The FINANCIAL — Two major themes look to influence the currency markets over the month ahead.
By Custom House, Western Union Company
Financial markets are kicking off September after being kicked in the teeth throughout August.
Economic pessimism began to set in when a series of negative employment, manufacturing and purchasing reports landed on trading desks in the early part of the month. Sentiment was given a further knock when Standard & Poor’s downgraded the United States in early August. Although the move was widely expected, and did little to dissuade investors from purchasing US dollar debt, it certainly served to damage faith in the real economy.
Buffeted by these crosswinds, investors spent much of the remainder of the month awaiting a magic show performed by Ben Bernanke and his Federal Reserve.
However, if developments over the last few years have established anything, it is that central banks are unable to resurrect economies on their own. The Federal Reserve may have the monetary rabbit, but it doesn't have the fiscal hat.
As a result, we expect central bankers to do their best to anchor policy expectations further into the future, while avoiding repeats of the massive asset-buying programmes seen over the past few years. The risks are too large, and the rewards too unclear.
Financial markets will be forced to ride on their own, without the support of government-provided training wheels. Asset prices are vulnerable, and traders will remain cautious around the growth-linked currencies for the foreseeable future.
The ride may be a little wobbly and prone to crashes in the coming months, but one hopes that an old skill is relearned by the turn of the calendar year.
European Trainwreck
The word “crisis” has lost its capacity to describe the unfolding European sovereign debt disaster.
In the three years since the financial collapse, the pattern has become formulaic. Bond markets grow fearful about debt in one country or another, and yields surge to unsustainable levels. Policymakers then meet to defuse the problem, and after much debate they effectively socialize more debt by taking it out of private sector hands and putting it under common ownership. The markets are initially placated, but soon turn their sights on another haplessly indebted European country, and the cycle repeats.
August saw this occur yet again, when investors fled the Italian bond market and began to fear a French credit downgrade. Yields jumped once more, and the European Central Bank was forced to step in. The ECB purchased the bonds of at-risk countries, and succeeded in temporarily stabilizing the demand side of the equation – but failed to alleviate longer-term concerns about the survivability of the euro project.
Once more, economists called for greater fiscal integration across the common currency area, and once more, they found their hopes dashed by politicians beholden to an increasingly uneasy public.
German and French voters have grown uncomfortable with the roles that have been thrust upon them, acting as financial saviours for the fiscally irresponsible “peripheral” countries. Discussion has begun about whether repeated rescue efforts are constitutionally legal under German law, and opposition parties have begun to campaign on anti-euro platforms. In recognition of this, leaders in the core countries find themselves with little room to manoeuvre.
Deeper political union may be achieved incrementally, by stealth, but true fiscal integration remains a distant prospect. As a result, the scale of the problem continues to increase, and markets continue to worry about the euro's staying power.
Schadenfreude would be tempting, if it were not for the fact that Europe's problems are the world's problems. With the US appearing to slow, and the emerging markets decelerating, a downturn in European sentiment is the last thing the world needs. Unfortunately, recent German data would suggest that is exactly what it will get.
Thus, the financial markets are entering September in an incredibly vulnerable position. Further turmoil is likely, and currency volatility is the only certainty.
Emerging Asia
By Jason Chen, FX Trader – Denver
Asian markets were not immune to global turmoil in the month of August. Equity markets in China, Korea, India and Taiwan fell between 10 and 14% with the exception of Shanghai and Shenzhen markets, which only dropped around 4% on the back of stronger corporate earnings. The interest rate hiking cycle in the Asian region appears to be on hold until Q4 at the moment as Asian central banks and market participants debate which is the bigger problem: stagnant world economic growth or rising domestic inflation (particularly in food and energy). CNY continues to strengthen, with the highlight being a 0.42% one-day gain on August 11.
Chinese consumer and producer inflation statistics continue to surprise to the upside while its trade balance for the month of July also beat expectations, with exports outpacing imports. This is a key figure to pay attention to, as exports represent 40% of China’s GDP. Money supply continues to tighten as evidenced by economic data and spikes in the Shibor rate in previous weeks and months, indicating bank liquidity is at a premium as Beijing continues to favour hikes in the required reserves that banks must hold rather than increasing interest rates for fear of attracting too much capital inflow, in turn causing excessive CNY strength.
USDINR has strengthened by 4% this month even though the Reserve Bank of India increased rates by 0.5% to 8% as investors believe that inflation may be spiralling out of control there in addition to India’s recent soft economic data. In both Singapore and Korea, economic growth has slowed while a managed float and multiple attempts at intervention respectively have prevented USDSGD and USDKRW from appreciating rapidly.
All in all, any indication of quantitative easing by developed countries will most likely cause Asian currencies to appreciate as capital flows to areas with the highest return and markets with the most growth potential. However, any global economic slowdown will cause interest rate hikes to be put on hold longer or even cut as inflation pressures give way to protectionist policies to support the region’s export-oriented economies.
EUR – Going into the final month of Q2 the Eurozone looks rather forlorn—to say the least.
