- FX And Bond Traders Skeptical About Equity Rally
- EUR: Backs Off Seven-Month High
- GBP: Hits Two-Month High Against USD
- AUD: Pares Gains Ahead Of RBA Minutes
- CAD: Shrugs Off Weaker Housing Data
- NZD: Consumer Confidences Highest In Five Quarters
- JPY: Japanese Names Hedging Into The Rally
In the final week before the Christmas holiday, the focus will be on the Fiscal Cliff. Based on the price action in the financial markets, equity traders are optimistic that there will be a deal by the end of the year but currency and bond traders are more skeptical. The U.S. dollar ended the day slightly higher against all of the major currencies with the exception of the British pound. President Obama and House Speaker Boehner met for 45 minutes Monday -- their third conversation in the past five days -- and while no announcements or hints of progress were made, the fact that they are talking often gave some investors hope that there will be an announcement by the end of the year. Republicans put forward a new deal that would extend tax cuts to households earning $1 million or less but the President rejected this offer quickly.
As the December 31 deadline approaches, currency and bond investors are growing weary of being overly exposed to a major risk and this concern has led to an intraday reversal in many of the major currencies like the EUR/USD, USD/JPY and NZD/USD. If we don’t receive daily updates on the Fiscal Cliff talks and more investors grow worried about the lack of progress, we could see further losses in all of the major currencies as investors take profit or hedge their positions before next week’s holidays. The latest U.S. economic reports left a lot to be desired. Manufacturing activity in the NY region contracted more aggressively in the month of December while demand for U.S. dollars dropped by -$56.7 billion according to the Treasury International Capital flow report. Foreigners were net sellers of dollars in the month of October but this was largely due to weaker demand for short term securities and a change in banks’ own net dollar denominated liabilities. Foreigners continued to buy long term U.S. assets but demand was weak with net buying totaling only $1.3 billion. While these numbers are discouraging, we expect demand to have recovered in November after the dollar hit a bottom in October. Current account and housing market numbers are due for release on Tuesday and based on the improvement in trade activity, we are looking for a narrower current account deficit.
- For more on the Fiscal Cliff, read our special report on What If There's No Fiscal Cliff Deal By December 21?
Having hit a seven-month high against the U.S. dollar at the start of the Asian trading session, the euro ended the day unchanged against the greenback. Euro-zone trade was the only piece of data from Europe this morning and even though the region’s trade surplus rose from EUR9.5 billion to EUR10.2 billion, the increase fell short of expectations and the trade numbers drove the EUR/USD to the day’s low. Comments from European officials had very little impact on the currency. ECB President Draghi admitted that LTRO money struggled to reach the economy and his view that there is no inflationary impact from the expansion of the monetary base implies that the central bank retains a dovish bias. More difficult times could be ahead for France as President Hollande warned of more spending cuts in coming years. The Bundesbank of Germany expects a “noticeable” contraction in German GDP growth this quarter but expects the weak phase to be over soon. Overall, it seems that policymakers are still worried about the Euro zone’s economic outlook but the EUR/USD continues to hold steady thanks to the rally in equities and the Federal Reserve’s balance sheet expansion. Progress continues to be made in Europe with Greece receiving its long waited aid payment this morning. No major Euro zone economic reports are due for release on Tuesday, leaving the EUR/USD vulnerable to risk appetite.
GBP: Hits Two-Month High Against USD
Based on the recent rally in the British pound, investors aren’t worried about the threat of a credit downgrade by S&P. Sterling rose to the highest level against the U.S. dollar in two months, Monday, and its highest against the euro in seven weeks. This is a very busy week for the British pound but the only piece of economic data released from the U.K. over the past 24 hours was Rightmove House Prices. According to the report, house prices dropped for the second month in a row by the largest amount since January 2002. Despite the government’s funding for lending scheme, the housing market is struggling. This week the Bank of England will release the minutes from their most recent monetary policy meeting and their bias should have a significant impact on the British pound. If a number of members support more easing, the GBP/USD could give up its gains. However for many members of the monetary policy committee, inflation is a big concern. Their fear is that the abundance of liquidity will drive up inflationary pressures. Consumer and producer prices are due for release Tuesday and we expect some of these concerns to be alleviated by softer price pressures.
AUD: Pares Gains Ahead Of RBA Minutes
The Australian and New Zealand dollars pared their recent gains against the greenback on reports of China’s tolerance of slower growth. China’s shift from seeking “relatively fast” growth in 2006 to higher “quality and efficiency” poses a risk to demand for Australian exports but the sell-off in the AUD/USD has been limited because even at 7%, that’s strong enough growth to prevent a sharp pullback in Australia’s mining sector. Monday night, the minutes from the most recent RBA meeting is/was scheduled for release. If you recall, the central bank cut interest rates by 25bp earlier this month. At the time, the RBA expressed concerns about the outlook for global growth, but maintained a neutral tone, providing no hints about their bias to ease again next year. Therefore investors will be looking to the minutes for confirmation of the central bank’s bias to ease. The market is currently pricing in 45bp of easing from the RBA over the next 12 months. New Zealand economic data was mixed with consumer confidence rising to its highest level in five quarters but service sector activity slowing. Yet despite the decline in activity, the service sector is still expanding. Stronger than expected demand for Canadian dollar denominated assets lent support to the CAD helping it shrug off the 1.7% decline in existing home sales last month. With a hawkish monetary policy bias from the central bank, the CAD remains one of the best performers.
JPY: Japanese Names Hedging Into The Rally
The Japanese Yen ended the North American trading session lower against some but not all of the major currencies. This represents a remarkable turnaround considering that nearly all of the yen pairs hit significant highs at the start of the Asian trading session. This weekend’s election victory by the LDP drove the Yen sharply lower at the Tokyo open, creating a gap that was almost completely filled in USD/JPY. After an initial knee-jerk rally, USD/JPY trickled lower throughout the European and North American trading sessions. Japanese names sold after the rally according to our interbank sources to hedge against Yen strength. With the U.S. Fiscal Cliff posing a major risk to the financial markets and global growth, there is a strong chance investors will pile back into the safety of the Yen if there is no deal by the end of the year. The recent rally in USD/JPY provides Japanese corporations with an attractive level to reinitiate their hedges. Since Japan is a net exporter, any hedging will be against Yen strength and would therefore involve selling USD/JPY. However ahead of the Bank of Japan’s monetary policy announcement, we expect any weakness in USD/JPY to be limited to the 82 level. The BoJ is expected to leave rates unchanged but increase asset purchases by another five to 10 trillion yen. LDP leader Abe pledged to be tough on China and implement more pro-growth measures such as easier monetary policy and big fiscal spending. The question now is whether Abe will temper his stance now that the LDP has returned to power. With Bank of Japan Shirakawa’s 5 year term ending in April, it may be more complicated to change BoJ law and force the central bank to adopt a higher inflation target than to nominate a candidate who supports easier monetary policy. In the long run, maintaining BoJ independence and repairing ties with their neighbors and their largest trading partner is essential to the country’s economic prosperity and viability.