment turned, Mrs Watanabe moved her savings back from Auckland to Tokyo and stressed hedge funds needed to square positions and buy yen. That wave of buying pressure on the yen is now over and, in the process, ramped up the price of Japanese exports, which account for a large percentage of GDP, at precisely the time when global demand collapsed in Q4 of last year. The economic picture is severe. The Bank of Japan’s Deputy last week said, “the speed and severity of the decline is something we haven’t experienced in decades.” And this comes from an official who presided over Japan’s “lost decade” in the 1990s. The last few weeks has seen a weakening of the JPY and a loss of its safe haven status. The sense of crisis is not helped by a political system in disarray, with the Prime Minister’s approval rating barely in double figures and the main opposition leader facing corruption charges and refusing to step down. A national election must be called by September.

Key events this week: Tuesday– February CGPI (-1.2 y/y exp) and January machinery orders (-4.5% exp), Wednesday Q4 GDP (12.7% q/a), Friday– Industrial Production