By Nadia Georgiou, Corporate FX Dealer – London
All the assurances and pledges by the Troika (EU, IMF and ECB) are not doing anything to calm global markets. But rather than hitting the euro alone, this situation is slamming global sentiment as a whole. The euro continues to benefit from its comparative strength against a flagging dollar due to its higher interest rate yield and general unease about the future of the Greenback, rising to 1.4549 in the final week of August.
With ever-fewer “safe” places to put their money, investors are still choosing to buy into the single currency. Considering the dire straits the 17-nation union is in, this seems somewhat counterintuitive, but the markets remain volatile, unpredictable and flighty. Underneath this brittle euro strength lays a torrid sea of trouble. The figurehead of EMU growth, Germany, posted a shocking 0.2% GDP figure for Q2, down from 0.8%. If the only economy that was really performing is halting growth, what hope is there for the rest of the bloc? French GDP was even worse, coming in flat for the quarter. The PIIGS disaster that we have discussed at length here all year continues to hurtle along with no real resolution. Apparently the ECB and European commission are considering a radical plan to prevent a fresh European debt credit crisis, involving policymakers offering central guarantees on certain types of bank debt. Again, this sounds like a lot of very expensive hot air with no decisive action. New head of the IMF Christine Lagarde has warned that European banks need to raise more capital, a concern that has been rife throughout this crisis. So, heading into September we have a strong euro but an exceptionally weak Eurozone. Investors are now predicting no further interest rate rises for the rest of the year. Comments last week by European Central Bank President Jean-Claude Tichet have alluded to a central bank that is now concerned that periphery sovereign debt will trouble economic growth and expansion in the coming months. Previously, Trichet has stuck to the “constant vigilance” on inflation rhetoric. However we may see a U-turn on this particular policy as downside risks to growth become the central bank’s main concern. Will new ECB President Mario Draghi take this U-turn on policy and cut rates? This, in the short-term, seems like the only way the euro will fall back.
GBP – The Sterling was one of the strongest performers on the month, as it benefited from safe haven flows from the euro area.
By Roosh Shah, FX Trader and Cash Manager – London
This support more than offset the downward revision to interest rate expectations following the more-dovish-than-expected Inflation Report and MPC minutes. Cable came close to two-year highs against the dollar last month after some hawkish dissent from one of the Fed Reserve’s policymakers. But overall output growth in the UK has been sluggish. Figures last month of a revised UK GDP figure showed a modest growth of 0.2% in Q2, although signs of weakness emerged in the Key Services sector with higher-than-expected inflation at 4.4% (y/y) and a drop in retail sales to 0.2% (m/m). Couple those with a rising unemployment figure and a near-1% fall in manufacturing production, and the only bright spark in the UK economy was a surprise fall in public sector borrowing.
The continuing squeeze on households’ real incomes, branching largely from increases in energy and import prices, will continue to weigh on growth in the near term. Rises in utility prices are likely to push CPI inflation higher over the coming months, and surprisingly the Monetary Policy Committee are now all in favour of a dovish stance, with a 0-0-9 vote in favour of maintaining the interest rate at 0.5%. Based on overnight index swaps, the BoE found that markets are discounting a 25bp rate hike by about Q3 2012. At the time of writing, Cable pairing was mildly lower and is extending last month’s retreat from 1.6572, challenging the mid-August low of 1.6252. Violation of the 1.6252 level will leave the market vulnerable to follow-through to retest the mid-July low at 1.6005 once again.
USD – Speculation that the US economy could slip into another recession is still present
By Adam Smith, Corporate FX Dealer – Vancouver
Those hoping that the US dollar would receive some short-term direction from Fed Chairman Bernanke by mapping out a path for a third round of quantitative easing were left disappointed Friday. Although not surprising to most, Bernanke was relatively mum about the finer details of any potential stimulus to stroke the economy, simply referring to the “availability of resources to aid the economy should it be warranted.” With no new details on what would warrant further intervention, the Fed will continue its focus on economic growth, unemployment and any potential risk of deflation, which does not look likely in the current environment. With further commentary likely at the Federal Open Market Committee meeting scheduled for this month, the markets will be closely focused on any developments from the Central Banker. August’s downgrade of the US credit rating from S&P coupled with a dovish outlook was not enough to materially weaken the dollar, although it did prompt the fed to commit to the depths of the rates pool well into 2013, which should add to long-term Greenback pressure. The DXY has remained within its current range of 73.5 to 75.5 as buying of US treasuries has been complementing a weakening economic outlook.
In the near term, data is still mixed, with a bias to the downside. Core Inflation is hovering at a reasonable 1.8% and annual inflation at 3.6%.The concern for the Fed is how lethargic unemployment has been when benchmarked against these figures. The dollar has, of late, returned to weakening when risk appetite is rising and strengthening during flights to safety. Speculation that the US economy could slip into another recession is still present, although it seems to have subdued as equity market volatility settles. On a macro basis, the global economy still faces many possible risks, including the Eurozone debt burden weighing on overseas markets. Any major development will see a USD reaction, especially if the heavily traded EURUSD is on the move. Expect these current trends to continue and many of the drivers of the Greenback to remain constant going into the dog days of summer.
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