ECU's FX Strategic Insight Big Trouble In Little China? Weighing On Risk

The positional squeeze failed to hold on to its dominance yesterday and as the day developed equities turned lower dragging risk and risk correlated assets with them. A couple of headlines may have helped reduce optimism: suggestions that the “Dexia rescue plan is unworkable” and that “Belgium is unable to meet agreed Dexia financing” helped to keep the ‘risk of financial crisis’ (as this morning's press quotes a BoE survey) at the forefront of investors' minds. As we come in this morning short-term accounts have been sellers of EUR and AUD overnight but there has been a rise in interest from more medium-term players to take some profits ahead of the US Thanksgiving holidays and the illiquidity that the reduced volume likely brings.

After the positive revelation that the People's Bank of China had supposedly cut the Reserve Ratio Requirement for selective regional banks in rural cities, the release of the HSBC China manufacturing PMI data for November added to the gloom as the index fell to a 32-month low of 48 (into sub 50 contractionary territory) from 51 in October. Suggestions that the housing market in China may also be slowing (particularly in the regions) with volumes declining sharply last month also adds to the concern over the Chinese economy and the broader Emerging Market support for the global economic recovery (forecasts suggest that the EM growth story is viewed as providing almost all the global growth momentum for (at least) the first half of 2012). As a result, AUD and global equities begin the day on the back foot.

On the good news front, suggestion that the International Monetary Fund have revamped credit or liquidity lines should be viewed as a positive development, with those nations deemed to be facing liquidity, but not solvency issues. The dampener on this, however, is that with most of Europe unable to bail itself out it is likely that a large proportion of the liability will have to be underwritten by the US – political accord on that front (or indeed seemingly any other front) seems unlikely.

The major event overnight was the release of the 2 November US Federal Open Market Committee meeting minutes. The minutes showed that some of the policy board members saw inflation moderating and favoured further easing, however, much of the discussion was about communication channels, where the committee debated publishing an explicit Fed funds path projection, an inflation target or indeed a nominal GDP target. The largely technical debate does not change the backdrop however and whilst there are some tentative signs of improving labour market conditions in the weekly data (further confirmation of this will come this afternoon) unemployment still dominates policy and the political debate on how best to tackle this issue is becoming lost in political bickering!

This morning’s Eurozone PMI data showed a continued slowdown in the manufacturing sectors of the union, however there was an improvement or slowing in the pace of contraction of the service sector (Germany in positive growth territory). This may be another rationale for more medium-term players to look to take some profit, but as I see things the EUR remains overvalued.  Today also brings us the minutes from the 10 November Monetary Policy Committee meeting, where policy was left unchanged. The GBP bears will be looking for signs of further quantitative easing as a rationale to sell GBP, which has disappointed this week so far, however my view remains that QE should be good for UK growth and ultimately good for the pound. I still see EUR/GBP rallies as possibly good selling opportunities.